Externalities, Public Goods, Imperfect Information, and Social Choice
(Part D)
by
Charles Lamson
PUBLIC (SOCIAL) GOODS
Another source of market failure lies in public goods, often called social, or collective, goods. Public goods are defined by two closely related characteristics: they are nonrival in consumption and/or their benefits are non-excludable. As we will see, these goods represent a market failure because they have characteristics that make it difficult for the private sector to produce them profitably. In an unregulated market economy with no government to see that they are produced, public goods would be best produced in insufficient quantity and at worst not produced at all. The Characteristics of Public Goods A good is nonrival in consumption when A's consumption of it does not interfere with B's consumption of it. This means that the benefits of the goods are collective---they accrue to everyone. National defense, for instance, benefits us all. The fact that I am protected in no way detracts from the fact that you are protected; every citizen is protected just as much as every other citizen. If the air is cleaned up, my breathing does not interfere with your breathing it, and (under ordinary circumstances) the air is not used up as more people breathe it. Private goods in contrast rival in consumption. If I eat a hamburger you cannot eat it too. Goods can sometimes generate collective benefits and still be rival in consumption. This happens when crowding occurs. A park or a pool can accommodate many people at the same time, generating collective benefits for everyone. However, when too many people crowd in on a hot day, they begin to interfere with each other's enjoyment.  Most public goods are also nonexcludable. Once the good is produced, people cannot be excluded for any reason from enjoying its benefits. Once a national defense system is established, it protects everyone. For a private profit-making firm to produce a good and make a profit, it must be able to withhold that good from those who do not pay. McDonald's can make money selling chicken sandwiches only because you do not get the chicken sandwich unless you pay for it first. If payment were voluntary, McDonald's would not be in business for long. Consider an entrepreneur who decides to offer better police protection to the city of Metropolis. Careful (and we assume correct) market research reveals that the citizens of metropolis want high-quality protection and are willing to pay for it. Not everyone is willing to pay the same amount. Some can afford more, others less, and people have different preferences and different feelings about risk. Our entrepreneur hires a sales force and begins to sell his service. Soon he encounters a problem. Because he is a private company, payment is voluntary. He cannot force anyone to pay. Payment for a hamburger is voluntary too, but a hamburger can be withheld for nonpayment. The good that our new firm is selling, however, is by nature a public good. As a potential customer of a public good, I face a dilemma. I want more police protection, and, let us say, I am even willing to pay $50 a month for it. But nothing is contingent on my payment. First, if the good is produced, the crime rate falls and all residents benefit. I get that benefit whether I pay for it or not. I get a free ride. That is why this dilemma is called the free-rider problem. Second, my payment is very small relative to the amount that must be collected to provide the service. Thus, the amount of police protection actually produced will not be significantly affected by the amount that I contribute, or whether I contribute at all. This is the drop-in-the-bucket-problem.  Consumers acting in their own self-interest have no incentive to contribute voluntarily to the production of public goods. Some will feel a moral responsibility or social pressure to contribute, and those people indeed may do so. Nevertheless, the economic incentive is missing, and most people do not find room in their budgets for many voluntary payments. The Public Goods Problem as a Prisoners' Dilemma The public goods problem can also be thought of as a large-number, prisoners' dilemma game theory problem (see part 70). This is best explained with a simple class exercise. Suppose that you are in a class of 100 students. The professor requires you to bring 10 single dollar bills to a class. At the beginning of class you must divide the $10 up between two boxes, box A and box B. The rule is that whatever you put in box A, you get back at the end of the hour. If you put all $10 in box A, you get back $10. If you put $5 in box A and the rest in box B, you will get back $5 at the end of the hour from box A. Box B is a bit more complicated. The professor has agreed to match every dollar put into box B with a quarter: $0.25 for every dollar. But here's the wrinkle. At the end of the hour, box B is divided up equally among all 100 in the class---no exclusions. Each member of the class gets an equal share regardless of the amount he or she put in box B. What is the best strategy? First of all, the best strategy for the whole class is to put all their money in B; then every member walks out with $12.50. But now think of the optimal strategy from the standpoint of an individual member of the class. Remember your payout from box B depends only trivially on how much you put in box B---it is divided up equally. The problem is that there is a free-rider problem and a drop-in-the-bucket problem. With 100 people in the class, each dollar that you put in cost you a dollar, but of that dollar, $0.99 goes to the rest of the class. The person who walks out with the most money at the end of the hour is the person who put all $10 in box A! The optimal strategy for individual class members is to put their $10 all in box A. Thus, there is a prisoners' dilemma; acting individually, there is a dominant strategy for each individual that leads to an undesirable outcome.  How do we overcome this problem? We collude. We form a committee to secure everyone's agreement to put their money in box B. Or, we form a government and collectively channel our money into box B. We produce those things that have public benefits, and we ensure that everyone contributes by levying a tax to finance them. Income Distribution as a Public Good? In future posts, we add the issues of justice and equity to the matters of economic efficiency that we are considering here. There we explain that the government may wish to change the distribution of income that results from the operation of the unregulated market on the grounds that the distribution is not fair. Before we do so, we need to note that some economists have argued for redistribution of income on grounds that it generates public benefits. For example, let us say that many members of us society want to eliminate hunger in the United States. Suppose you are willing to give $200 per year in exchange for the knowledge that people are not going to bed hungry. Many private charities in the United States use the money they raise to feed the poor. If you want to contribute, you can do so privately, through charity. So why do we need government involvement? To answer this, we must consider the benefits of eliminating hunger. First, it generates collective psychological benefits; simply knowing that people are not starving helps us sleep better. Second, eliminating hunger may reduce disease, and this has lots of beneficial effects. People who are fit and strong are more likely to stay in school and to get and keep jobs. This reduces welfare claims and contributes positively to the economy. If people are less likely to get sick, insurance premiums for everyone will go down. Robberies may decline because fewer people are desperate for money. This means that all of us are less likely to be victims of crime, now and in the future.  These are goals that members of society may want to achieve. But just as there is no economic incentive to contribute voluntarily to national defense, so there is no economic incentive is to contribute to private causes. If hunger is eliminated, you benefit whether you contributed or not---the free rider problem. At the same time, poverty is a huge problem and your contribution cannot possibly have any influence on the amount of national hunger---the drop in the bucket problem. The goals of income redistribution may be more like national defense than like a chicken sandwich from McDonald's. If we accept the idea that redistributing income generates a public good, private endeavors may fail to do what we want them to do, and government involvement may be called for.  *CASE & FAIR, 2004, PRINCIPLES OF ECONOMICS, 7TH ED., PP. 315-317* end |
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