Chapter 19: Public Goods and Common Resources

11© 2014 by McGraw-Hill Education Chapter 19 Public Goods and Common Resources 2© 2014 by McGraw-Hill Education • What the difference is between rival and excludable goods and services. • What the free-rider problem is and what its consequences are. • What the tragedy of the commons is and what its consequences are. • How and when social norms, government regulation, and expansion of property rights can be used to solve problems with public goods or common resources. What will you learn in this chapter? 3© 2014 by McGraw-Hill Education • There are two important characteristics that determine how goods are used and whether they are allocated efficiently by markets: – When a good is excludable, it is possible for sellers to prevent its use by those who have not paid for it. – When a good is rival in consumption (or just rival), one person’s consumption prevents or decreases others’ ability to consume it. Characteristics of goods 24© 2014 by McGraw-Hill Education Rival Not rival Excludable Not excludable Four categories of goods and services based on excludability and rivalry. Characteristics of goods Many goods lack one or both of these characteristics. 5© 2014 by McGraw-Hill Education For each of the following, identify what kind of good they are (private, public, artificially scarce, or common resource): 1. Popular software. 2. AM/FM radio. 3. Street art. 4. A gaggle of geese. 5. A motorcycle. Active Learning: Identify type of good 6© 2014 by McGraw-Hill Education • Whether a good is excludable and rival in consumption has important implications for how it is allocated through a market system. – Common resources are goods that are not excludable but are rival. – Artificially scarce goods are excludable, but not rival. • Markets work well for allocating private goods efficiently, but not always so well for allocating public goods and common resources. – Free-rider problem. – Tragedy of the commons. Allocation of goods 37© 2014 by McGraw-Hill Education • The free-rider problem starts when someone decides to not pay for a public good and enjoys a “free ride” from those that have paid. • The free-rider problem occurs when the non- excludability of a public good leads to undersupply due to a loss of revenue. – Free-riders enjoy positive externalities from others’ choices to pay. • Under positive externalities, the equilibrium quantity is less than the level that maximizes total surplus. The free-rider problem 8© 2014 by McGraw-Hill Education • Common resources are not a public good (since they are rival), but they are nonexcludable. – Nonexcludability causes demand to be higher than if people had to pay for what they consumed. – Rivalry causes quantity to dwindle. • This combination leads to the tragedy of the commons; the depletion of a common resource due to individually rational but collectively inefficient overconsumption. The tragedy of the commons 9© 2014 by McGraw-Hill Education Active Learning: Identifying the problem For each of the following, identify whether it suffers from a free-rider problem, a tragedy of the commons problem, or neither. 1. Earth’s atmosphere. 2. Children’s museum paid by donations. 3. Common room microwave. 4. Litter at community parks. 410© 2014 by McGraw-Hill Education • The problem with undersupply of public goods and overdemand for common resources leads to an inefficient quantity of production and consumption. • Solutions to these market failures fall under three categories: social norms, government regulation and provision, and private property rights. • Strong social norms help rebalance the trade-off by imposing costs on people. – Social disapproval carries a higher cost in places where people know each other and will interact with each other in the future. Dealing with public goods and common resources 11© 2014 by McGraw-Hill Education • Government bodies can impose consumption limits or make up for inadequate supply when individuals cannot. • Bans and quotas are applied to common-resource problems to reduce the inefficiency created by overuse. • Making something illegal is one way of changing the trade-offs that people face. – If the punishment is not severe, or the likelihood of getting caught is low, the cost may not be high enough to change the trade-off. – Bans and quotas fail in situations where it is costly for authorities to monitor and punish rule-breakers. – Tough moral and practical questions come into play. Dealing with public goods and common resources 12© 2014 by McGraw-Hill Education • To combat undersupply of public goods, the typical regulatory solution is government provision. • If the government is supplying a public good, the efficient quantity is the one at which the marginal social benefit equals the cost. • Two difficulties arise when attempting to provision: – Calculating the marginal social benefit. – How to finance the provision. Bans, quotas, and government provision 513© 2014 by McGraw-Hill Education • In some cases, the most convenient solution to public good and common resource problems is to privatize the goods. • The patent system is an example of turning a common resource (knowledge) into private property. – It assures corporations that others will not be able to free-ride on their innovations. • Assigning property rights over common resources is often far from simple. – Especially when many people are already using a resource; it’s difficult to decide who owns what. Property rights 14© 2014 by McGraw-Hill Education • One common way that governments institute private property rights is through the use of tradable allowances or permits. • These work the same way as externalities. • They ensure that resources are allocated to those with the highest willingness to pay, while still limiting overall quantity to an efficient level. Property rights 15© 2014 by McGraw-Hill Education • When a good is excludable, those who haven’t paid for it can be prevented from using it. • When a good is rival, one person’s consumption prevents or decreases others’ ability to consume it. • Private goods are both excludable and rival. • Public goods are neither excludable nor rival. • Common resources are rival, but not excludable. • Artificially scarce goods are excludable, but not rival. Summary 616© 2014 by McGraw-Hill Education • The free-rider problem is caused by nonexcludability leading to undersupply of a public good. • The tragedy of the commons is the depletion of a common resource due to individually rational but collectively inefficient overconsumption. Summary 17© 2014 by McGraw-Hill Education • Strong social norms can help rebalance tradeoffs in consuming public goods or common resources – Imposes social costs on those who break the “rules” of good behavior. • Often, government bodies have the power to solve the nonexcludability problem, while individuals do not. – Bans and limits address overuse, but are inefficient. However, tradable allowances help to make them efficient. – Government provision addresses undersupply. Summary 18© 2014 by McGraw-Hill Education • Sometimes the best way to solve the tragedy of the commons is to convert a common resource into a private good. – This can be difficult when it is not possible to divide a resource or when it is not clear how to do so in a fair way. • Public-policy approaches can harness individual incentives to manage use and excludability. Summary