Chapter 4.3 – Public Goods

By the end of this section, you will be able to:

  • Identify a public good using nonexcludable and non-rival as criteria
  • Explain the free rider problem
  • Identify several sources of public goods

 

Even though new technology creates positive externalities so that perhaps one-third or one-half of the social benefit of new inventions spills over to others, the inventor still receives some private return. What about a situation where the positive externalities are so extensive that private firms could not expect to receive any of the social benefits? We call this kind of good a public good. Spending on national defense is a good example of a public good. Let’s begin by defining the characteristics of a public good and discussing why these characteristics make it difficult for private firms to supply public goods. Then we will see how the government may step in to address the issue.

 

The Definition of a Public Good

Economists have a strict definition of a public good, and it does not necessarily include all goods financed through taxes. To understand the defining characteristics of a public good, first consider an ordinary private good, like a piece of pizza. We can buy and sell a piece of pizza fairly easily because it is a separate and identifiable item. However, public goods are not separate and identifiable in this way.

Instead, public goods have two defining characteristics: they are nonexcludable and non-rival. The first characteristic, that a public good is nonexcludable, means that it is costly or impossible to exclude someone from using the good. If Larry buys a private good like a piece of pizza, then he can exclude others, like Lorna, from eating that pizza. However, if national defense is provided, then it includes everyone. Even if you strongly disagree with America’s defense policies or with the level of defense spending, the national defense still protects you. You cannot choose to be unprotected, and national defense cannot protect everyone else and exclude you.

The second main characteristic of a public good, that it is non-rival, means that when one person uses the public good, another can also use it. With a private good like pizza, if Max is eating the pizza then Michelle cannot also eat it; that is, the two people are rivals in consumption. With a public good like national defense, Max’s consumption of national defense does not reduce the amount left for Michelle, so they are non-rival in this area.

A number of government services are examples of public goods. For instance, it would not be easy to provide fire and police service so that some people in a neighborhood would be protected from the burning and burglary of their property, while others would not be protected at all. Protecting some necessarily means protecting others, too.

Positive externalities and public goods are closely related concepts. Public goods have positive externalities, like police protection or public health funding. Not all goods and services with positive externalities, however, are public goods. Investments in education have huge positive spillovers but can be provided by a private company. Private companies can invest in new inventions such as the Apple iPad and reap profits that may not capture all of the social benefits. We can also describe patents as an attempt to make new inventions into private goods, which are excludable and rivalrous, so that no one but the inventor can use them during the length of the patent.

 

The Free Rider Problem of Public Goods

Private companies find it difficult to produce public goods. If a good or service is nonexcludable, like national defense, so that it is impossible or very costly to exclude people from using this good or service, then how can a firm charge people for it?

When individuals make decisions about buying a public good, a free rider problem can arise, in which people have an incentive to let others pay for the public good and then to “free ride” on the purchases of others. We can express the free rider problem in terms of the prisoner’s dilemma game, which we discuss as a representation of oligopoly in Monopolistic Competition and Oligopoly. When individuals make decisions about buying a public good, a free rider problem can arise, in which people have an incentive to let others pay for the public good and then, since once there is a provided public good it is available to all, to “free ride” on the purchases of others.

There is a dilemma with the Prisoner’s Dilemma, though. See the Work It Out feature.

 

WORK IT OUT

The Problem with the Prisoner’s Dilemma

Suppose two people, Rachel and Samuel, are considering purchasing a public good. The difficulty with the prisoner’s dilemma arises as each person thinks through his or her strategic choices.

Step 1. Rachel reasons in this way: If Samuel does not contribute, then I would be a fool to contribute. However, if Samuel does contribute, then I can come out ahead by not contributing.

Step 2. Either way, I should choose not to contribute, and instead hope that I can be a free rider who uses the public good paid for by Samuel.

Step 3. Samuel reasons the same way about Rachel.

Step 4. When both people reason in that way, the public good never gets built, and there is no movement to the option where everyone cooperates—which is actually best for all parties.

 

The Role of Government in Paying for Public Goods

The key insight in paying for public goods is to find a way of assuring that everyone will make a contribution and to prevent free riders. For example, if people come together through the political process and agree to pay taxes and make group decisions about the quantity of public goods, they can defeat the free rider problem by requiring, through the law, that everyone contributes.

However, government spending and taxes are not the only way to provide public goods. In some cases, markets can produce public goods. For example, think about the radio. It is nonexcludable, since once the radio signal is broadcast, it would be very difficult to stop someone from receiving it. It is non-rival, since one person listening to the signal does not prevent others from listening as well. Because of these features, it is practically impossible to charge listeners directly for listening to conventional radio broadcasts.

Radio has found a way to collect revenue by selling advertising, which is an indirect way of “charging” listeners by taking up some of their time. Ultimately, consumers who purchase the goods advertised are also paying for the radio service, since the station builds in the cost of advertising into the product cost. In a more recent development, satellite radio companies, such as SiriusXM, charge a regular subscription fee for streaming music without commercials. In this case, however, the product is excludable—only those who pay for the subscription will receive the broadcast.

Some public goods will also have a mixture of public provision at no charge along with fees for some purposes, like a public city park that is free to use, but the government charges a fee for parking your car, for reserving certain picnic grounds, and for food sold at a refreshment stand.

In other cases, we can use social pressures and personal appeals, rather than the force of law, to reduce the number of free riders and to collect resources for the public good. For example, neighbors sometimes form an association to carry out beautification projects or to patrol their area after dark to discourage crime. In low-income countries, where social pressure strongly encourages all farmers to participate, farmers in a region may come together to work on a large irrigation project that will benefit all. We can view many fundraising efforts, including raising money for local charities and for the endowments of colleges and universities, as an attempt to use social pressure to discourage free riding and to generate the outcome that will produce a public benefit.

 

Common Resources and the
“Tragedy of the Commons”

There are some goods that do not fall neatly into the categories of a private good or public good. While it is easy to classify a pizza as a private good and a city park as a public good, what about an item that is nonexcludable and rivalrous, such as the queen conch?

In the Caribbean, the queen conch is a large marine mollusk that lives in shallow waters of seagrass. These waters are so shallow, and so clear, that a single diver may harvest many conches in a single day. Not only is conch meat a local delicacy and an important part of the local diet, but artists use the large ornate shells and craftsmen transform them. Because almost anyone with a small boat, snorkel, and mask, can participate in the conch harvest, it is essentially nonexcludable. At the same time, fishing for conch is rivalrous. Once a diver catches one conch another diver cannot catch it.

We call goods that are nonexcludable and rivalrous common resources. Because the waters of the Caribbean are open to all conch fishermen, and because any conch that you catch is conch that I cannot catch, fishermen tend to overharvest common resources like the conch.

The problem of overharvesting common resources is not a new one, but ecologist Garret Hardin put the tag “Tragedy of the Commons” to the problem in a 1968 article in the magazine Science. Economists view this as a problem of property rights. Since nobody owns the ocean, or the conch that crawl on the sand beneath it, no one individual has an incentive to protect that resource and responsibly harvest it. To address the issue of overharvesting conch and other marine fisheries, economists typically advocate simple devices like fishing licenses, harvest limits, and shorter fishing seasons. When the population of a species drops to critically low numbers, governments have even banned the harvest until biologists determine that the population has returned to sustainable levels. In fact, such is the case with the conch, the harvesting of which the government has effectively banned in the United States since 1986.

 

Positive Externalities in Public Health Programs

One of the most remarkable changes in the standard of living in the last several centuries is that people are living longer. Thousands of years ago, scientists believe that human life expectancy ranged between 20 to 30 years. By 1900, average life expectancy in the United States was 47 years. By 2015, life expectancy was 79 years. Most of the gains in life expectancy in the history of the human race happened in the twentieth century.

The rise in life expectancy seems to stem from three primary factors. First, systems for providing clean water and disposing of human waste helped to prevent the transmission of many diseases. Second, changes in public behavior have advanced health. Early in the twentieth century, for example, people learned the importance of boiling bottles before using them for food storage and baby’s milk, washing their hands, and protecting food from flies. More recent behavioral changes include reducing the number of people who smoke tobacco and precautions to limit sexually transmitted diseases. Third, medicine has played a large role. Scientists developed immunizations for diphtheria, cholera, pertussis, tuberculosis, tetanus, and yellow fever between 1890 and 1930. Penicillin, discovered in 1941, led to a series of other antibiotic drugs for bringing infectious diseases under control. In recent decades, drugs that reduce the risks of high blood pressure have had a dramatic effect in extending lives.

These advances in public health have all been closely linked to positive externalities and public goods. Public health officials taught hygienic practices to mothers in the early 1900s and encouraged less smoking in the late 1900s. Government-funded many public sanitation systems and storm sewers because they have the key traits of public goods. In the twentieth century, many medical discoveries emerged from government or university-funded research. Patents and intellectual property rights provided an additional incentive for private inventors. The reason for requiring immunizations, phrased in economic terms, is that it prevents spillovers of illness to others—as well as helping the person immunized.

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Agribusiness Management 101 by William Rossman is licensed under a Creative Commons Attribution 4.0 International License, except where otherwise noted.

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