Public Goods, Common Resources and Merit Goods

Public Goods, Common
Resources and Merit

10
Goods
Copyright*©*2014*Cengage*Learning
“The best things in life are free. . .”
!Most goods in our economy are allocated in markets.

!Free goods provide a special challenge for economic
analysis.
!When goods are available free of charge, the market
forces that normally allocate resources in our economy
are absent.
“The best things in life are free. . .”
!In such cases, government policy can potentially
remedy the market failure that results and raise
economic well-being.
• public sector: part of the economy where business
activity is owned financed and controlled by the state
and goods and services are provided by the state on
behalf of the population as a whole.
• private sector: part of the economy where business
activity is owned financed and controlled by private
individuals.
THE DIFFERENT KINDS OF GOODS
!When thinking about the various goods in the

economy, it is useful to group them according to
two characteristics:
• Is the good excludable?
• Is the good rival?
Excludability and Rivalry
!Excludability
• Excludability refers to the property of a good
whereby a person can be prevented from using it.
!Rivalry
• Rivalry refers to the property of a good whereby
one person’s use diminishes other people’s use.
Types of Goods
Private Goods
o Are both excludable and rival.
Public Goods
o Are neither excludable nor rival.
Common Resources
o Are rival but not excludable.
Natural Monopolies
o Are excludable but not rival.
Figure 1. Four Types of Goods
Rival?
Yes No
Private/Goods Natural/Monopolies
Yes • Chocolates • The/fire/service

• Clothing • Cable/TV
• Congested/toll/roads • Uncongested/toll/roads
Excludable?
Common/Resources Public/Goods
No • Fish/in/the/ocean • Street/lighting
• The/environment • Flood/control/dams
• Congested/non?toll/roads • Uncongested/non?toll/roads
Copyright©2014>>Cengage
PUBLIC GOODS
!A free-rider is a person who receives the benefit of a

good but avoids paying for it.
The Free Rider Problem
!Since people cannot be excluded from enjoying the

benefits of a public good, individuals may
withhold paying for the good hoping that others
will pay for it.
!The free rider problem prevents private markets
from supplying public goods.
The Free Rider Problem
!Solving the Free Rider Problem

• The government can decide to provide the public
good if the total benefits exceed the costs.
• The government can make everyone better off by
providing the public good and paying for it with tax
revenue.
Some Important Public Goods
!National Defence
!Basic Research
!Fighting Poverty
The Difficult Job of Cost-Benefit Analysis
!Cost-benefit analysis refers to a study that

compares the costs and benefits to society of
providing a public good.
!In order to decide whether to provide a public good
or not, the total benefits of all those who use the
good must be compared to the costs of providing
and maintaining the public good.
The Difficult Job of Cost-Benefit Analysis
!A cost-benefit analysis would be used to estimate the

total costs and benefits of the project to society as a
whole.
• It is difficult to do because of the absence of prices needed
to estimate social benefits and resource costs.
• The value of life, the consumer’s time and aesthetics are
difficult to assess.
• Contingent valuations can be used.
o Willingness to pay
o Willingness to accept
The Optimal Provision of a Public Good
!Governments should continue to provide a public

good up to a point where the marginal benefit
gained from an extra unit provided is equal to the
marginal cost of providing that extra unit.
MSB=MC
Figure 2. Optimal Provision for a Public Good
(a)*Price*Inelastic*Supply
1.#Assume#there#are#only#two#consumers#who#
place#different#values#on#the#provision#of#a#
public#good#as#shown.#
2.#The#combined#values#of#their#individual#
demand#curves#make#up#the#MSB#curve#ABC.
3.#Optimum#provision#where#MC#crosses#MSB#
at#an#output#30.
Copyright©2014**Cengage
COMMON RESOURCES
!Common resources, like public goods, are not

excludable. They are available free of charge to
anyone who wishes to use them.
!Common resources are rival goods because one
person’s use of the common resource reduces other
people’s use.
Tragedy of the Commons
!The Tragedy of the Commons is a parable that

illustrates why common resources get used more
than is desirable from the standpoint of society as a
whole.
!Common resources tend to be used excessively
when individuals are not charged for their usage.
!This is similar to a negative externality.
Some Important Common Resources
!Clean air and water

!Congested roads
!Fish, whales and other wildlife
MERIT GOODS
Can be provided by the market
!Merit goods arise because consumers may have
imperfect information about the benefits of these
goods and are not able to value them appropriately
as a result.
• Merit goods can be provided by the market but may
be under-consumed as a result.
• Intertemporal choice where decisions made today
can affect choices facing individuals in the future
Education as a Merit Good
!Merit goods have two key benefits:
• Private benefits of education include career
prospects.
o Difficult to calculate private education benefits.
• Social benefits include better stock of human
capital.
o Individuals don’t take account of social benefits when
making decisions about their education, so left to the
private market education would be under-consumed.
Healthcare, Insurance and Pensions as Merit
Goods
!Individuals are bad at assessing risks especially
those in the future.
!Governments subsidize health and make laws
about insurance cover.
!Governments encourage savings for private
pensions.
De-merit Goods
!De-merit goods are over-consumed if left to the

market mechanism.
• They generate both private and social costs which
are not taken into account by the decision-maker.
!Alcohol has a private and social cost.
• Social cost includes health care and antisocial
behaviour.
• Governments can tax alcohol or make laws to help
control consumption.
Summary
Goods differ in whether they are excludable and
whether they are rival.
• A good is excludable if it is possible to prevent
someone from using it.
• A good is rival if one person’s enjoyment of the good
prevents other people from enjoying the same unit of
the good.
Summary
Public goods are neither rival nor excludable.
Because people are not charged for their use of
public goods, they have an incentive to free ride
when the good is provided privately.
Governments provide public goods, making
quantity decisions based upon cost-benefit
analysis.
Summary
Common resources are rival but not excludable.
Because people are not charged for their use of
common resources, they tend to use them
excessively.
Governments tend to try to limit the use of
common resources.
Merit goods are provided by the public sector but
are either over or under consumed.

Public Goods, Common Resources and Merit Goods

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Public Goods, Common Resources and Merit Goods

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Public Goods, Common

Resources and Merit

!Most goods in our economy are allocated in markets.

!When thinking about the various goods in the

Yes • Chocolates • The/fire/service

!A free-rider is a person who receives the benefit of a

!Since people cannot be excluded from enjoying the

!Solving the Free Rider Problem

!Cost-benefit analysis refers to a study that

!A cost-benefit analysis would be used to estimate the

!Governments should continue to provide a public

!Common resources, like public goods, are not

!The Tragedy of the Commons is a parable that

!Clean air and water

!De-merit goods are over-consumed if left to the

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