Public Goods

Definition
Public good: purely public if nonexcludable $ nonrival in consumption
Nonexcludable: all consumers can consume the good
Nonrival: each consumer can consume all of the good
Ex. broadcast radio & TV programs
- national defense
- reductions in air pollution
- national parks
Reservation Prices
consumers reservation price: max willingness-to-pay for unit of good
o wealth: w
o utility of not having good: U(w,0)
o utility of paying p for good: U(w p, 1)
o reservation price r:
U(w,0) = U(w r,1)
When

Should a Public Good be Provided?

1 unit good costs c
2 consumers A & B
individual payments for providing public good gA & gB
o if good is to be provided: gA + gB > c
payments = individually rational

o
o

each individ pays no more than their reservation $

if individs are better off paying for and having the public good
Pareto-Improving to supply the unit of good
provision of public good to be Pareto-efficient

Private Provision of a Public Good?

Suppose rA > c & rB < c
o A would supply the good even if B made no contribution
o B enjoys good for free; free-riding
Suppse rA < c & rB < c
o Neither A nor B supply the good alone
o If rA + rB > c also, Pareto-improving for the good to be supplied
o A & B may try to free-ride on each other no good to be supplied
Variable Public Good Quantities
Ex. how many broadcast TV programs, how much land to include in national park
c(G) = production cots of G units of public good
individuals A & B
private consumption: xA, xB
budget allocation must satisfy:
xA + xB + c(G) = wA + wB
MRSa & MRS b are As & Bs MRS between private and public goods
o Pareto-efficiency condition for public good supply (Samuelson condition)

o Public good is nonrival in consumption; extra 1 unit is fully consumed by A & B

Suppose MRSa + MRSb < MC(G)
o MRSa = As utilities-preserving consumption in private good units for 1 unit reduction in
public good
o Same with B
o MRSa + MRSb total payment to A & B of private good that preserves both utilities of G is
lowered by 1 unit
o Making 1 less public good unit releases more private good than the compensation payment
requires pareto-improvement from reduced G

Suppose MRSa + MRSb > MC(G)

o MRSa + MRSb total payment by A & B of private good that preserves both utilities if G is
raised by 1 unit pareto-improvement from increased G
Hence
n consumer efficient public good production requires

*MANY external Benefits Collective Consumption Goods (Public Goods)

good each unit of which simultaneously provides benefit for several people
potentially each square kilo of park can provide benefit
the different people do NO need separate, private areas
o ALL of them can collectively consume same area of park
Park ex of a good that is non-rivalrous in consumption collective consumption

2 questions:
1. should park be made available? (social perspective)
some quantity of park such that the SUM os all benefits > cost of making oark
available
YES that quantity
2. how much parkland?
What is socially optimal (pareto-efficeint) quantity of parkland to provide?
What is optimal amount of a good that provides a +ve externality (spillover benefit)?
Add benefits to ALL CONSUMERS and then find that quantity of park where total
benefit > total cost by largest amount
Want to find Qpark to maximize total surplus

Collective Consumption example

Cost of provision of park
o Opp cost of NOT clearing this land and using it for something else
Total cost of parkland per time period
TC(L) = 2000 + 1000L + 200L^2
L = unit (km^2); 2000 per period
Total benefit per period to a single individual i
TBi(L) = 25000L 100L^2
Single individ optimal amount of park to provide quantity at which surplus total benefit
total variable cost is maximized
Optimal amount of parkland is found by maximizing choice
o Slope = 0
OR
Marginal benefit = MC &
find L

Suppose there are 2

people:
o Same benefit
o to find optimal L
slope set = 0
set MB = MC & find implicit

3 people:

socially-efficient amount of park to provide

o add benefits to all users and then find amount of park that
maximizes surplus
o = to finding amount of park which SUM od individ MB
intersect the MC function
o the more users greater the amount of park that is
provided

Collective Consumption Goods: Exclusion

park consumed by anyone, whether or nor consumer has contributed anything its cost
2 problems:
1. if someone can consumer public good w/o paying anything for it free-riders
2. we have no independent revelation of peoples values of benefit from public goods b/c
consumers do not have to purchase good before consuming it
Collective Consumption Goods: Free Riding
individuals care about PRIVATE net benefits
o individually rational actions (that max expected private net benefit) result in reduction in
social net benefit (collective net benefit)
o if individs can free-ride amount of public good provided can be collectively too little
PAYOFF matrix prisoners dilemma)
Payoff matrix
o 2 players
o 50 A and 50 B 50 separate but identical parcel of parkland
preserves anonymity but still allow us to use 2 x 2 matrix
Game

Theory
amount of park size 5km (L = 5), or no park provided
if anyone states that they want the park, park will be provided
cost of provision will be collected pro rata (in proportion) from those stating that they want park
o 1 player states a want for park entire cost will be collected from that player
o both state they want the park half cost will be collected from each
determine net benefits of each:
1. player A state want the park; B stat doesnt want A pays ALL of the cost
2. player B stats want the park ; A states doesnt want B pays ALL of the cost
3. both players state they want the park cost is split evenly b/w them
4. neither states a preference for park park NOT provided and neither has to pay anything

compute total benefit of a 5km^2 to single player & compare to total cost of provision:

o net benefit to single player paying entire cost of park = 10,000 12000 = -2000
cost shared equally b/w 2 players
o total benefit of 5km^2 park to single player & compare HALF the total cost of provision:
o

net benefit to each person (collectively consumed) = 10000 6000 = $4000

What should each player reveal as preference
for park?
- A: depends no only on As actions but
also B
- (stated preference) also (pref
reveleation)
- reward each is affected by action of
other

nash equilibrium: socially sub-optimal since social surplus is higher

when both state what they want

Free Riding: Inefficient Outcomes

free-riding leads to social inefficient quantities of collective-consumption goods
o even when a +ve quantity is actually provided
o Wilderness park 3 potential users
All have identical willingness to pay
Issue:
What are individ net benefits and social surplus if these are not al revealed
honestly
Total benefit of all 3:
Total cost:
Optimal L from before = 6.5 km^2

Cost of provision divided evenly surplus/person more than $7000

o Net benefit per person (after paying $2000) = $6375

1/3 lies about value of park worth nothing

sum of STATED benefit = sum of only 2 benefit
functions
STATED social MB:

MC = MB 5 units

1 person would lie:

o TBi same as before
o
2 who reveal benefit (willingness to pay) honestly are charged with half the cost of
park (before 12000 so honest pays 6000)
net benefit = 4000 (honest people
net benefit of liar = total benefit (no cost)
rd
if 3 person reveled benefit honesly shared net benefit = 6375

Efficient Public Good Supply the Quasilinear Preferences

Case
2 cosnumers

utility-max requires:

is public good demand/marg utility curve; i =

A,B

Free-Riding Revisited
when is free-riding individually rational?
o Can contribute positively to public good supply nobody can lower the supply level
o Individual utility-max may require lower public good level
Given A contributes gA units of public good, Bs problem :
subject to
x private good
w = wealth

Demand Revelation
Scheme that makes it rational for individuals to reveal truthfully their private valuations of a public
good is a revelation mechanism
Ex. Groves-Clarke taxation scheme
N individuals
All have quasi-linear preferences
Vi = individual is ture (private) valuation of public good
Individ i must provide Ci private good units of the public good is supplied
Ci = contribution of individ i to public good

Ni = Vi Ci net value
for i = 1 N
- pareto-imporivng to supply the public

good if:

if sum of net values (total values cost) is +Ve

then individual j is pivotal (changes the supply decision)

what loss does a pivotal individual j inflict on others?

o

all others together value public good at less than the amounts they would have to pay
for it
forcing good to be provided imposes losses on everyone else

all others value the public good at more than their respective shares cost
individ i prevents the goods provision, individ causes all others to lose a net benefit

Demand Revelation
for efficiency a pivotal agent must face the full cost/benefit of her action
GC tax scheme makes pivotal agents face the full stated costs/benefits of their actions in a way
that makes these statements truthful
GC Tax Scheme:
o Assign cost Ci to each individ
o Each agent states public good net valuation Si (may not be truthful)
o Public good supplied if:
otherwise not

Pivotal person j who changes the outcome from supply to not supply Pays a tax of
Pivotal person j who changes the outcome from not supply to supply Pays tax of
o *taxes arent paid to other individuals, but to some other agent outside market

Demand Revelation, Clarke Tax Ex

3 people, A,B,C
valuations of public good: $40 A, $50 B, $110 C
cost of supplying good = $180
$180 < 40 + 50 + 110 = $200 efficient to supply good

assign c1 = 60 , c2 = 60, c3 = 60
B & Cs net valuations sum to
o (50 60) + (110 60) = $40 > 0
A,B & Cs net valuations sum to
o (40 60) + 40 = 20 > 0
A is not pivotal
If B & C are truthful what net valuation Sa should A state?
o If Sa > -40 A makes supply of public good, & loss of $20 to him (net payoff of -$20)
o A prevents supply by becoming pivotal
Sa + (50 60) + (110 60) < 0
ex. A must state Sa < -40

Then A pays Clarke tax of

-10 + 50 = $40
As net payoff when lying = -40
As net payoff when truthful = -20
A cant do better than state the truth Sa = -20

assign c1 = 60 , c2 = 60, c3 = 60
A & Cs net valuations sum to
o (40 60) + (110 60) = $30 > 0
A,B & Cs net valuations sum to
o (50 60) + 30 = 20 > 0
B is not pivotal

what net valuation Sb should B state?

o If Sb > -30 B makes supply of public good, & loss of $10 to him (net payoff of -$10)
o B prevents supply by becoming pivotal
Sb + (40 60) + (110 60) < 0
ex. B must state Sb < -30
o Then B pays Clarke tax of
-20 + 50 = $30
Bs net payoff when lying = -30
Bs net payoff when truthful = -10
B cant do better than state the truth Sb = -10

assign c1 = 60 , c2 = 60, c3 = 60
A & Bs net valuations sum to
o (40 60) + (50 60) = -30 > 0
A,B & Cs net valuations sum to
o (110 60) - 30 = 20 > 0
C IS pivotal

(dont want public good)

what net valuation Sc should C state?

o Sc > 30 changes nothing
o C stays pivotal & pays Clarke tax of
-(40 60) (50 60) = $30 (=losses imposed on A & B)

net payoff
o (110 60) 30 = 20
o Sc < 30 less likely that the public good will be supplied
No public good
C saves $60 cost
C loses the $110 benefit of public good
Cs net payoff now = $0 (<$20 payoff if truthful)
C cant do better than state of truth Sc = $50

Clarke tax scheme implements due to taxes removing private good (money) from pivotal
individuals
o Ri = voter i reservation price
o Voters equally share the cost c of a discrete public good
o Each voter states a net value Si
Public good is provided
otherwise it is not provided
is pivotal if changes the vote by stating a net value which is
> in abs value
&
of opposite sign to
sum of all other voters states values
pivotal voter pays Clarke tax = to abs value of all voters stated value
o result: all voters reveal honestly by stating
Si = Ri c/n
public good is provided if an only if it is efficient to do so
o
Voter
o
o

ex.

Another Clarke Tax example

assumptions:
o 4 voters each has an income of 500
o Ui = Yi + AiG
A1 = 30, a2 = 40, a3 = 45, a4 = 100
o 2 levels of public good provision : G = 0, G = 1
o reservation prices: Ri = Ai
o cost of public good: c = 200
o voter share of cost c/4 = 50

Problems with Clarke Tax

some people are made worse off as a result of Clarke tax decision (persons 1,2,3 in prev ex)

Clarke tac ant be allocated to people voting level of private good consumption is not at Pareto
efficient level