Public Finance, Econ 132, Foldvary

Holcombe, Chapter 5

Collective consumption good: non-rival.

Excludabile: impossible to exclude.

E.g. TV broadcast and cable programs.

The cable is an individually used good; the program is a public good.

Whether a good is rival depends not on the physical good but on the amount of use.

E.g. highways.

More users make a collective good more crowded, but sometimes this is welcomed.

Sometimes existing users might actually enjoy the good more if more other people were using it. Drivers on a deserted highway in an unpopulated area might prefer driving if more other drivers used the road.

Spectators at a sporting event or rock concert might enjoy the show if more fans were present. Up to some point, additional congestion may benefit users of a public good.

In that case, the good is still non-rivalrous.

But when crowding is undesirable, such as a crowded road,

every extra user generates a negative externality.

Another car slows down traffic for others,

or makes parking spaces less available,

so the good becomes rival.

Policy analysis should be comparative.

P. 91: Argument for public-sector production

Cable movies: marginal cost per user is zero.

But it has a fixed cost.

Perfect price discrimination would charge each his maximum willingness to pay,

but the company cannot know the maxima.

Should government provide free movies?

It is similar to move theaters:

so long as seats are empty, the cost of one more viewer is zero.

Should government provide movie theaters for free?

Is private provision inefficient? A market failure?

Another way to look at it: users pay a rental to be located there during that time.

Many firms charge admission as a rental. WDW.

The relevant marginal cost is the next film or performance.

Cable or satellite: one pays admission to a club.

Broadcast TV has not MC per show, paid by ads.

If the service, free to users, raises the land rent,

then it would be more efficient to provide it free,

paid for by the rent it generates.

If the service does not generate rent equal to the cost,

then a user charge is efficient, because that is the best we can do.

It is not inefficient to not do what is impossible.

P. 93: the argument for private sector production

The price paid by customers indicates the value of the service to them.

If a service is free, we can know how many are using it,

but can we know the value of the service to the customers?

We can if the service generates rent.

We can also use demand revelation.

Otherwise, we don’t know, and so charging a fee will

provide information on the value of the service.

We need information on value to know whether to produce the good.

E.g. how much should government spend on education, and do the preferences of parents matter?

In a static sense, customers are best served with free goods, but dynamically,

markets can better determine the best use of resources in the future.

P. 95: The Optimal Output of a Collective Consumption Good

Market demand = total demand .

For individually used goods, sum quantities.

For collective goods: market demand is the vertical sum of individual demands,

at the collective quantity, which is also the individual quantity.

Optimal amount in principle is the quantity for which

the marginal social cost = marginal social value.

The vertically-added demands equal the MC of the public good.

P. 96: Lindahl pricing.

The model by Erik Lindahl 1919, Swedish economist

A Lindahl tax: each person pays his maximum willingness to pay, his marginal benefit.

But how to find the marginal willingness to pay?

Rent solves the problem for territorial goods, but only for the whole package.

Demand revelations shows willingness to pay, but that is not what persons pay.

P. 99: Public Policy Toward Collective Consumption Goods

Private sector suppliers must charge for their output, which limits use, but

if the charge is a rental, this does not limit use, because that is the market price to be there.

P. 200 Non-excludability

Complete nonexcludability means that it is physically impossible to exclude persons,

to prevent persons from using a good, or to expel a person who is using a good.

There can be a public demand for free access to an excludable good such as a sidewalk.

The physical impossibility involves a reasonable cost.

Economy-wide collective goods such as defense are excludable because

only those in U.S. territory are being defended.

Also, some persons within the territory are excluded from protection.

American Indians were attacked, not defended.

Most public service are non-excludable by choice.

There is also territorial exclusion by cost,

as those far away do not use it because of the cost of the trip.

The prisoner’s dilemma, part of game theory.

One basic game is called the prisoners' dilemma.

The story is that there are two thieves who get caught.

They are partners in crime, but they don't care about each other.

They are questioned in separate rooms.

If one confesses and the other does not, the confessor gets 1 year and the other 15 years in prison.

If they both confess they get 10 years.

If neither confesses, they get a lesser charge, and only 3 years in prison.

The incentive is for both to confess.

Confessing is the dominant strategy.

During the Cold War, the arms race was also a prisoners' dilemma.

Advertising another example.

Free riding for a collective good is an application.

Can we overcome the prisoner’s dilemma in paying for national defense?

Clubs such as homeowners’ associations solve it withe mutual contracts.

p. 104: Public Policy toward Public Goods

Computer software is produced privately

even though distribution is non-rivalrous and usually easy to copy.

p. 106: Public goods do not need to be produced or even assisted by government.

Henry George theorem in public finance.

The public revenue that provides for the optimal amount of collective goods equals the land rent of that community.

The utility function is U(G,X), where G is a collective and X a private good.

Output Y is a function of N workers: Y = f(N) = XN + G.

Y = f(N) = XN + G. Then:

(1) ∂f/∂N = X  

(2) X = {f(N)-G} / N

(3) ∂f/∂N = {(f(N)-G)/N}

(4) G = f(N) - Nf’(N)

R (rent) is the difference between total product Y and total wages:

(4) R = f(N) - Nf'(N) = G.

A community chooses the level of public goods that maximizes land rent.

Land value maximization leads to an efficient amount of public goods.