Public Goods

Key Concepts: Nonrival, nonexcludable, pure public good, congestible good

Lighthouses are public goods; so is the ozone layer. The term "public good" is used to refer to a good that is nonrival, meaning that the consumption or use of the good by one individual does not subtract from the amount of the good or service available for others to enjoy. A second attribute of some public goods is that they may be nonexcludable, meaning that it is impossible, or prohibitively costly, to exclude or keep individuals from consuming the public good. A pure public good is one that has both these characteristics of nonrivalry and nonexcludability, without qualification. National security is a frequently cited example; radio and TV signals are very close to being pure public goods. Not all public goods are excludable, however, and most public goods are not perfectly nonrival. They are congestible public goods, meaning they are nonrival up to a certain level of use, but then beyond that point rivalry sets in, as with public highways, wilderness areas, or city parks. At high levels of use, the enjoyment or "consumption" of the public good by one individual is affected by the number of other users.

Our analysis of public goods focuses on two aspects: (a) the inefficiency or undersupply of nonrival or public goods by the market and (b) the dilemma of financing the provision of public goods at their optimal level. Nonexcludability makes it difficult or impossible to charge a price for a good like a radio broadcast since anybody with a radio can pick up the transmission. Famous works of art or other objects can be put in a museum and an entry fee can be charged, so they are excludable. But this does not completely eliminate the problem of efficiency for public goods. Indeed, both excludable and nonexcludable public goods involve market failures and inefficiencies, as we will see.

Key Concept: Willingness to pay (WTP) for public goods is summed vertically

The reason for this market failure can be illustrated by the following example, where the individual demands for, say, hours of radio broadcasting by three people are represented by the three demand curves DA, DB, and DC. Because radio broadcasts are nonrival, all users can benefit from the same unit of the public good. This implies that the marginal social benefit (MSB), or collective willingness to pay, for a public good will be the vertical sum of the demands, or individual's willingness to pay, at each quantity or level—since all can listen to the same hour of broadcasting. The total demand is constructed by summing the individual demands vertically (rather than horizontally as in the case of a normal "rival" good) as indicated by the dotted line in figure 5.1. If this were a rival good, like pizzas or houses or cookies, the quantity demanded at each price would be summed horizontally.

Individuals will be willing to pay for radio broadcasts only when the benefits exceed the costs. According to figure 5.1, if the marginal cost is $15, only individual C will pay for some radio broadcasting (about ten hours). Individuals A and B will be able to enjoy the radio broadcasting paid for by individual C, but they would not be willing to pay for it themselves. Because of this free riding by A and B, there would be only ten hours of radio broadcasting even though the efficient level (where MSB = MC) would be about seventeen hours.

■ FIGURE 5.1 The social value of a public good: radio broadcasting

What if there were thousands of individuals with MB curves similar to the ones in figure 5.1, but with the marginal cost above $20? The market could easily "fail" to provide any units of this public good even though its collective value to society is very high. Most individuals are willing to pay for national security, but few would be willing or able to pay for an aircraft carrier or an army! This is a fundamental source of market failure—the failure to supply public goods at the efficient level.

Even if government intervened to produce the efficient level of seventeen hours of radio broadcast, how should it be paid for? Asking people to contribute based on how much they value the public good is unlikely to work owing to free riding (although many public radio stations try). For most public goods such as national security, public education, health, safety, and so on, general taxation is the way most societies pay for public goods. But funding public goods entirely from general tax revenues has the drawback that the total cost of providing the desired level of the public good (a fixed cost plus the marginal cost per hour of broadcast) will likely mean asking some individuals to pay more for the public good than they would want, and they would surely vote against doing so. So we face a dilemma: let the public good be undersupplied, or pay for it with taxation in a way that will force some individuals to pay more than what they would want to. Often some combination of low user charges and partial public funding is the resulting compromise.

At first glance, it would seem that excludability for a public good (the ability to control access) would solve the problem, but this is not the case. If it were possible to charge for listening to the radio, for example, if $8 were charged for each hour up to the ten hours being supplied, individual A would pay for only two hours and would not listen to the other eight hours of broadcasting, even though the marginal cost of allowing A to listen in would be zero. By forcing A to turn off the radio after two hours, there is a deadweight loss to society. Anytime the price is not equal to marginal cost this will happen, and the marginal cost (for one listener) is zero! The deadweight loss in this case is the area under A's demand curve between the actual level of two hours and the ten hours of total broadcasting

((1) x 8 x 8), or $32 of deadweight loss from pricing the public good at $8.

With public goods we can either accept undersupply or try to pay for the efficient level of the public good in distortionary and potentially unfair ways. Both have drawbacks. Herein lies the fundamental debate about government and the perennial political struggles over funding the military and the Environmental Protection Agency, subsidizing the arts, raising fares for subways, whether Amtrak should pay for itself, whether taxes should be used to build baseball stadiums, and so on.

Was this article helpful?

0 0
Project Management Made Easy

Project Management Made Easy

What you need to know about… Project Management Made Easy! Project management consists of more than just a large building project and can encompass small projects as well. No matter what the size of your project, you need to have some sort of project management. How you manage your project has everything to do with its outcome.

Get My Free Ebook


  • Margherita
    Does global warming caused by public goods or common goods?
    1 year ago

Post a comment