CHAPTER CHECKLIST

When you have completed your study of this

chapter, you will be able to
1 Distinguish among private goods, public goods, and
common resources.
2 Explain the free-rider problem and how public
provision can help to overcome that problem.
3 Explain the problem of the commons and review the
possible solutions to that problem.
 10.1 CLASSIFYING GOODS AND RESOURCES

What is the essential difference between:

• A city police department and Brinks security
• Fish in the Atlantic Ocean and fish in a fish farm
• A live concert and a concert on television
These, and all goods and services can be classified
according to whether they are excludable or
nonexcludable and rival or nonrival.
 10.1 CLASSIFYING GOODS AND RESOURCES

Excludable
Excludable
A good, service, or resource is excludable if it is
possible to prevent a person from enjoying its benefits.
Nonexcludable
A good, service, or resource is nonexcludable if it is
impossible to prevent a person from enjoying its
benefits.
 10.1 CLASSIFYING GOODS AND RESOURCES

Examples of excludable items are:

• The services of Brinks security
• Fish in a fish farm
• A live concert
Examples of nonexcludable items are:
• The services of the city police department
• Fish in the Atlantic Ocean
• A broadcast television signal
 10.1 CLASSIFYING GOODS AND RESOURCES

Rival
Rival
A good, service, or resource is rival if its consumption by
one person decreases its consumption by other people.
Nonrival
A good, service, or resource is nonrival if its consumption
by one person does not decrease its consumption by
other people.
 10.1 CLASSIFYING GOODS AND RESOURCES

Examples of rival items are:

• The services of Brinks security
• Fish both in ocean and in a fish farm
• A seat at a live concert
Examples of nonrival items are:
• The protection provided by a city police
department
• A broadcast television signal
 10.1 CLASSIFYING GOODS AND RESOURCES
A Four-Fold Classification
Private good
A good or service that can be consumed by only one
person at a time and only by those people who have
bought it or own it.
Public good
A good or service that can be consumed simultaneously
by everyone and from which no one can be excluded.
 10.1 CLASSIFYING GOODS AND RESOURCES
A Four-Fold Classification
Common resource
A resource that is nonexcludable and rival—can be
used only once but no one can be prevented from using
what is available.
Natural monopoly
A good or service that is nonrival but excludable—can
be produced at zero marginal cost.
 10.1 CLASSIFYING GOODS AND RESOURCES

Figure 10.1
shows this
four-fold
classification
of goods and
services.
 10.1PUBLIC
10.2 PUBLIC GOODS
GOODS AND FREE RIDER PROBLEM

The Free-Rider Problem

Public goods create a free-rider problem.
Free rider
A person who enjoys the benefits of a good or service
without paying for it.
Because of the free-rider problem, the market would
provide too small a quantity of a public good.
To produce the efficient quantity, government action is
required.
 10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

The Marginal Benefit of a Public Good

The benefit a public good provides is the value of its
services.
Because satellite services are nonrival and
nonexcludable, they are a public good.
• Everyone consumes the same quantity of them.
To find the economy wide value of the satellites, we
add together the marginal benefits of everyone in the
economy.
 10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

Figure 10.2 shows how to

find an economy’s MB curve.
Lisa’s marginal benefit curve
is MBL.
Max’s marginal benefit curve
is MBM.

The MB curve for the

economy is the vertical sum
of the marginal benefit
curves of everyone in the
economy.
 10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

The Marginal Cost of a Public Good

Marginal cost increases as the quantity of satellites
produced increases—the principle of increasing
marginal cost.
So the marginal cost curve of satellites slopes upward.
 10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

The Efficient Quantity of a Public Good

Resources are used efficiently if marginal benefit equals
marginal cost.
If marginal benefit exceeds marginal cost, resources can
be used more efficiently by increasing the quantity
produced.
If marginal cost exceeds marginal benefit, resources can
be used more efficiently by decreasing the quantity
produced.
 10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

Figure 10.3 shows the efficient

quantity of a public good.

1. If MB exceeds MC, an increase

in the quantity will make
resource use more efficient.

2. If MC exceeds MB, a
decrease in the quantity will
make resource use more
efficient.
 10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

3. If MB equals MC, resource

use is efficient.

4. The efficient quantity is 200

satellites.
 10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

Private Provision
No one would have an incentive to buy his or her share
of the satellite system—the free-rider problem.
So a private firm would not supply satellites.

Public Provision
The political process determines the quantity of a
public good provided.
 10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

Figure 10.4(a) shows the

preferences of two political
parties in an election.

1. Doves would like to provide

100 satellites.

2. The Hawks would like to

provide 300 satellites.
 10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

Figure 10.4(b) shows an

efficient political outcome.

3. The political outcome is 200

satellites because, unless
each party proposes 200
satellites, the other party can
beat it in the election.
 10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

Principle of Minimum Differentiation

Principle of minimum differentiation
The tendency for competitors to make themselves
identical to appeal to the maximum number of clients or
voters.
 10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

The Role of Bureaucrats

Bureaucrats translate the choices of politicians into
programs and control the day-to-day activities that
deliver public goods.
The behavior of bureaucrats modifies the political
outcome.
Rational Ignorance
The decision not to acquire information because the
marginal cost of doing so exceeds the expected
marginal benefit.
 10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

Why Government Is Large and Grows

Government grows in part because the demand for
some public goods increases at a faster rate than the
demand for private goods.
Two possible reasons are:
• Voter preferences
• Inefficient overprovision
 10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

Voter Preferences
As voters’ incomes increase, the demand for many
public goods increases more quickly than income.
These goods include:
• Highways; air-traffic control systems; public health;
education; and national defense.
Inefficient Overprovision
• The goal of budget maximization combined with
voters’ rational ignorance might explain the
expanding government budgets.
 10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

Voter Backlash
A backlash against government programs might force
politicians of all parties to embrace smaller and leaner
government.
Privatization of the production of public goods might
also counter the tendency for government budgets to
grow.
 10.3 COMMON RESOURCES

The Problem of the Commons

The problem of the commons is the absence of
incentives to prevent the overuse and depletion of a
commonly owned resource.
Examples include the Atlantic Ocean cod stocks, South
Pacific whales, and the quality of the earth’s
atmosphere.
The traditional example from which the term derives is
the common grazing land surrounding middle-age
villages.
 10.3 COMMON RESOURCES

Figure 10.5 illustrates

production possibilities
from a common
resource.
As the number of fishing
boats increases, the
quantity of fish caught
increases to some
maximum.
Beyond that maximum,
the sustainable catch
decreases.
 10.3 COMMON RESOURCES

Figure 10.6 shows why a

common resource get
overused.
1. The average catch per boat,
which is the marginal private
benefit, MPB, decreases as
the number of boats
increases.
2. The marginal cost per boat
is MC (assumed constant).
 10.3 COMMON RESOURCES

3. Equilibrium occurs where

marginal private benefit,
MPB, equals marginal cost,
MC.

In equilibrium, the resource is

overused because no one
takes into account the effects
of her/his actions on other
users of the resources.
 10.3 COMMON RESOURCES

The Efficient Use of the Commons

The quantity of fish caught by each boat decreases as
the number of boats increases.
But no one has an incentive to take this fact into
account when deciding whether to fish.
The efficient use of a common resource requires
marginal cost to equal marginal social benefit.
 10.3 COMMON RESOURCES

Marginal Social Benefit

Marginal social benefit is the increase in total fish catch
that results from an additional boat, not the average
catch per boat.
Table 10.1 on the next slide shows the calculation of
marginal social benefit.
 10.3 COMMON RESOURCES

Boats Total Catch MSB

A 0 0
90
B 1 90
70
C 2 160
50
D 3 210
30
E 4 240
 10.3 COMMON RESOURCES

Efficient Use
Figure 10.7 illustrates the
efficient use of a common
resource.
1. The marginal social benefit
curve, MSB, is below the
MPB curve.
2. The resource is used
efficiently when MSB
equals MC.
 10.3 COMMON RESOURCES

Achieving an Efficient Outcome

It is harder to achieve an efficient use of a common
resource than to define the conditions under which it
occurs.
Three methods in use are:
• Property rights
• Quotas
• Individual transferable quotas (ITQs)
 10.3 COMMON RESOURCES

Property Rights
By assigning property rights, common property becomes
private property.
When someone owns a resource, the owner is
confronted with the full consequences of her/his actions
in using that resources.
The social benefits become the private benefits.
 10.3 COMMON RESOURCES

In Figure 10.7, the marginal

social benefit curve, MSB,
becomes the marginal
private benefit curve.
The resource is used
efficiently because the
owner of the resources is
best off when MSB equals
MC.
 10.3 COMMON RESOURCES

Quotas
By assigning setting a
production quota at the
efficient quantity, a
common resource might
remain in common use but
be used efficiently.
Figure 10.8(a) shows this
situation.
It is hard to make a quota
work.
 10.3 COMMON RESOURCES

Individual Transferable Quotas

An individual transferable quota (ITQ) is a production
limit that is assigned to an individual who is free to
transfer the quota to someone else.
A market emerges in ITQs.
If the efficient quantity of ITQs is assigned, the market
price of a quota confronts resource users with a marginal
cost that equals MSB at the efficient quantity.
 10.3 COMMON RESOURCES

Figure 10.8(b) shows the

situation with an efficient
number of ITQs.
Marginal cost rises from
MC0 to MC1.
Users of the resource make
marginal private benefit,
MPB, equal to marginal
private cost, MC1, and the
outcome is efficient.