Chapter 16 Public Goods and Public Choice © 2009 South-Western/ Cengage Learning.

Chapter 16

Public Goods

and Public Choice

© 2009 South-Western/ Cengage Learning

Private, Public Goods, and in Between

1. Private goods– Rival in consumption– Exclusive– Provided by private sector

2. Public goods– Nonrival in consumption– Nonexclusive– Provided by government

2

Private, Public Goods, and in Between

3. Natural monopoly– Nonrival but exclusive– With congestion: private goods– Provided by private sector or government

4. Open-access good– Rival but nonexclusive– Regulated by government

3

Exhibit 1Categories of goods

4

Optimal Provision of Public Goods• Nonrival in consumption

– Once produced: available to all consumers

• Market demand curve– Vertical sum of individual demand curves– Marginal benefit

• Efficient level of public good– Market D curve intersects MC curve

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Exhibit 2Market for public goods

6

10

5

$15

Dol

lars

per

hou

r

20 Hours of mosquito

spraying per week

Dm

Da

Marginal cost

D

D

e

Because public goods, once produced, are available to all in identical amounts, the demand for a public good is the vertical sum of each individual’s demand.

The efficient level :MC of mosquito spraying equals its marginal benefit; at point e, where the marginal cost curve intersects the market demand curve .

The market demand for mosquito spraying (D) is the vertical sum of Maria’s demand, Dm, and Alan’s demand, Da.

Paying for Public Goods• Tax = marginal valuation

– Free-rider problem• People try to benefit from the public goods

without paying for them

– Ability to pay

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Public Choice in Representative Democracy

• Public choices– Government decisions

• Public goods• Taxes

• Median-voter model– The preference of the median voter will

dominate other choices

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Special Interest and Rational Ignorance

• Elected officials: Maximize political support– Special interest rather than – Public interest

• Asymmetry • Voters ‘rational ignorance’

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Distribution of Benefits and Costs

1. Widespread benefits; widespread costs– Traditional public-goods legislation– Positive impact on economy

• Total benefits > total costs

2. Concentrated benefits; widespread costs– Special-interest legislation– Harms the economy

• Total costs > total benefits

– Pork-barrel spending10

Distribution of Benefits and Costs

3. Widespread benefits; concentrated costs– Populist legislation– Beneficiaries: rationally ignorant

4. Concentrated benefits; concentrated costs

– Competing-interest legislation– Fierce political battles

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Exhibit 3Categories of legislation based on the distribution of

costs and benefits

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Farm subsidies

• The Agricultural marketing agreement act, 1937–Prevent ‘ruinous competition’–One in four Americans: farm–Floor prices

• 2007–One in fifty Americans: farm

• $18 billions a year

13

Farm subsidies

• To subsidize farmers, consumers pay–Higher product price–For the surplus (taxpayers)–For storage (the government buys the

surplus)–E.g. milk

• Free market p=$1.50• Subsidized p=$2.50+$2.50+$0.50

• Farmers: normal profit14

Exhibit 4Effect of milk price supports

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0 75 100 150Millions of gallons

per month

$2.50

1.50

Dol

lars

per

gal

lon

S

D

Excess quantity supplied

No government intervention: market price = $1.50 per gallon, and 100 million gallons are sold per month.

Government: floor price = $2.50 per gallon, quantity supplied increases and the quantity demanded decreases.

To maintain the higher price, the government must buy the excess quantity at $2.50 per gallon.

Rent Seeking• Activity interest groups undertake

– Secure special favors from government• Political action committees• Shift resources from production• No incentive for economic efficiency

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Campaign finance reform

• Special-interest money• Soft money• Hard money• Money matters more to challengers • Efforts to limit campaign spending

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The Underground Economy• Unreported market activity

– To avoid taxes– Illegal

• Tax avoidance– Legal– Pay least possible tax

• Tax evasion – Illegal– No or fraudulent tax return

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The Underground Economy• Underground economy grows more

– Government regulation increase– Tax rates increase– Government corruption widespread

• Estimated: $1.4 trillion in 2007

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Bureaucracy in Representative Democracy

• Bureaus– Government departments, agencies

• Ownership– Taxpayers

• Funding– Government appropriation

• Less incentive to eliminate waste and inefficiency

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• Bureaucratic objectives– Serve the public– Maximize budget

• Larger budget than desired by median voter

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Bureaucracy in Representative Democracy

• Private vs. public production– Private production – may be more

efficient– Public production – preferred by public

officials

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Bureaucracy in Representative Democracy