Public vs. Private Goods; Non-rival Consumption; Non-excludability; Free Rider Problem

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Strategic Business Management - Microeconomics

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University of California, Irvine

Strategic Business Management - Microeconomics

23 notes

This course weds business strategy with the principles of microeconomics. It offers valuable a powerful toolbox together with cases and lessons across all major functions of business, management, from finance, operations management, and marketing to human resource management, organizational behavior, statistics, and, of course, business strategy.

À partir de la leçon

Public Goods, Externalities, and Income Redistribution

The Logic of Government Intervention4:39

Public vs. Private Goods; Non-rival Consumption; Non-excludability; Free Rider Problem9:23

Economic Efficiency and Public Goods; Market Demand for Public Goods8:48

Benefit-Cost Analysis and the Decision Rule4:18

Negative and Positive Externalities10:04

Correcting Market Failures; Pigovian Taxes and Subsidies, Direct Regulation, Lawsuits, Coase Theorem9:16

Direct Government Intervention; Pigovian Taxes and Subsidies; Internalizing Externalities7:45

Wealth, Poverty, and the Redistribution of Income; Progressive, Proportional, and Regressive Taxes6:00

Public Choice, Median Voter Model, and Paradox of Voting8:21

Rencontrer les enseignants

Dr. Peter Navarro
Professor
Paul Merage School of Business

[MUSIC]

As a student at a public college or university,

taxpayers heavily subsidize your education.

If you work in a private corporation, the government will impose a wide

range of health, safety, and environmental regulations on your firm.

The same time, that very same government

will take a large tax bite out of your profits or wages.

When you visit a restaurant or butcher shop, the government is there too,

helping to prevent food poisoning through meat inspections.

[NOISE] And as you jump into your car or onto your motorcycle, that seat belt or

helmet you must wear has been mandated by the government as well.

In fact, from cradle to grave, the government always seems to be with us.

Whether it is providing police protection or

a national defense system, or roads and bridges and clean air.

What we want to do now is come to better understand

the economic underpinnings of government intervention into the marketplace.

And there is perhaps no better place to start than with the Public Goods problem.

If I ate a hot dog, you can't.

But if I enjoy the benefits of the National Defense umbrella of my country,

you as a citizen of that country can enjoy the benefits too.

That's the essence of the so-called public goods problem.

And let's put it into its proper perspective with these observations.

Each year, governments around the world spend billions on one public good alone,

National Defense.

And billions more in tax dollars are spent on other public goods.

Ranging from parks, roads, and bridges to systems of criminal justice.

Then, of course, there are various flood control programs and

even lighthouses on the high seas.

[SOUND] So why exactly is it that the government,

rather than the private marketplace, has to provide for all these public goods?

And what is the true nature of the public goods market failure?

Let's pause now, as you take a minute and

see if you can think of at least three characteristics that distinguish public

goods like national defense from private goods like hot dogs.

[MUSIC]

[NOISE] So what

are the three major characteristics that distinguish private from public goods?

Let's look at the issues of divisibility,

the degree of rivalry in consumption, and excludability.

[NOISE] On the one hand, private goods like hot dogs and

shotguns and flashlights are divisible.

That is, they come in small enough units to be afforded by individual buyers.

On the other hand, public goods like roads and bridges are indivisible.

They come in such large units that individual buyers cannot afford them.

In addition, private goods like hot dogs and shoes are Rival in Consumption.

If I consume the hot dog or wear the shoes, you can't.

In contrast, public goods are Nonrival in Consumption.

That is, both you and

I can consume a public good without interfering with the other's enjoyment.

[NOISE] For example, suppose you were standing on

your country's soil protected by an army, a navy, and an air force.

And perhaps a deadly array of nuclear missiles if you live in

countries like America, China, France India or Russia.

But guess what?

If I lived in your country too,

I would be protected by that defense umbrella as well.

More importantly,

my protection by that defense umbrella does not interfere with your protection.

In other words, the defense umbrella is nonrivaling consumption.

[MUSIC]

Finally, a private good is subject to the exclusion principle.

That is, those unable or

unwilling to pay can be excluded from the product's benefits.

In contrast, exclusion from the consumption of a public good is

economically and technically infeasible.

[NOISE] To see what I mean by economic and

technical infeasibility, take the case of city streets.

In theory,

we could restrict the use of such streets to only those who pay to use them.

And we could do this by putting up a gate on every corner.

But of course, it would be exceedingly expensive and impractical to do.

So city streets have the characteristics of a public good.

[MUSIC]

So here's the problem we face when we try to rely

on the free market to provide public goods like national defense.

Nobody wants to pay for them.

And the reason has to do with the third characteristic of a public good,

non-excludability.

Here's the deal.

Once the public good is provided, a producer cannot exclude

non-payers from receiving its individual benefits.

This creates a perverse incentive among potential buyers to want to free ride.

And by the way, the term free rider is one of the most important and

interesting in economics.

In this Key Definition, the Free Rider Problem

refers to a situation in which some individuals in a group or a population

pay less than their fair share of the costs for the benefit received.

[MUSIC]

Now here's a second problem with public goods,

very much related to that of the free rider problem.

Not only will some free riding consumers not want to pay for them.

Consumers will be reluctant to reveal their true preferences as to how much

they value the good and would be willing to pay for it prior to its provision.

Just why do you think this is true?

That is, why don't consumers/citizens want to reveal how much they value a particular

public good?

For example, a bridge before that bridge is built.

Let's pause now as you try and solve this interesting riddle.

Well, the reason free rider consumers don't want to reveal their true

preferences is that they are fearful they might be taxed by that amount.

So for example, a person that really, really wants the bridge might be

forced to pay more than a person who would like to have the bridge built, but

doesn't really value its existence that highly.

Now here's the important implication of this observation.

Because consumers are reluctant to reveal their preferences, and

because of the Temptation to Free Ride, the market demand curve for

a public good is either non-existent or significantly understated.

As a result, the perceived demand for the public good fails to generate

enough revenue to cover the costs of production of the public good.

And this is so, even though the collective benefits

of the public good may well exceed the economic costs of building it.

[MUSIC]

We can easily illustrate the free rider problem with the help of our

cartoon team and the curious case of the missing flood control project.

>> It looks like it might be a very rainy year in the valley.

>> Yes, my parents are very worried that our ranch might get flooded again.

>> How come we never build that flood control project my parents are always

talking about?

We certainly need it.

>> Yes, we do need it, but nobody wants to pay for it.

>> And the grownups call us the ones who act like children.

>> Maybe the government can step in to help.

>> I hope so.

>> Me, too.

It would cost a lot less to build a flood control dam than it would to repair all

the damages from a major flood.

[MUSIC]

[NOISE] [MUSIC]

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