Welcome back to the last week the Power of Markets course.

In our last few sessions,

we'll focus on Public Goods and Externalities.

Two cases that militate for government action,

provide the opportunity for government intervention to improve efficiency.

Now, two characteristics of public goods to keep in mind.

One, there are nonrival in consumption,

the same good can provide benefits to multiple individuals take the case of

national defense where a missile or

a submarine can benefit more than just one person in a country,

or police protection can benefit.

The other characteristic is nonexclusion,

public goods are cases where it's prohibitively costly or

impossible to limit one person's consumption of a good.

Now, there's certain goods that are nonrival in consumption

or it's still possible to exclude certain individuals.

Take the case of a wallstreetjournal.com.

Once the informations on the website that information can benefit in

particular Wall Street Journal stories or New York Times stories multiple individuals.

And yet both The Wall Street Journal and The New York Times and

other papers have figured out a way to create a paywall,

how to exclude individuals from accessing that information from the Website.

So, there are cases where not both of

the characteristics of supply and if exclusion is possible,

and then we have nonrivalness in consumption but not a public good,

because exclusion is possible.

A Free Rider Problem comes into play,

when we have public goods.

Public goods economists believe will tend to be under provided.

Why? Because multiple people benefit and may not

have the incentive to pay for additional provision of the good.

Take the case of a construction of a dam that benefits potentially 10 households.

And each household let's assume,

will benefit $200,000,

if the dam is constructed and there 10 household.

So, the cumulative benefit from

flood protection across these 10 households is 2 million dollars.

And let's also assume that the cost is one million to build the dam,

the dam still might not get built.

Why? Because each household has an incentive to

let the other households make the payments do the work.

Why throw in my two hundred thousand,

if there are at least five other households that would

contribute enough to get the dam built.

The problem is exacerbated,

the more members in the group,

say instead of 10 households,

there were a thousand households.

Each receiving $2,000 in benefit if the dam gets built,

your $2,000 will make virtually no impact on the dam getting built.

So, this is for those that are

familiar with the Chicken Little story, the childhood story,

where everybody has an incentive for the bread to get baked and yet,

also has an incentive to shirk to not do the work along the way.

The Free Riding Problem is more severe,

the more members there are,

the potentially benefit in the group.

The few applications of this,

the novel of Stephen King in the year two thousand,

decided to publish online of new book called The Plant.

And he said look, I'll keep publishing so long

as each individual pays one dollar per chapter,

and I get at least 75% of readers accessing the material to kick in $1.

After a few chapters,

Stephen King had to give up on the experiment,

only 43% of the individuals accessing,

were paying the $1 taxes and he couldn't figure out a way to exclude the non-payers.

Several decades prior, General Motors faced a similar problem,

where for 30 to 50 dollars,

sorry, for $20 per car.

If a car buyer paid that amount,

It would reduce air pollution by 30 to 50%.

So, the benefits would be immense,

if every car buyer had been willing to pay that $20,

but because it wasn't mandated every individual had an incentive to free ride,

very few people bought this submission control device for $20

and virtually none of

the potential benefits were realized in terms of lower overall pollution.

What's the efficient level for providing a public good?

And what we'll see in the next figure is involves

vertically summing the marginal benefits,

all the different consumers from a public good get from that public good.

And let's look in particular and figure 20.1.

Let's assume there are only two consumers in this case, Ted and Jane.

So subscript T and subscript J,

but both of them end up benefiting from submarines getting produced.

And you can't exclude one once the submarine is built,

you can't exclude Jane's receiving the benefits from that submarine.

You couldn't tell an enemy look leave Ted alone,

but just end up inflicting damage on Jane.

So, nonexclusion is characterized

as well as nonrivalness in this particular case by the good.

For the first submarine to figure out

the total benefits that these two individuals derive from this first submarine,

we have to vertically sum the marginal benefit Jane derives

$250 with the marginal benefit Ted derives $400,

so, the height of the cumulative marginal benefit curve,

the social marginal benefit,

is everywhere above the individual demand curves.

So long as or out to the point where the benefits to Jane becomes zero.

So, we vertically sum to derive the total the cumulative marginal benefit.

What's the official level of output?

It's where the cumulative benefit ends up we want each submarine

produced that the cumulative benefit at least

equals the marginal cost of providing that submarine.

Ten submarines.

Now, how do we end up paying for those 10 submarines,

in an ideal world we charge what Ted,

is willing to pay three hundred twenty five and what Jane is willing

to pay the height of her marginal benefit 175 and between the two of them,

we end up collecting five hundred dollars for that incremental submarine.

Now, getting individuals to truthfully reveal what they're willing to pay is a challenge,

especially, in cases like this where there's an incentive to free ride.

The government of China figured out a novel way to do

this centuries ago where it said look you're going to reveal or

tell us how much your house is worth when

we go about figuring out the taxes we're going to levy

and we reserve the option to buy your house that

the value that you reveal for your house.

So, that scheme ended up promoting

more truthful revelation when it came time to measuring

the wealth and how much benefit

an individual gut from government service in that particular case in China.

Now, when we look at efficiency in production and consumption,

by looking at the sum by

the vertical summation of marginal benefits comparing to marginal cost,

we end up promoting efficiency in production.

The one condition for efficiency that isn't met is efficiency in consumption,

because the marginal benefit to Ted,

doesn't end up equaling the marginal benefit to Jane.

Since we can't exclude Jane or Ted,

once a submarine gets built from

realizing the benefits and it doesn't make any sense too,

the satisfaction of the efficiency and

consumption condition is not important in the situation.

Public goods also highlight the debate

over patents and providing an incentive to encourage innovation.

Any innovation, whether it's a cure for AIDS or a cure for cancer,

we'll have a public goods component,

that information will benefit multiple people once somebody comes up with the idea.

As a way to spur innovation,

because if everybody shares that benefit,

there may not be any incentive to

undertake the research project to come up with the innovation.

So that's where patent law providing the innovator

a certain period in the US 17 years to benefit

from that information of exclusive rights to

sell that patented and benefit from that patent information comes about.

At the heart of the patent problem is a public goods problem.

So we've covered public goods in the session,

next sessions will turn to externalities.

Externalities and Public Goods

The Power of Markets III: Input Markets and Promoting Efficiency

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