Chapter 4

Public Goods
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 Public Goods

▪ Public Goods are goods for which

exclusion is impossible.
▪ One example is National Defense: A
military that defends its citizenry from
invasion does so for the entire public.

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 Characteristics of Public Goods
▪ Nonexclusion: The inability of a seller to
prevent people from consuming a good when
they do not pay for it.

▪ Nonrivalry: The characteristic that if one

person “consumes” a good, another person’s
pleasure is not diminished nor is another
person prevented from consuming it.

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 Pure Public Goods and
Pure Private Goods
▪ Pure Public Good: There is no ability to
exclude and there is no rivalry for the
benefits.
▪ Pure Private Good: There is a clear
ability to exclude and there is rivalry for
the benefits.

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 Marginal Costs for Provision of
Public Goods
▪ The marginal cost of allowing
another person to benefit
from a pure public good is
zero while the marginal cost
of a greater level of public
good is positive.
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 Figure 4.1 Marginal Costs of Consuming and Producing a
Pure Public Good-Figure A

200
Cost (Dollars)

Marginal Cost of Allowing an

Additional Person to Consume a
Given Quantity of Pure Public Good

0 1 Number of Consumers
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 Figure 4.1 Marginal Costs of Consuming and Producing a
Pure Public Good--Figure B

Marginal Cost of Producing

a Pure Public Good
200 MC = AC
Cost (Dollars)

0 Units of a Pure Public Good per Year

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 Example
Bread versus Heat
▪ Bread – Clearly a pure private good
because there is the ability to exclude
and there is rivalry.

▪ Heat – Clearly a pure public good

because there is no ability to exclude
and there is no rivalry.
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 Provision of Private Good and
Public Goods: Markets and
Government

▪Price Excludable Public Goods

vs
▪Congestible Public Goods

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 Price Excludable Public Goods
Excludability but no rivalry

▪ Another type of good is a price-

excludable public good: no rivalry but
exclusion is easy.

Examples: Country Clubs, Cable TV

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 Congestible Public Goods
Rivalry but no excludability

▪ There are public goods where, after a

point, the enjoyment received by the
consumer is diminished by crowding or
congestion. These are called
Congestible Public Goods.
▪ Examples: roads and parks

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 Figure 4.2 A Congestible Public Good
Marginal Cost

Marginal Cost per User

0 1 Number of Consumers per Hour

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 Table 4.1a Alternate Means of Producing, Distributing, and
Financing Goods and Services
CHARACTERISTICS MEANS OF MEANS OF METHODS PUBLIC PRIVATE
OF THE GOOD OR PRODUCTION DISTRIBUTION OF EXAMPLE EXAMPLE
SERVICE FINANCE
Pure Private Goods Privat e f irms; Market s; direct unit Revenue Food; Government
No ext ernalit y; government charge f rom sales clot hing; liquor st ores;
low-cost exclusion cars government
t obacco
monopoly
Government ; No direct unit charge; Taxes Government
privat e f irms eligibilit y t o consume dist ribut ion of
under cont ract various amount s medical services
wit h government det ermined polit ically and f ood t o low
income cit izens
Price-Excludable Privat e f irms; Market s; direct unit Revenue Schools; Transit f acilit ies;
Public Goods government charge ( may be f rom hospit als; public hospit als
Ext ernal benef it s subsidized) sales; t ransport a
when produced or t axes t ion
consumed; low-
cost exclusion
Government ; No direct unit charge; Taxes Public schools;
privat e f irms consumpt ion available or public
under cont ract required only at sanit at ion;
wit h government collect ively chosen inoculat ions
quant it y and qualit y
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 Table 4.1b Alternate Means of Producing, Distributing, and
Financing Goods and Services

CHARACTERISTICS MEANS OF MEANS OF METHODS OF PUBLIC PRIVATE

OF THE GOOD OR PRODUCTION DISTRIBUTION FINANCE EXAMPLE EXAMPLE
SERVICE
Congest ible Public Privat e f irms; Fees f or t he right t o Revenue Clubs; Public golf
Goods government use t he f acilit y sold in f rom sales t heat ers; courses; roads
Collect ively market s amusement
consumed benef it s parks;
subject t o sport ing
crowding; event s
possibilit y of
exclusion
Government ; No direct user charge Taxes; Public parks;
privat e f irms ( or part ial charge) revenue f rom public recreat ion;
under cont ract sales roads, bridges
wit h
government
Pure Public Goods 1 . Privat e f irms; No direct unit charge; Fees; Privat e Public t elevision
Collect ively government quant it y dependent on cont ribut ions charit y and radio Nat ional
consumed benef it s 2 . Government ; amount collect ed Taxes def ense;
not subject t o privat e f irms No direct unit charge; environment al
crowding; high- under cont ract quant it y and qualit y of prot ect ion
cost exclusion wit h service collect ively
government chosen

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 Figure 4.3 Classifying Goods According to the Degree of
Rivalry and Excludability of Benefits from Their Use

A
1
C

B
0 1
Rivalry

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 Demand For a Pure Public
Good
▪ Demand for a Pure Private Good is
derived by adding quantities at each
price.
▪ Demand for a Pure Public Good is
derived by adding how much people will
be willing to pay at each quantity.

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 Price per Loaf of Bread (Dollars)
Figure 4.4 Demand For a Private Good

7
6
5
4
E S = MC = AC
3 D = QD
DC = MBC
2 DB = MBA
DA = MBA
1

0 1 2 3 4 5 6 7 8 9 10
Loaves of Bread Purchased per Week
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 Figure 4.5 Demand For A Pure Public Good

800
Marginal Benefit (Dollars)

Z1
700
Z2
600
500 Z3
400 Z4
300 DA= MBA
200 DA = MBA
DB = MBB
100 DC = MBC
0 1 2 3 4 5
Security Guards per Week
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 Figure 4.6 Efficient Output for a Pure Public Good

800
Marginal Benefit (Dollars)

700
600
500 E MC = AC = MSB
400
DA= MBA = MSB
300
200 MBA
MBB
100 MBC
0 1 2 3 4 5
Security Guards per Week
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 Efficient Output of a
Pure Public Good
▪ The socially optimal level of the public good
requires that we set the Marginal Social
Benefit of that good equal to its Marginal
Social Cost. MSB = MSC
▪
▪ Lindahl Pricing: Everyone in a group
cooperates and pays their marginal benefit.
▪ We can demonstrate this issue mathematically,
numerically (using a table), and graphically.

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 Mathematically
Recall from Figure 4.5 that the marginal
social benefit for a pure public good is the
sum of the individual marginal benefits.
That is: MSB = MB.

Efficient output is therefore:

MSB = MB = MSC.

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 Numerically
▪Suppose we have three
people who are discussing
the issue of hiring security
guards. Note that each
person places a different
value on the levels of
security.
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 A Numerical Example
Number of Security Guards per Week
1 2 3 4
MBA $300 $250 $200 $150
MBB $250 $200 $150 $100
MBC $200 $150 $100 $50
MB $750 $600 $450 $300
If the cost of security guards is $450 per week, then no individual will
hire even one guard, even though to group one is worth $750. The
group should hire three.
If they pay their marginal benefit, then three guards are hired. Person
A pays $600 ($200 per guard), person B pays $450 ($150 per guard)
and person C pay $300 ($100 per guard).
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 The Peace Dividend
▪ National Defense is the classic pure public
good.
▪ Defense spending as a percentage of GDP
▪ Fell from above 8 percent during the Vietnam era
to just above 5 percent in the late 1970s;
▪ Grew during the Reagan defense buildup of the
1980s;
▪ Fell below 5 percent with the demise of the Soviet
Union.

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 Public Policy Perspective: Defense Purchases as a
Percentage of GDP, 1966–1999
11
10
Percentage of GDP

9
8
7
6
5

1966 1971 1976 1981 1987 1993 1999

Year
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 Lindahl Equilibrium
▪ The amount each person contributes, ti,
depends on their individual desires for
the public good.
▪ The sum of the contributions equals the
total cost of the public good.
▪ tiQ* = MC(Q*) = AC(Q*)
▪ ti = MC = AC
▪ All individuals agree to pay their share.

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 Freeriding
▪ Freeriding occurs when people
are not honest in stating their
Marginal Benefit because if they
understate it, they can get a
slightly reduced level of the public
good while paying nothing for it.

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 Freeriding is easier with
▪ Anonymity: If everyone knows who
contributes, there can be powerful social
stigmas applied to shirkers.

▪ Large numbers of people: It’s easier to

determine the shirkers in a small group and
the punishment is more profound when
people close to you shun you.

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 Illustrating Voluntary
Contributions to a Public Good:
The Gulf War
▪ Under the premise that defeating Iraq in the
Gulf War was a public good to be consumed
by the industrialized economies and Arab
nations, each nation was expected to
contribute.
▪ The U.S. and UK contributed the bulk of the
fighting forces.
▪ Saudi Arabia, Kuwait, the UAE, Japan, and
Germany voluntarily paid $54 billion of the
estimated $61 billion cost.
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