© 2007 Thomson South-Western. Boston Harbor 1987 This was taken just before the harbor cleanup was...


Boston Harbor 1987

This was taken just before the harbor cleanup was about to begin


Boston Harbor Today

After a 4.5 billion dollar investment Boston Harbor went from being the “dirtiest harbor in America” to “a Great American Jewel” offering some of the cleanest urban beaches in America


Deer Island Treatment Plant

To clean the harbor 3.8 billion was spent on the Deer Island Treatment Plant

The treatment plant has two characteristics which make it particularly problematic:Non-excludableNon-rival

Goods with both these characteristics are known as Public Goods


EXCLUDABILITY

• Excludability - refers to the property of a good whereby a person can be prevented from using it– Deer Island Treatment Plant-can someone be

prevented from benefiting from the clean harbor?– Examples:

• excludable: tacos, dial-up internet service• not excludable: FM radio signals, national defense


• Rivalry in consumption refers to the property of a good whereby one person’s use diminishes other people’s use.– Deer Island Treatment Plant-benefits that result from

the treatment plant do not depend on how many others also benefit

– Examples:• rival: tacos• not rival: An MP3 file of the latest hit song

RIVALRY


THE DIFFERENT KINDS OF GOODS

Rival in consumption?

Yes No

Excludable?

Yes

Private GoodsCoffee/TeaClothing

Collective Good (club goods)Fire ProtectionCable TV

No

Common ResourcesFish in the oceanClean water

Public GoodsNational Defense Sewer systems


Public Goods?• Free meals at a soup kitchen?

– Non rival?• No!

– Non excludable?• No!

• Library?– Non rival?

• No!

– Non excludable?• No!


Public Goods?

• Street lighting?– Non rival?

• Yes!

– Non excludable?• Yes!


Why can’t market efficiently provide public goods?• Public goods are difficult for private markets

to provide because of the free-rider problem.

• A free-rider is a person who receives the benefit of a good but avoids paying for it.


The Free-Rider Problem

• If good is not excludable, people have an incentive to be free riders, because firms cannot prevent non-payers from consuming the good.

• The free-rider problem prevents private markets from supplying efficient amounts of public goods


Fireworks Display

• Smalltown, USA, enjoys fireworks on the Fourth of July.

• Value to each of the town’s 500 residents: $10• Ellen’s cost of the fireworks display: $1000• Benefit > Cost• Socially Efficient outcome: Have a fireworks

display on the Fourth of July. • But, Private Outcome ≠ Social Outcome, why?


Solving the Free Rider Problem

• Government Provision:• The government can decide to provide the public good

if the total benefits exceed the costs.• The government can make everyone better off by

providing the public good and paying for it with tax revenue.

• Problem: Measuring the benefit is usually difficult• To determine which public goods to provide and how

much of them to provide, the government conducts Cost/Benefit Analyses


Cost-Benefit Analysis

• Technique for decision making in the public sector

• Compare:• the benefit of providing incremental units of public

goods• with the costs of providing these additional units

• The comparison is based on marginals

(rational decisions are made at the margin!)


The Difficult Job of Cost-Benefit Analysis

• It is difficult to do because of the absence of prices needed to estimate social benefits and resource costs.

• Without accurate prices, it is difficult to assess value good would provide to the public


Ex/Building a Bridge in Virginia

• What type of a good is a bridge?• Excludable?

• Yes, could put a toll on a bridge

• Rival?• No, unless it is congested

• Would consider this to be a collective good (or a club good)


What is the market failure?

• This good is excludable can charge to use the good, so free markets will provide some of these goods (ex/Cable TV)

• BUT this good is non-rival, meaning that many people can enjoy the good without diminishing other people’s enjoyment of the good

• Because the marginal cost of allowing an extra user to benefit from the good is very small (often 0), the free market will under-provide these goods


Building a Bridge in Virginia

Case 1: Annual cost of maintaining the bridge = $40,000

Benefits? Area under demand curve (willingness to pay for bridge)½ (1) (100,000) = $50,000

Socially Efficient to build bridge? Yes, consumer surplus > annual cost

Question: Should the bridge be built?




Would the private market provide this bridge?

Only if total revenue they could raise would be greater than 40,000

In this case maximum possible revenue is $25,000 so would not build the bridge even though it is socially efficient




Case 2: Annual cost of the bridge = $20,000

Would the private market provide this bridge?

Socially Efficient to build bridge? Yes, consumer surplus > annual cost

Yes, maximum possible revenue is $25,000 so would build the bridge, but since marginal cost of provision is 0 (or very small) this private provider will charge a toll above the optimum, leading to an outcome that is not efficient


Providing the right amount of a public good

• Though there are no prices on these goods, people still have an underlying willingness to pay which should help us determine optimal provision of a good.


Example – Demand for Streetlights in Privet Drive

Note: Willingness to Pay represents marginal benefits, not total, i.e. how much willing to pay for 2nd lamp, etc.

Question: How do we aggregate individual demand curves to arrive at market demand?

Answer: Remember that streetlights are public goods, which means they are non-rival, so benefits accrue simultaneously to everyone. Only one quantity can be produced, and everyone will get that quantity. So we sum the demand curves vertically rather than horizontally as we did with private goods.



Draw the Market Demand for streetlights



Marginal Benefit of a Public Good is the sum of the marginal benefits of all individuals that consume the good.

If the marginal cost of providing the street lamp is $40, how many should we provide?

3 Street Lights – point where society’s MB = MC



Problem: How could we get people to be honest about what they are truly willing to pay?

If we ask people directly and their payment is based on their answer, then they have an incentive to under-report their willingness to pay (free-rider problem)


Does Voting Solve the Problem?

In the U.S. and other democratic counties we determine output of public goods through political system Voting

Voting can be imperfect as too. Why?

Voting will result in no streetlamp.

But would it have been socially efficient to have streetlamps?

YES! Problem is that voting does not take into account the intensity of people’s preferences, so many socially valuable public goods will not be provided through this system.


Does Voting Solve the Problem?

Another problem with voting is that once a program is voted on, it is usually “one size fits all” i.e. everyone receives the same level of services.

Solutions?

Many small jurisdictions with powers of taxation. In our country one of the primary functions of local governments is the provision of public schools.

Business Improvement District (BID) is an organization that is granted power to levy supplemental surcharge on businesses in a local area. The organization then uses revenues to provide supplemental public services in a community, like street clean-up, graffiti removal, and sidewalk repair, it organizes street fairs, and constructs attractive signs, etc.


COMMON RESOURCES

• Common resources, like public goods, are not excludable • They are available free of charge to anyone who

wishes to use them• Little incentive for firms to provide• Role for govt: ensuring that they are provided


COMMON RESOURCES

• Common resources are rival goods because one person’s use of the common resource reduces other people’s use.• Role for govt: ensuring they are not overused


Tragedy of the Commons

• The Tragedy of the Commons is a parable that illustrates why common resources get used more than is desirable from the standpoint of society as a whole.

• Common resources tend to be used excessively when individuals are not charged for their usage.

• This is similar to a negative externality.


The Tragedy of the Commons

• Setting: A medieval town, where sheep graze on common land.

• As the population grows, the number of sheep grows.

• The amount of land is fixed, the grass begins to disappear from overgrazing.

• The private incentives (using the land for free) outweigh the social incentives (using it carefully).

• Result: People can no longer raise sheep.


The Tragedy of the Commons

• The tragedy is due to an externality: Allowing one’s flock to graze on the common land reduces its quality for other families.

• People neglect this external cost, resulting in overuse

of the land.


A C T I V E L E A R N I N G 2:

Policy options for common resources

• What could the townspeople (or their government) have done to prevent the tragedy?

• Try to think of two or three options.


A C T I V E L E A R N I N G 2:

Answers

• Impose a corrective tax on the use of the land to “internalize the externality”

• Regulate use of the land (the “command-and-control” approach)

• Auction off permits allowing use of the land

• Divide the land, sell lots to individual families Each family will have incentive not to overgraze its own land.


Policy Options to Prevent Overconsumption of Common Resources

• Regulate use of the resource

• Impose a corrective tax to internalize the externality• Example: hunting & fishing licenses,

entrance fees for congested national parks

• Auction off permits allowing use of the resource• Example: spectrum auctions by the U.S. Federal

Communications Commission

• If the resource is land, convert to a private good by dividing and selling parcels to individuals

© 2007 Thomson South-Western. Boston Harbor 1987 This was taken just before the harbor cleanup was...

Documents

Transcript of © 2007 Thomson South-Western. Boston Harbor 1987 This was taken just before the harbor cleanup was...