26|Part One|The Economic Basis of Government Activity

CHAPTER 4

Public Goods

INSTRUCTIONAL OBJECTIVES
Chapter 4 discusses the properties of public goods. The concept of a pure public good is developed and
contrasted with the concept of a pure private good. Many examples are given to help students understand
the important differences between these two types of goods. In addition, students are shown the impor-
tant distinction between the demand curves for pure public goods and pure private goods. Throughout
the chapter, the theory of externalities is applied to emphasize the fact that market provision of pure
public goods is unlikely to be an efficient alternative. Intermediate cases between pure public goods and
pure private goods are also analyzed. Congestible public goods and price-excludable public goods are
explicitly considered along with many examples of other intermediate cases. The goal here is to make
students aware of the fact that it is difficult to generalize about actual arrangements used to provide public
goods.
An important goal of this chapter is to derive the efficiency conditions for a pure public good. In
deriving these conditions, I emphasize the external benefit associated with the provision of pure public
goods. In this way, students see that consumption of a unit of a pure public good by any one person results
in external benefits to all others. A pure public good, therefore, requires the annual output up to the point
at which the sum of the marginal benefits of all consumers equals the marginal costs of making the good
available. The sum of the individual marginal benefits is the marginal social benefit of each unit of the
pure public good.
An extended numerical example dealing with the provision of security protection in a small com-
munity is used to derive the efficiency conditions and to illustrate a Lindahl equilibrium. The model of
cooperative supply for a pure public good shows the student how the efficient output of a pure public
good could be provided in a small community without government. It sets the stage for analysis of the
free-rider problem and provides a basis for understanding why government supply with compulsory
taxation emerges in large groups.

CHANGES IN THIS EDITION

The discussion of national defense and homeland security has been expanded. New data and estimates
are provided on defense spending as a share of GDP and the costs of the conflict in Iraq based on recent
empirical research.

CHAPTER OUTLINE
The Characteristics of Public Goods
Pure Public Goods and Pure Private Goods
An Example: Bread versus Heat
27|Part One|The Economic Basis of Government Activity

Provision of Private Goods and Public Goods: Markets and Government

Congestible Public Goods and Private Goods with Externalities
Education as a Public Good

The Demand for a Pure Public Good

Efficient Output of a Pure Public Good

A Numerical Example

Public Policy Perspective: National Defense and Homeland Security

A Cooperative Method of Efficiently Supplying Pure Public Goods:Voluntary Contributions and

Cost Sharing
The Lindahl Equilibrium
Generalizing the Results

The Free-Rider Problem

Compulsory Finance

International View: The Marginal Cost of the Persian Gulf War to the United States and How
International Cost-Sharing Financed It

MAJOR POINTS AND LECTURE SUGGESTIONS

1. Students easily catch on to the distinctions between pure public goods and pure private goods.
Television programming is an excellent example of a good that is nonrival in consumption. An
improvement in environmental quality through a reduction in air pollution provides a good example
of a good whose benefits are nonexclusive. You can also point out that the transactions costs of
excluding consumers depends on current technology. Improvements in technology can reduce the
transactions costs of pricing goods and thereby subject them to exclusion. A pure public good is
both nonrival and nonpriceable.

2. I believe that it is important to relate the theory of public goods to the theory of externalities. This
helps students understand why pure public goods are unlikely to be efficiently supplied through
markets. A pure public good is one whose market exchange would result in positive externalities to
all citizens of a nation.

3. I also like to emphasize that the nonrival characteristic of a pure public good implies that the mar-
ginal cost of accommodating an additional consumer is zero for a given quantity of the good. Use
Figure 4.1 in the text to make the distinction between the marginal cost of producing another unit of
the good and the marginal cost of allowing another consumer to enjoy a given quantity of the good.

4. Students like the bread versus heat example. To make the point more strongly, I usually adjust the
thermostat level in the classroom to emphasize that there is no way I can change the temperature
for myself without changing it for everyone else in the room.

5. When discussing the difference between demand curves for pure public and pure private goods,
point out that for private goods consumers have freedom to move along the quantity axis, given
price. For the pure public good, consumers must move along the quantity axis together.

6. Cooperative supply of pure public goods requires a means of allowing consumers to express their
valuation of additional units of pure public goods. The marginal social benefit of any given quantity
 Chapter Four|Public Goods|28

of a pure public good is the sum of the individual marginal benefits of all consumers. To achieve
efficiency, this must equal the marginal social cost of the good.

7. The security guard example is quite realistic. Some students may in fact live in condominiums where
the problem of providing security must be confronted and financed. I recommend going through the
example in class. I have been very careful in the text to point out that a persons tax is stated as a
certain amount per unit of the pure public good. Other texts are often sloppy on this point, and it
leads to endless student confusion. The total tax bill in equilibrium for each member of the commu-
nity is their tax per unit multiplied by the number of units supplied. The numerical example makes
this clear.

8. Students readily see that the Lindahl equilibrium is efficient. The Lindahl prices are tax shares per
unit of the public good equal to each persons marginal benefit at the output for which MSB = MSC.

9. The free-rider problem is intuitively obvious to students. Perhaps the best example to illustrate this
is the provision of public television and radio programming. It is clear that many beneficiaries of
these services choose not to contribute to financing the programming. Nonetheless, many viewers
and listeners do contribute. The analysis in the chapter alerts students to the fact that the free-rider
problem can be overcome. You should, however, point out to students that the free-rider problem
becomes more acute in large groups. This is because each participant realizes that withholding his
contribution is unlikely to have a significant effect on total output. As all reason this way, the
probability of no voluntary contributions becomes all the greater. Discussion of the free-rider
problem sets the stage for the analysis of compulsory taxation and the role of government in
supplying pure public goods.

10. The discussion of goods that fall between the extremes of pure public and pure private goods is
very pragmatic. The discussion and accompanying table alert students to the fact that in the real
world actual provision of goods by alternative means must be evaluated on an ad hoc basis. In class
emphasize the characteristics of congestible and price-excludable public goods and point out the
implications for efficiency.

TRUE /FALSE QUESTIONS

1. Bread is an example of a good that is nonrival in consumption. (F)

2. A pure public good is one for which it is easy to exclude consumers from benefits if they refuse to
pay. (F)

3. The marginal social cost of producing another unit of a pure public good will always be positive. (T)

4. To obtain a demand curve for a pure public good, the marginal benefit of each consumer must be
summed for each possible quantity produced per time period. (T)

5. If the efficient amount of a pure public good is produced, each person consumes it up to the point at
which his or her marginal benefit equals the marginal social cost of the good. (F)

6. In a Lindahl equilibrium, each consumer of a pure public good consumes the same quantity and
pays a tax share per unit of the good equal to his or her marginal benefit. (T)

7. If the marginal social cost of a pure public good exceeds its marginal social benefit, additional units
of the good can still be financed by voluntary contributions. (F)
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8. The free-rider problem is less acute in small groups than it is in large groups. (T)

9. A congestible public good is one for which the marginal cost of allowing an additional consumer to
enjoy the benefits of a given quantity is always zero. (F)

10. Television programming is a good example of a price-excludable public good. (T)

11. It is possible to price a pure public good and sell it by the unit. (F)

12. The demand curve for a pure public good is obtained by adding the quantities demanded by each
individual consumer at each possible price. (F)

13. A Lindahl equilibrium usually has each participant paying the same tax share per unit of a public
good even though their marginal benefit of that unit varies. (F)

14. Internet service is an example of a price-excludable public good. (T)

15. Clubs are a means of providing congestible public goods through markets. (T)

MULTIPLE CHOICE QUESTIONS

1. A pure public good is:
a. one that can easily be sold by the unit.
b. one that is nonrival in consumption.
c. one whose benefits are not subject to exclusion.
d. both (b) and (c)

2. The marginal cost of providing a certain quantity of a pure public good to an additional consumer
after it is provided to any one consumer is:
a. zero.
b. positive and increasing.
c. positive and decreasing.
d. positive and constant.

3. The nonrival property of pure public goods implies that the:

a. benefits enjoyed by existing consumers decline as more consumers enjoy a given quantity of
the good.
b. benefits enjoyed by existing consumers are unaffected as more consumers enjoy a given quan-
tity of the good.
c. good cannot be priced.
d. marginal cost of producing the good is zero.

4. The demand curve for a pure public good is:

a. a horizontal line.
b. obtained by adding the quantities individual consumers would purchase at each possible price.
c. obtained by adding the marginal benefit obtained by each consumer at each possible quantity.
d. the marginal cost curve for the pure public good.
 Chapter Four|Public Goods|30

5. The efficient output of a pure public good is achieved at the point at which:
a. the marginal benefit obtained by each consumer equals the marginal social cost of producing
the good.
b. the sum of the marginal benefits of all consumers equals the marginal social cost of producing
the good.
c. the marginal benefit of each consumer equals zero.
d. the marginal social cost of producing the good is zero.
e. both (c) and (d)

6. The monthly rental rate for a satellite dish antenna is $200. The maximum marginal benefit that
any resident of a condominium community will obtain per month from the antenna is $50. There
are 100 residents in the community, none of whom values the antenna at less than $25 per month.
Assuming that the antenna is a pure public good for residents of the community,
a. each resident of the community will rent his own antenna.
b. it is inefficient for the community to rent an antenna.
c. it is efficient for the members of the community to rent an antenna for their common use.
d. it is efficient for each resident to rent his own antenna.

7. In a Lindahl equilibrium,
a. each consumer purchases a pure public good up to the point at which his or her marginal bene-
fit equals the marginal social cost of the good.
b. each person pays a tax per unit of the pure public good equal to his or her marginal benefit.
c. the sum of the marginal benefits of all consumers equals the marginal social cost of the good.
d. both (a) and (c)
e. both (b) and (c)

8. The free-rider problem:

a. becomes more serious as the number of persons involved in voluntarily financing a pure public
good decreases.
b. becomes more serious as the number of persons involved in voluntarily financing a pure public
good increases.
c. is independent of the number of persons involved in a scheme to voluntarily finance a pure
public good.
d. does not prevent voluntary cooperation from efficiently providing pure public goods.

9. The marginal cost of making a given quantity of a congestible public good available to more con-
sumers is:
a. always zero.
b. positive and increasing.
c. positive and decreasing.
d. zero at first but eventually becomes positive and increasing.

10. Cable TV programming is an example of a:

a. congestible public good.
b. price-excludable public good.
c. pure public good.
d. pure private good.
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11. A major distinction between pure public goods and pure private goods is that:
a. pure private goods can easily be priced and sold in markets.
b. pure public goods can easily be divided into units.
c. pure public goods can only be collectively consumed.
d. both (a) and (c)

12. The principle of nonexclusion for pure public goods means that the benefits of the good:
a. are shared.
b. can be priced.
c. cannot be withheld from consumers even if they refuse to pay.
d. are not reduced to any one consumer when a given quantity is consumed by another.

13. Which of the following is true in a Lindahl equilibrium for cooperative supply of a pure public
good?
a. The sum of the tax shares per unit paid by each consumer is equal to the marginal social cost of
the public good.
b. The sum of the tax shares per unit paid by each consumer is equal to the marginal social benefit
of the good.
c. The sum of the tax shares per unit paid by each consumer is maximized.
d. both (a) and (b)

14. Which of the following is a good example of a congestible public good?

a. TV programming
b. a road
c. a loaf of bread
d. homeland security

15. Education is:

a. a pure public good.
b. a pure private good.
c. a good that has characteristics of both public goods and private goods.
d. not subject to the exclusion principle.

ESSAY QUESTIONS
1. Summer open-air concerts are a pure public good in a small town. The average cost of each concert
per night is constant at $500. Explain why it would be inefficient to require each resident of a com-
munity to hire their own orchestra at the $500 rate for each concert. Assuming that the marginal
benefit of the first concert is $25 for each of the 1,000 residents of the community, prove that it will
be efficient to have more than one concert per summer. If the concert were financed with voluntary
contributions, what conditions would have to prevail to achieve the efficient number of concerts per
summer?

2. The property of nonexclusion of a pure public good depends on the technology of pricing. Changes
in technology can make it possible to price goods and services that were previously unpriceable.
Suppose a new electronic device is available that can monitor the miles travelled by vehicles on
 Chapter Four|Public Goods|32

public roads. The device would be required on all vehicles and would make it feasible to price each
mile travelled at any rate. How would you determine the price of road services per mile to achieve
efficient road utilization?

ANSWERS TO TEXT PROBLEMS

1. a. 10
b. $2,000
c. zero
d. 2

2. The sum of the marginal benefits must equal the marginal cost in the Lindahl equilibrium. When
MC is increasing, MC > AC for any given quantity supplied. At the efficient level of output, the
sum of the contributions will be greater than AC. Because contributions per unit exceed cost per
unit, the total revenue collected will exceed the cost of making the good available, which is AC(Q).
Thus, there is a budget surplus.

3. At less than 50,000 vehicles per hour, no toll is required to achieve efficiency. When traffic rises
above 50,000 vehicles per hour, the toll should be set at the marginal congestion cost.

4. a. The demand curve shows how the sum of the marginal benefits of all consumers varies with
the number of concerts.
Number of Concerts MB
1 $975
2 $700
3 $425
4 $250
b. At a marginal cost of $1,000, it is efficient not to hold any outdoor rock concerts at all. At a
marginal cost of $425, the efficient number of concerts per summer is three.

5. The efficient number of concerts would be four; John would be charged $75, and Mary would be
charged $50, while Loren would pay $25 for each concert.