Gruber4e_ch07

Public Finance and Public Policy

Copyright 2012 Worth Publishers

Public Finance and Public Policy Jonathan Gruber Fourth Edition Copyright 2012 Worth Publishers# of 2817Dan SacksP R E P A R E D B Y7.1 Optimal Provision of Public Goods7.2 Private Provision of Public Goods7.3 Public Provision of Public Goods7.4 Conclusion

Public GoodsPublic Finance and Public Policy Jonathan Gruber Fourth Edition Copyright 2012 Worth Publishers# of 2827Public Goods: Trash CollectionWhy dont people pay to have their neighbors trash collected? No one wants to pay, but everyone wants someone else to pay.Private trash collection, financed by a voluntary fee paid by neighborhood residents, faces the classic free rider problem.Goods that suffer from this free rider problem are known in economics as public goods.

Public Finance and Public Policy Jonathan Gruber Fourth Edition Copyright 2012 Worth Publishers# of 28C H A P T E R 7 P U B L I C G O O D S37.1Pure public goods: Goods that are perfectly non-rival in consumption and are non-excludable.Non-rival in consumption: One individuals consumption of a good does not affect anothers opportunity to consume the good.Non-excludable: Individuals cannot deny each other the opportunity to consume a good.Impure public goods: Goods that satisfy the two public good conditions (non-rival in consumption and non-excludable) to some extent, but not fully.

Public Goods: A taxonomyPublic Finance and Public Policy Jonathan Gruber Fourth Edition Copyright 2012 Worth Publishers# of 28C H A P T E R 7 P U B L I C G O O D S47.1Defining Pure and Impure Public GoodsIs the good rival in consumption?Is the good excludable?YesNoYesPrivate good(ice cream)Impure public good(Cable TV)NoImpure public good(crowded sidewalk)Public good(defense)Public Finance and Public Policy Jonathan Gruber Fourth Edition Copyright 2012 Worth Publishers# of 28C H A P T E R 7 P U B L I C G O O D S57.1How much of the public good should society provide?Markets will not provide the correct amount.To answer this question, start by reconsidering the market for a private good, ice cream cones.Ben and Jerry have different tastes for ice cream (ic), relative to the other good (c). How does the market aggregate their preferences?Optimal Provision of Public GoodsPublic Finance and Public Policy Jonathan Gruber Fourth Edition Copyright 2012 Worth Publishers# of 28C H A P T E R 7 P U B L I C G O O D S67.1Horizontal Summation in the Private Goods MarketPublic Finance and Public Policy Jonathan Gruber Fourth Edition Copyright 2012 Worth Publishers# of 28C H A P T E R 7 P U B L I C G O O D S7Price of ice cream conePrice of ice cream conePrice of ice cream coneQuantity of conesQuantity of conesQuantity of cones$2$2$2213000DBDJES = SMCDB&J = SMBTo find social demand curve, add quantity at each pricesum horizontally.Horizontal Summation in the Private Goods Market7.1Bens MarginalBenefitJerrys MarginalBenefitMarketPublic Finance and Public Policy Jonathan Gruber Fourth Edition Copyright 2012 Worth Publishers# of 28C H A P T E R 7 P U B L I C G O O D S7.1Optimal Provision of Public GoodsPublic Finance and Public Policy Jonathan Gruber Fourth Edition Copyright 2012 Worth Publishers# of 28C H A P T E R 7 P U B L I C G O O D S9Price of missilesPrice of missilesPrice of missilesQuantity of missilesQuantity of missilesQuantity of missilesDBDJS = SMCDB&J = SMB$21000$4$623151515Vertical Summation in the Public Goods Market7.1Bens marginal benefitJerrys marginal benefitSocial marginal benefit and costPublic Finance and Public Policy Jonathan Gruber Fourth Edition Copyright 2012 Worth Publishers# of 28C H A P T E R 7 P U B L I C G O O D S7.2The market does not produce the efficient amount of public goods, because of the free rider problem.Free rider problem: When an investment has a personal cost but a common benefit, individuals will underinvest.Since Bens consumption of missiles also benefits Jerry, Jerry may not want to pay (or vice versa).Private Provision of Public Goods: Private-Sector Under-ProvisionPublic Finance and Public Policy Jonathan Gruber Fourth Edition Copyright 2012 Worth Publishers# of 28C H A P T E R 7 P U B L I C G O O D S117.2The free rider problem is one of the most powerful concepts in all of economics. Radio and television programming:WNYC has an estimated listening audience of about 1 million people, but only 7.5% of their listeners support the station. The United Kingdom uses a non-market solution: The BBC charges an annual licensing fee to anyone who owns and operates a TV!APPLICATION: The Free Rider Problem in PracticePublic Finance and Public Policy Jonathan Gruber Fourth Edition Copyright 2012 Worth Publishers# of 28C H A P T E R 7 P U B L I C G O O D S12APPLICATION: The Free Rider Problem in Practice7.2File sharing: 85% of users of a file sharing program download files only from others. The file-sharing software Kazaa gives download priority to users according to their ratings, thus discouraging free riders.Bicycle shares: Users were expected to return each bike riding. Within four days, not a single bicycle was left. Literal example of a free ride.Public Finance and Public Policy Jonathan Gruber Fourth Edition Copyright 2012 Worth Publishers# of 28C H A P T E R 7 P U B L I C G O O D S7.2The free rider problem does not lead to a complete absence of private provision of public goods.Plenty of private-sector TV programmingThe private sector can in some cases combat the free rider problem to provide public goods by charging user fees that are proportional to their valuation of the public good.Can Private Providers Overcome the Free Rider Problem?Public Finance and Public Policy Jonathan Gruber Fourth Edition Copyright 2012 Worth Publishers# of 28C H A P T E R 7 P U B L I C G O O D S147.2Clean, safe sidewalks are public goods.Cities attempt to provide them through street repair and police work, financed with tax revenue.But New York Citys Times Square in the 1980s was a failure:Dirty, dangerous, decrepit, and increasingly derelictIn 1992, a group of private firms formed a Business Improvement District to improve the area themselves.APPLICATION: Business Improvement Districts Public Finance and Public Policy Jonathan Gruber Fourth Edition Copyright 2012 Worth Publishers# of 28C H A P T E R 7 P U B L I C G O O D S157.2How did this BID work?A (BID) is a legal entity that privately provides local services and funds these services with fees charged to local businesses.How do BIDs overcome free rider problem? NYC law allows BIDs to levy fees on non-paying members, as long as 60% of members contribute.Resounding success: Crime has dropped significantly.The area is cleaner and more attractive.Business and tourism are booming.

APPLICATION: Business Improvement Districts Public Finance and Public Policy Jonathan Gruber Fourth Edition Copyright 2012 Worth Publishers# of 28C H A P T E R 7 P U B L I C G O O D S167.2Resounding success: Crime has dropped significantly.The area is cleaner and more attractive.Business and tourism are booming.Success of BIDs depends on the legal underpinnings: Can members charge fees to encourage payment?

APPLICATION: Business Improvement Districts Public Finance and Public Policy Jonathan Gruber Fourth Edition Copyright 2012 Worth Publishers# of 28C H A P T E R 7 P U B L I C G O O D S177.2When Is Private Provision Likely to Overcome the Free Rider Problem?Public Finance and Public Policy Jonathan Gruber Fourth Edition Copyright 2012 Worth Publishers# of 28C H A P T E R 7 P U B L I C G O O D S187.2Private markets provide public goods when people are altruistic.Altruistic: When individuals value the benefits and costs to others in making their consumption choices.Many laboratory experiments provide evidence for altruism and show that people contribute to public goods.How altruistic people are is measured by social capital.Social capital: The value of altruistic and communal behavior in society.

Altruism and social capital.Public Finance and Public Policy Jonathan Gruber Fourth Edition Copyright 2012 Worth Publishers# of 28C H A P T E R 7 P U B L I C G O O D S197.2People might simply feel good about contributing to public goods or charity. Warm glow model: A model of the public goods provision in which individuals care about both the total amount of the public good and their particular contributions as well.Different from altruism because people dont care about just the amount of the public good.Warm GlowPublic Finance and Public Policy Jonathan Gruber Fourth Edition Copyright 2012 Worth Publishers# of 28C H A P T E R 7 P U B L I C G O O D S207.3Despite private provision, there is a role for government provision of public goods:Under private provision, not everyone contributes to the good, even though everyone benefits.Government provision potentially solves the problem of non-contributors.Nonetheless, there are several challenges to government provision.

Public Provision of Public GoodsPublic Finance and Public Policy Jonathan Gruber Fourth Edition Copyright 2012 Worth Publishers# of 28C H A P T E R 7 P U B L I C G O O D S217.3Crowd-out: As the government provides more of a public good, the private sector will provide less.Warm glow: If people care about contributions per se, they may continue to contribute even when the government contributes. Evidence on crowd-out: Mixed.No evidence for full crowd-outNo consensus on the size of this important individual response to government intervention

Private Responses to Public Provision: The Problem of Crowd-OutPublic Finance and Public Policy Jonathan Gruber Fourth Edition Copyright 2012 Worth Publishers# of 28C H A P T E R 7 P U B L I C G O O D S227.3The evidence on crowd-out is mixed.Kingman (1989) looked at how contributions varied as local governments contributed different amounts to public radio.The study found that $1 increase in government funding for public radio, private contributions fell by 13.5. Bias: Areas with high government contribution could be high income, or have a high taste for radio.

EVIDENCE: Measuring Crowd-OutPublic Finance and Public Policy Jonathan Gruber Fourth Edition Copyright 2012 Worth Publishers# of 28C H A P T E R 7 P U B L I C G O O D S237.3Laboratory evidence seems more convincing.In another study, individuals tokens to a public good.A 2-token tax on every player was then contributed to the public good. Without warm glow effects, players should have reduced their contributions by 2 tokens. However, each player cut his or her contributions by only 1.43 tokens. Unclear how well this result generalizes outside of the lab, however.EVIDENCE: Measuring Crowd-OutPublic Finance and Public Policy Jonathan Gruber Fourth Edition Copyright 2012 Worth Publishers# of 28C H A P T E R 7 P U B L I C G O O D S247.3Optimal public good provision requires knowing the MRS for each person. How to measure this?Consider the case of a highway. Cost include wages and materials.What if, without this highway project, half of the workers on the project would be unemployed? How can the government take into account that it is not only paying wages but also providing a new job opportunity for these workers? Measuring the Costs and Benefits of Public GoodsPublic Finance and Public Policy Jonathan Gruber Fourth Edition Copyright 2012 Worth Publishers# of 28C H A P T E R 7 P U B L I C G O O D S257.3The benefits of highway construction are also difficult to measure.What is the value of the time saved for commuters due to reduced traffic jams? And what is the value to society of the reduced number of deaths if the highway is improved?Measuring the Costs and Benefits of Public GoodsPublic Finance and Public Policy Jonathan Gruber Fourth Edition Copyright 2012 Worth Publishers# of 28C H A P T E R 7 P U B L I C G O O D S267.3Three challenges in measuring preferences for public goods.Preference revelation: People may not want to reveal their true valuation because the government might charge them more for the good if they say that they value it highly.Preference knowledge: People may not know what their valuation is.Preference aggregation: How can the government combine the preferences of millions of citizens?How Can We Measure Preferences for the Public Good?Public Finance and Public Policy Jonathan Gruber Fourth Edition Copyright 2012 Worth Publishers# of 28C H A P T E R 7 P U B L I C G O O D S277.4ConclusionA major function of governments at all levels is the provision of public goods.Sometimes, the private sector can provide public goods, but usually not the optimal amount.Government intervention can potentially increase efficiency. Success of intervention depends on:Ability of government to measure costs and benefitsAbility to implement optimal plan

Public Finance and Public Policy Jonathan Gruber Fourth Edition Copyright 2012 Worth Publishers# of 28C H A P T E R 7 P U B L I C G O O D S28