1 Public Goods and Public Choice Chapter 16 © 2006 Thomson/South-Western.

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Public Goods and Public Choice

Chapter 16

© 2006 Thomson/South-Western

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Introduction

Private goods have two important features:They are rival in consumption – the amount

consumed by one person is unavailable for others to consume

They are exclusive – suppliers can easily exclude those who don’t pay

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Public Goods

Nonrival in consumption One person’s consumption does not diminish the

amount available to others Once produced, public goods are available to all in

equal amount Marginal cost of providing the good to additional

consumers is zeroNonexclusive

Once a public good is produced, suppliers cannot easily deny it to those who fail to pay it is nonexclusive

Because they are nonrival and nonexclusive, for-profit firms cannot profitably sell public goods

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Classification of Goods

Quasi-Public goods When not congested are non rival Producers can with relative ease exclude non payers

Open-access goods Rival but nonexclusive

Fish in the ocean are rival in the sense that once caught they are not available for others to catch

Nonexclusive in the sense that it would be costly or impossible for a private firm to prevent access to these goods

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Exhibit 1: Categories of Private and Public Goods

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Optimal Provision of Public Goods

Suppose the public good in question is mosquito control in a neighborhood, which, for simplicity, consists of only two houses

One is headed by Alan and the other by Maria Alan spends a lot of time in the yard, thus values a

mosquito-free environment more than does Maria

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Exhibit 2: Market for Public Goods

Da and Dm are the demand curves reflecting the marginal benefits that Alan and Maria, respectively, enjoy at each rate of outputHow much mosquito spraying should the government provide?Suppose the marginal cost of spraying is a constant $15 an hour; the efficient level of output is 2 hours per week, where the marginal benefit to the neighborhood equals the marginal cost Hours of mosquito spraying

per week

0

Dm

D

D

5

2

eMarginal

cost

10

$15

Do

llars

per

ho

ur Da

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Optimal Provision of Public Goods

Efficient approach would be to impose a tax on each resident equal to marginal valuation Once people realize their taxes are based on how much

the government thinks they value the good, people tend to understate their true valuation

Taxpayers are reluctant to offer this information, creating what is called the free-rider problem

Even if the government had accurate information about marginal valuations, some households earn much more than others a greater ability to pay taxes

Taxing people according to their marginal valuations may be efficient, but it may not be considered fair or equitable

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Median-Voter Model

Voter whose preferences lie in the middle of the set of all voters’ preferences

The median-voter model predicts that under certain circumstances, the preference of the median, or middle voter will dominate other choices

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Special Interest and Rational Ignorance

Households have neither the time nor the incentive to understand the effects of public choices on every product

They realize that each of them has only a tiny possibility of influencing the outcome of public choices

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Special Interest and Rational Ignorance

Rational ignorance: voters remain largely oblivious to the costs and benefits of the thousands of proposals considered by elected officials

The cost to the typical voter of acquiring and acting on such information is usually greater than any expected benefits

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Distribution of Costs and Benefits

Traditional public-goods legislationWidespread benefits and widespread costs Usually has a positive impact on the economy

because total benefits exceed total costsSpecial-interest legislation

Benefits are concentrated but costs widespread across nearly all consumers and taxpayers

Generally harms the economy, on net, because total costs often exceed total benefits

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Distribution of Costs and Benefits

Populist legislationWidespread benefits but concentrated costsDifficult time getting approved because the

widespread group that benefits typically remains rationally ignorant of the proposed legislation voters provide little political support

Group adversely affected by costs will object Competing-interest legislation

Involves both concentrated benefits and costs

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Exhibit 3: Categories of Legislation Based on the Distribution of Costs and Benefits

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Exhibit 4: Effects of Milk Price Supports

If Congress establishes a floor price of $2.50 per gallon, then the quantity supplied will increase and the quantity demanded will decreaseTo maintain the higher price, the government must buy the excess quantity at $2.50 per gallon

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Rent Seeking

Rents: government transfer or subsidy constitutes a payment to the resource owner that exceeds the earnings necessary to call forth that resource – payment exceeding opportunity cost

The activity that interest groups undertake to elicit these special favors from government is called rent-seeking

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Rent Seeking

Shifts resources from productive endeavors that create output and income to activities that focus more on transferring income to the special interest Do nothing to increase output Frequently reduce output

Special interest groups compete for the same government advantage, so more resources wasted

If the advantage conferred by government requires higher income taxes, the net return individuals expect from working and investing will fall and they may work and invest less

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Underground Economy

It is reasonably accurate to say that when government taxes productive activity, less production gets reported

The underground economy is a term used for all market activity that goes unreported to the government either to avoid taxes or because the activity itself is illegal

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Underground Economy

A tax on productive activity has two effects:Resource owners may supply less of the taxed

resource because the after-tax wage declinesTo evade taxes, some people will shift from the

formal, reported economy to an underground, “off-the-books” economyTax avoidance is a legal attempt to arrange one’s

economic affairs so as to pay the least possible taxTax evasion is illegal

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Bureaucracy

Elected representatives approve legislation

The task of implementing legislation is typically left to bureaus

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Ownership and Funding of Bureaus

Bureaus are typically financed by budget appropriation from the legislature, which comes from taxpayers

Becomes of the differences in the forms of ownership and in the sources of revenue, bureaus have different incentives than do for-profit firms so are likely to behave differently

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Ownership and Behavior

Government bureaus receive less consumer feedback and have less incentive to act on any feedback they do receive

Government bureaus have less incentive to act on the information available

Profits or losses arising in the bureau are spread among all taxpayers, and because there is no transferability of ownership, bureaus have less incentive to satisfy customers or to produce their output using the least-cost combination of resources

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Bureaucratic Objectives

The legislature has only limited ability to dig into the budget and cut particular items

If the legislature tries to cut the bureau’s budget, the bureau will threaten to make those cuts as painful to the legislature and constituents as possible

Budget maximization results in a larger budget than that desired by the median voter

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Private versus Public Production

Simply because some goods and services are financed by the government does not mean that they must be produced by the government

Elected officials may also use some combination of bureaus and firms to produce the desired output

The trend is toward increased privatization production by the private sector of government provided goods and services

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Private versus Public Production

Legislators might prefer dealing with bureaus rather than firms for two reasonsThe internal organization of the bureau may

be more responsive to the legislature’s concerns than the manager of a firm would be

Bureaus provide legislators with opportunities to reward friends and supporters with government jobs