2010 Pearson Addison-Wesley

2010 Pearson Addison-Wesley

Classifying Goods and Resources

What is the essential difference between:

A city police department and Brinks security

Fish in the Atlantic Ocean and fish in a fish farm

A live concert and a concert on television

These and all goods and services can be classified

according to whether they are excludable or
nonexcludable and rival or nonrival.

2010 Pearson Addison-Wesley

Classifying Goods and Resources

Excludable
A good is excludable if only the people who pay for it are
able to enjoy its benefits.
Brinkss security services, East Point Seafoods fish, and a
Coldplay concert are examples.
Nonexcludable
A good is nonexcludable if everyone benefits from it
regardless of whether they pay for it.
The services of the LAPD, fish in the Pacific Ocean, and a
concert on network television are examples.
2010 Pearson Addison-Wesley

Classifying Goods and Resources

Rival
A good is rival if one persons use of it decreases the
quantity available for someone else.
A Brinkss truck cant deliver cash to two banks at the same
time. A fish can be consumed only once.
Nonrival
A good is nonrival if one persons use of it does not
decrease the quantity available for someone else.
The services of the LAPD and a concert on network
television are nonrival.
2010 Pearson Addison-Wesley

Classifying Goods and Resources

A Four-Fold Classification
Private Goods
A private good is both rival and excludable.
A can of Coke and a fish on East Point Seafoods farm are
examples of private goods.
Public goods
A public good is both nonrival and nonexcludable. A public
good can be consumed simultaneously by everyone, and no
one can be excluded from its benefits.
National defense is the best example of a public good.
2010 Pearson Addison-Wesley

Classifying Goods and Resources

Common Resources
A common resource is rival and nonexcludable.
A unit of a common resource can be used only once, but
no one can be prevented from using what is available.
Ocean fish are a common resource.
They are rival because a fish taken by one person isnt
available for anyone else.
They are nonexcludable because it is difficult to prevent
people from catching them.

2010 Pearson Addison-Wesley

Classifying Goods and Resources

Natural Monopolies
In a natural monopoly, economies of scale exist over the
entire range of output for which there is a demand.
A special case of natural monopoly arises when the good
or service can be produced at zero marginal cost. Such a
good is nonrival. If it is also excludable, it is produced by a
natural monopoly.
The Internet and cable television are examples.

2010 Pearson Addison-Wesley

Classifying Goods and Resources

Figure 17.1
shows this
four-fold
classification
of goods and
services.

2010 Pearson Addison-Wesley

Public Goods
The Free-Rider Problem
A free rider enjoys the benefits of a good or service without
paying for it.
Because no one can be excluded from the benefits is a
public good, everyone has an incentive to free rise.
Public goods create a free-rider problemthe absence of
an incentive for people to pay for what they consume.

2010 Pearson Addison-Wesley

Public Goods
The value of a private good is the maximum amount that a
person is willing to pay for one more unit of it.
The value of a public good is the maximum amount that all
the people are willing to pay for one more unit of it.
To calculate the value placed on a public good, we use the
concepts of total benefit and marginal benefit.

2010 Pearson Addison-Wesley

Public Goods
Marginal Social Benefit of a Public Good
Total benefit is the dollar value that a person places on a
given quantity of a good.
The greater the quantity of a good, the larger is a persons
total benefit.
Marginal benefit is the increase in total benefit that results
from a one-unit increase in the quantity of a good.
The marginal benefit of a public good diminishes with the
quantity of the good provided.
2010 Pearson Addison-Wesley

Public Goods
Figure 17.2 shows that the
marginal social benefit of a
public good is the sum of
marginal benefits of
everyone at each quantity
of the good provided.
Part (a) shows Lisas
marginal benefit.
Part (b) shows Maxs
marginal benefit.

2010 Pearson Addison-Wesley

Public Goods
The economys marginal
social benefit of a public
good is the sum of the
marginal benefits of all
individuals at each quantity
of the good provided.
The economys marginal
social benefit curve for a
public good is the vertical
sum of all individual
marginal benefit curves.

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Public Goods
The marginal social benefit
curve for a public good
contrasts with the demand
curve for a private good,
which is the horizontal sum
of the individual demand
curves at each price.

2010 Pearson Addison-Wesley

Public Goods
The Marginal Social Cost of a Public Good
The marginal social cost of a public good is determined
in the same way as that of a private good.
The Efficient Quantity of a Public Good
The efficient quantity of a public good is the quantity that
at which marginal social benefit equals marginal social
cost.

2010 Pearson Addison-Wesley

Public Goods
Figure 17.3 illustrates
the efficient quantity of
a public good.
With fewer than
2 satellites,
MSB exceeds MSC.
Resources a can be
used more efficiently by
increasing the quantity.

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Public Goods
With more than
2 satellites,
MSC exceeds MSB.
Resources can be used
more efficiently if fewer
satellites are provided.
So the quantity at which
MSB = MSC, resources
are used efficiently.
Private production would
produce 0 satellites.
2010 Pearson Addison-Wesley

Public Goods
Inefficient Private Provision
If a private firm tried to produce and sell a public good,
almost no one would buy it.
The free-rider problem results in too little of the good being
produced.

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Public Goods
Efficient Public Provision
Because the government can tax all the consumers of the
public good and force everyone to pay for its provision,
public provision overcomes the free-rider problem.
If two political parties compete, each is driven to propose
the efficient quantity of a public good.
A party that proposes either too much or too little can be
beaten by one that proposes the efficient amount because
more people vote for an increase in net benefit.
2010 Pearson Addison-Wesley

Public Goods
Figure 17.4 illustrates
the efficient political
outcome.
Two parties, Doves and
Hawks, agree on
everything except the
number of satellites.
If Doves propose 1
satellites and Hawks
propose 3, voters are
equally unhappy and
the election is too close
to call.
2010 Pearson Addison-Wesley

Public Goods
If Doves increase the
number of satellites to 2, it
will win the election if
Hawks propose 3.
If Hawks decrease the
number of satellites to 2, it
will win the election if
Doves propose 1.
Both parties propose 2
satellites and each party
gets 50 percent of the
votes.
2010 Pearson Addison-Wesley

Public Goods
Principle of Minimum Differentiation
The attempt by politicians to appeal to a majority of voters
leads them to the same policiesan example of the
principle of minimum differentiation.
The principle of minimum differentiation is the
tendency for competitors to make themselves similar so as
to appeal to the maximum number of clients (voters).
(The same principle applies to competing firms such as
McDonalds and Burger King).

2010 Pearson Addison-Wesley

Public Goods
Inefficient Public Overprovision
If competition between two political parties is to deliver
the efficient quantity of a public good, bureaucrats must
cooperate and help achieve this outcome.
Objective of Bureaucrats
Bureaucrats want to maximize their departments
budget.
A bigger budget increases their status and power.
Bureaucrats might try to persuade politicians to provide
more than the efficient quantity.
2010 Pearson Addison-Wesley

Public Goods
Rational Ignorance
Rational ignorance is the decision by a voter not to
acquire information about a policy or provision of a public
good because the cost of doing so exceeds the expected
benefit.
For voters who consume but dont produce a public good, it
is rational to be ignorant about the costs and benefit.
For voters who produce a public good, it is rational to be
well informed.
When the rationality of uninformed voters and special
interest groups is taken into account, the political
equilibrium results in overprovision of a public good.
2010 Pearson Addison-Wesley

Public Goods
Figure 17.5 shows
bureaucratic overprovision.
If rationally ignorant voters
enable the bureaucrats to
achieve their goal of
maximizing their budget,
public good might be
overprovided and
and a deadweight loss
created.
2010 Pearson Addison-Wesley

Public Goods
Two Types of Political Equilibrium
The two types of political equilibriumefficient provision
and inefficient overprovision of public goods correspond to
two theories of government:
Social interest theory predicts that political equilibrium
achieves efficiency because well-informed voters refuse
to support inefficient policies.

Public choice theory predicts that government delivers

an inefficient allocation of resourcesthat government
failure parallels market failure.

2010 Pearson Addison-Wesley

Public Goods
Why Government Is Large and Grows
Two possible reasons are

Voter preferences

Inefficient overprovision

Government grows because the voters demand for some

public goods is income elastic.
Inefficient overprovision might explain the size of
government but not its growth rate.

2010 Pearson Addison-Wesley

Public Goods
Voters Strike Back
If government grows too large relative to the value voters
place on public goods, there might be a voter backlash
that leads politicians to propose smaller government.
Privatization is one way of coping with overgrown
government and is based on distinguishing between public
provision and public production of public goods.

2010 Pearson Addison-Wesley

Common Resources
The Tragedy of the Commons
The tragedy of the commons is the absence of
incentives to prevent the overuse and depletion of a
commonly owned resource.
Examples include the Atlantic Ocean cod stocks, South
Pacific whales, and the quality of the earths atmosphere.
The traditional example from which the term derives is the
common grazing land surrounding middle-age villages.

2010 Pearson Addison-Wesley

Common Resources
Sustainable Production
Sustainable production is the rate of production that
can be maintained indefinitely.
This production rate depends on the existing stock of
fish and the number of boats that go fishing.
For a given fish stock, as more boats go fishing, the
quantity of fish caught increases.
But with too many boats fishing, the quantity of fish
caught decreases.

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Common Resources
Table 17.1 illustrates the
number of boats and the
quantity if fish caught.
As the number of fishing
boats increases, the
quantity of fish caught
increases to some
maximum.
Overfishing occurs when
the maximum sustainable
catch decreases.

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Common Resources
Table 17.1 also shows the
average and marginal
catch depends on the
number of boats that go
fishing.
As the number of fishing
boats increases:

The average quantity of

fish caught decreases.

The marginal catch

decreases.

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Common Resources
Figure 17.6 illustrates the
sustainable production of
fish.
As the number of fishing
boats increases, the
quantity of fish caught
increases to some
maximum.
Overfishing occurs when
the maximum sustainable
catch decreases.

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Common Resources
An Overfishing Equilibrium
Figure 17.7 shows why
overfishing occurs.
Marginal private benefit, MB,
is the average catch per
boat.
Marginal private benefit
decreases as the number of
boats increases.
The marginal cost per boat
is MC (assumed constant).
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Common Resources
Equilibrium occurs where,
MB equals MC.
In equilibrium, the resource
is overused
because no one takes into
account the effects of her/his
actions on other users of the
resources.

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Common Resources
The Efficient Use of the Commons
The quantity of fish caught by each boat decreases as the
number of boats increases.
But no one has an incentive to take this fact into account
when deciding whether to fish.
The efficient use of a common resource requires marginal
social cost to equal marginal social benefit.

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Common Resources
Marginal Social Benefit
Marginal social benefit is the increase in the total fish
catch that results from an additional boat.
Marginal social benefit equals the marginal catch of a
boat, not the average catch per boat.

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Common Resources
Efficient Use
Figure 17.8 shows the
marginal private benefit
curve, MB, and the marginal
social benefit curve, MSB.
With no external costs, the
marginal social cost MSC
equals marginal cost MC.
Resources are used
efficiently when
MSB equals MSC.
2010 Pearson Addison-Wesley

Common Resources
Achieving an Efficient Outcome
It is harder to achieve an efficient use of a common
resource than to define the conditions under which it
occurs.
Three methods that might be used are

Property rights

Production quotas

Individual transferable quotas (ITQs)

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Common Resources
Property Rights
By assigning property rights, common property becomes
private property.
When someone owns a resource, the owner is
confronted with the full consequences of her/his actions
in using that resources.
The social benefits become the private benefits.
But assigning property rights is not always feasible.

2010 Pearson Addison-Wesley

Common Resources
Production Quotas
By setting a production
quota at the efficient
quantity, a common
resource might remain in
common use but be used
efficiently.
Figure 17.9 shows this
situation.
It is hard to make a
production quota work.
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Common Resources
Individual Transferable Quotas
An individual transferable quota (ITQ) is a production
limit that is assigned to an individual who is free to
transfer (sell) the quota to someone else.
A market in ITQs emerges.
If the efficient quantity of ITQs is assigned, the market
price of an ITQ confronts resource users with a marginal
cost of MC + price of ITQ.
With MC + price of ITQ equal to MSB, the quantity
produced is efficient.
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Common Resources
Figure 17.10 shows the
situation with an efficient
number of ITQs.
The market price of an
ITQ increases the
marginal cost to
MC0 + price of ITQ.
Users of the resource
make MB equal
MC0 + price of ITQ, and
the outcome is efficient.
2010 Pearson Addison-Wesley

Common Resources
Public Choice and Political Equilibrium
It is easy for economists to agree that ITQs make it
possible to achieve an efficient use of a common
resource.
It is difficult to get the political marketplace to deliver that
outcome.
In 1996, Congress killed an attempt to use ITQs in the
Gulf of Mexico and the Northern Pacific Ocean.
Self-interest and capture of the political process
sometimes beats the social interest.
2010 Pearson Addison-Wesley