7

Public Goods

7.1 Optimal Provision of Public Goods

7.2 Private Provision of Public Goods
7.3 Public Provision of Public Goods
7.4 Conclusion

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7
Public Goods: Trash Collection

Why don’t people pay to have their neighbor’s 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.

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7.1
Optimal Provision of Public Goods
Goods that are pure public goods are
characterized by two traits.

First, they are non-rival in consumption; that is,

my consuming or making use of the good does not
in any way affect your opportunity to consume the
good.

Second, they are non-excludable; even if you

want to deny someone else the opportunity to
consume or access the public good.

Very few goods meet these conditions in practice.

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Pure private goods

Goods that are both excludable and rival are pure private
goods.

Private goods such as ice cream are completely rival.

A private good IS rival and excludable.

Ex. A private good is my car. Audi has manufactured a

fixed number of A series sedans; there are not enough built
for everyone to own one.

My car is also excludable. No one else is allowed to drive it

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Impure public goods

Most of the goods as public goods are really impure

public goods, which satisfy these two conditions to some
extent but not fully.

There are two types of impure public goods.

Some goods are excludable, but not rival.

Eg. Cable television: the use of cable TV by others in no way

diminishes your enjoyment of cable, so consumption is non-
rival. It is possible to exclude you from consuming cable TV.

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Pure public goods

Pure public goods are rare because there are few
goods that are both not excludable and not rival.

Eg. A pure public good is national defense.

National defense is not rival because if someone builds a

house next to yours, that action in no way diminishes your
national defense protection.

National defense is not excludable because once an area

is protected by national defense, everyone in the area is
protected:
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Public good as externality

It is helpful to think about a public good as one with a large
positive externality.

Ex. If you set off fireworks high into the sky, it benefits
many more people beyond yourself because many people
will be able to see the display.

You are not compensated for other people’s enjoyment,

you can’t exclude others from seeing the fireworks, so you
can’t charge them for their enjoyment.

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7.1
Defining Pure and Impure Public Goods

Is the good rival in consumption?

Yes No

Is the good Yes Private good Impure public good

excludable? (ice cream) (Cable TV)
No Impure public good Public good
(crowded sidewalk) (defense)

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7.1
Optimal Provision of Public Goods

How 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.

• Ex. Ben and Jerry have different tastes for ice cream
(ice-cream), relative to the other good (cable).
• How does the market aggregate their preferences?

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MRS
• marginal cost of production, equals marginal benefit, or .

• MRS= Marginal Rate of Substitution

• In economics, the marginal rate of substitution is

the rate at which a consumer is ready to give up one
good in exchange for another good while maintaining
the same level of utility.

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7.2
Private Provision of Public Goods

The 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.

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Private-Sector Under-Provision

In general, the private sector in fact underprovides

public goods because of the free rider problem
because your enjoyment of public goods is not
solely dependent on your contribution to them, you
will contribute less to their provision than is socially
optimal.

• Since Ben’s consumption of missiles also benefits

Jerry, Jerry may not want to pay (or vice versa).

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Private sector Under-production

Suppose Ben and Jerry live by themselves far away from

others. It is July 4th, and they want to have a celebration.
For this celebration, they care about only two consumption
goods: ice cream cones and fireworks.

The price of each of these goods is $1, so for every

firework they buy, they forgo a serving of ice cream. Ice
cream is a private good here, but fireworks are a pure
public good.

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Private sector underproduction

Fireworks are non-rival because both Ben and Jerry can
enjoy them without impinging on the other’s enjoyment, and
fireworks are non-excludable because they explode high in
the sky for both Ben and Jerry to see.

Neither Ben nor Jerry cares about who sends up the

firework, as long as it’s up in the sky for them to see. Both
Ben and Jerry benefit equally from a firework sent up by
either of them; what matters to them is the total amount of
fireworks.

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7.2
APPLICATION: The Free Rider Problem in Practice

The free rider problem is one of the most powerful

concepts in all of economics.
• Radio and television programming:
o WNYC has an estimated listening audience of
about 1 million people, but only 7.5% of their
listeners support the station.
o The United Kingdom uses a non-market solution:
The BBC charges an annual licensing fee to anyone
who owns and operates a TV!

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7.2
APPLICATION: The Free Rider Problem in Practice

• File sharing:
o 85% of users of a file sharing program download
files only from others.
o The file-sharing software Kazaa gives download
priority to users according to their ratings, thus
discouraging free riders.
• Bicycle shares:
o Users were expected to return each bike riding.
o Within four days, not a single bicycle was left.
o Literal example of a “free ride.”

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7.2
Can Private Providers Overcome the Free Rider
Problem?

• The free rider problem does not lead to a complete

absence of private provision of public goods.

• Plenty of private-sector TV programming

• The 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.

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7.2
APPLICATION: Business Improvement Districts

Clean, safe sidewalks are public goods.

• Cities attempt to provide them through street repair
and police work, financed with tax revenue.
• But New York City’s Times Square in the 1980s was a
failure:
“Dirty, dangerous, decrepit, and increasingly derelict”
• In 1992, a group of private firms formed a “Business
Improvement District” to improve the area
themselves.

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7.2
APPLICATION: Business Improvement Districts
(BID)

How 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.

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7.2
APPLICATION: Business Improvement Districts

Resounding 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?

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7.2
When Is Private Provision Likely to Overcome
the Free Rider Problem?

Markets can (mostly) overcome the free rider

problem when some Individuals care more than
others.
• Suppose Ben cares much more about fireworks
than Jerry.
• Then Ben will want to buy a lot of fireworks for
himself ).
• And the efficiency loss is not too great (.

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7.2
Altruism

Private markets provide public goods when people

are altruistic.

• Altruistic: When individuals value the benefits

and costs to others in making their consumption
choices, that is, they care about the outcomes
of others as well as themselves.

• If individuals are altruistic, they may be willing

to contribute to a public good even if the free
rider problem suggests they should not .
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Altruism
• In terms of our model, this would be equivalent to Ben
caring not only about the costs of fireworks to himself
but the cost to Jerry as well, so that he is willing to
contribute more to lower Jerry’s burden.

• Many laboratory experiments provide evidence for altruism

and show that people contribute to public goods.

• Evidence for altruism comes from laboratory

experiments of the kind that are typically employed in
other fields, such as psychology, but that are gaining
popularity as a means of resolving difficult economic
issues.
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Social capital
• How altruistic people are is measured by social
capital.
• Social capital: The value of altruistic and communal
behavior in society.
• What determines altruism?

• This is a very difficult question and has given rise to an

entire field of study of social capital, the value of
altruistic and communal behavior in society.

• A central finding of this field is that individuals are likely

to be more altruistic when they are more “trusting” of
others.
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7.2
Warm Glow

People 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 don’t care

about just the amount of the public good.

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7.3
Public Provision of Public Goods
Despite 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.
• Three of those barriers: private responses to public
provision, or “crowd-out”; the difficulty of measuring the
costs and benefits of public goods; and the difficulty of
determining the public’s preferences for public goods.

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7.3
Private Responses to Public Provision: The Problem
of Crowd-Out

• Crowd-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.
o No evidence for full crowd-out
o No consensus on the size of this important
individual response to government intervention

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7.3
EVIDENCE: Measuring Crowd-Out

The 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.

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7.3
EVIDENCE: Measuring Crowd-Out

Laboratory evidence seems more convincing.

• In another study, individuals tokens to a public good.
o A 2-token tax on every player was then contributed
to the public good.
o Without warm glow effects, players should have
reduced their contributions by 2 tokens.
o However, each player cut his or her contributions
by only 1.43 tokens.
• Unclear how well this result generalizes outside of the
lab, however.

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7.3
Measuring the Costs and Benefits of Public Goods

Optimal 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?

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7.3
Measuring the Costs and Benefits of Public Goods

The 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?

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Costs & benefits of public goods

• There is a clear free rider problem in relying on the
private sector for this improvement.

• The benefits of highway improvement are fairly small for

any one driver, although they may be quite large for the
total set of drivers using the highway.

• Thus, no one driver will invest the necessary resources

to improve the highway.

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7.3
How Can We Measure Preferences for the Public
Good?

Three challenges in measuring preferences for public

goods.
1. 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.
2. Preference knowledge: People may not know what
their valuation is.
3. Preference aggregation: How can the government
combine the preferences of millions of citizens?

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7.4
Conclusion
• A 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:
o Ability of government to measure costs and
benefits
o Ability to implement optimal plan

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Conclusion
• Pure public goods are goods that are non-rival (your
consuming or making use of the good does not in any
way affect someone else’s opportunity to consume the
good)

• And non-excludable (even if you want to deny someone

else the opportunity to consume or access the public
good, there is no way you can do so).

• For pure public goods, the optimal level of provision is

the point at which the sum of marginal benefits across
all recipients equals the marginal cost.

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Conclusion

• The private market is unlikely to provide the optimal level

of public goods due to the free rider problem.

• In some cases, the private market can overcome the

free rider problem, at least partially.

• A solution closer to the socially optimal one is more

likely if there are individuals with high incomes or high
demand for the public good, individuals who are
altruistic, or individuals who derive a “warm glow” from
their contributions.

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