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Public Goods, Externality, and Free Riders: Containment Thread
I'd like to excise the discussion of the random public goods-related topics from the low content thread. So that this post has some content, a brief summary.
If Mises.org is your primary source for learning economics, you will certainly have some misconceptions. If you reject that possibility, then this thread is probably not for you. Mostly, this should be a place for people who are willing to learn stuff to ask questions. A brief review of the words in the title -- Wikipedia is as always a decent source. Public Good -- a good which is non-rivalrous (infinitely consumable) and non-excludable (all have access). Like such ideal goods don't exist, but to the extent that a good is like a "public good" the theory of public goods applies. Note that these are properties of the good. Who produces them is immaterial -- private actors can and do produce public goods, and state can and do produce goods which are not public goods. Also note the possibility that one can make a similar good which is excludable is not always relevant. These are just different goods. (A walled garden is not a public garden.) Externality -- a property of transactions, this is a cost or benefit which is incurred by a third party. Free Riders -- people can benefit from stuff without paying for it. What is the free rider problem? That public goods don't get produced (aren't produced to optimal levels) because people who are willing to pay to have the good produced figure that they can get the benefit without paying, and so don't. Finally, I'll conclude with these words of Coase: "All solutions have costs and there is no reason to suppose that government regulation is called for simply because the problem is not well handled by the market or the firm." That's to get us started... |
Re: Public Goods, Externality, and Free Riders: Containment Thread
Originally Posted by Sholar
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Re: Public Goods, Externality, and Free Riders: Containment Thread
Also, how is a free rider not someone benefiting from an externality? He is a third party not involved in a transaction benefiting from that transaction.
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Re: Public Goods, Externality, and Free Riders: Containment Thread
I've got sort of a cute example/illustration to start things off. And the government is nowhere to be found in it!
Suppose there is afirm looking to provide a particular public good. It can be supplied in different levels (say in hour long increments). Two people in town, Alice and Bob. Their actual values--also known as marginal benefits (and willingness to pay for the good) along with the firm's marginal cost per hour are listed below Hours........Alice......Bob....Marginal Cost 1...........$18.......$10..........$2 2...........$16........$9..........$5 3...........$14........$8..........$8 4...........$12........$6..........$11 5...........$10........$4..........$14 6...........$8..........$3..........$17 So here, the optimal amount of the public good would be 5 hours, with Alice paying $10 and Bob paying $4. The marginal cost of providing that fifth hour equals the marginal benefit, which is the decision making metric which maximizes social welfare (it maximizes consumer surplus plus producer surplus). Now suppose Alice is a lying bitch :). She under reports her willingness to pay for this public good by $7. Now, the firm can only supply four hours of protection, and collects $5 from Alice and $6 from Bob for their good. Is this in Alice's best interest? well, she loses the 5th hour of the public good, which means she loses something she values at $10. But instead of paying $50 (5 hours x $10/hr) she pays only $5/hour x 4 hours, or $20. So she is better off by $30, so she has incentive to lie, and to cause underproduction. Note: the demand curve in this case makes it so the firm may want to under-produce if it is a monopoly (another market failure), but the willingnesses to pay could be adjusted to make the demand curve more inelastic so that the firm--even if it is a monopoly--will want to produce as much of the good as possible (possible meaning that the money/hour it can collect is greater than the Marginal cost) |
Re: Public Goods, Externality, and Free Riders: Containment Thread
Also, sholar, do you agree with DrModern when he said in the LC thread that I have the definitions of public good and externality "weirdly tangled?"
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Trouble is that in the Block article, Block either was confused or redefining common economic terms. The definition of a private good has nothing to do with whether or not an externality exists. |
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In some sense, Alice is paying less than she should, which causes underproduction of the good since she lied in order to pay a smaller amount. |
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Externality is a property of the transaction. Public Good is a property of the good. Second, I don't know if it's a problem of definitions, necessarily. It's also related to how people misuse those terms when discussing "the problem of public goods" which is much, much more about "the problem of free riders" than it is "the problem of externality". "to the extent that bread is a source of external economies it is a public good" makes the mistake of confusing the two ideas. Talking about the value of the (positive) externality of a public good, for example, in this exchange, is what causes that reaction: Quote:
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The problem of free riders doesn't disappear by asking those people to join the transaction (which removed the externality). Compare this to the problem of (negative) externalities, which is solved by incorporating everyone into the transaction (hence the stuff about Coase). |
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I didn't see his statements about people arguing for government intervention. My own view is that you could come up with at least three alternatives once you know about the problem with public goods. 1. Gubmint provision 2. Ignore the problem (or at least know how big the problem that you've decided to live with is.) 3. Try to come up with novel ways of dealing with the problem. The third alternative may include second-best solutions, or actually first-best solutions with 'weird' ways of asking and collecting money from people. It's been a while, but I remember some strange rules when asking people how much they're willing to pay and then deciding how much they should pay that result in better allocations. |
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And actually, in my example, the firm was able to perfectly price discriminate to determine the optimal level of the good. Alice paid $10 and Bob $4 in the optimum. Finally, I'd say that price discrimination doesn't really have anything to do with public goods. I replied to you to help, but this is sort of a tangent to the main thrust of the thread. |
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If the market were -- magically, through clever mechanism design, whatever -- able to get everyone to contribute enough to produce the efficient outcome, then we wouldn't speak of a "free rider problem". |
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I'm not sure why you bring it up. The producer of the public good is welcome to use price discrimination or any other mechanism. |
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If it were provided at that level, it is because Alice, Bob or both of them lied about their willingness to pay for the good. In other words, one or both of them is not paying their marginal benefit of the last unit of the good. In a perfectly competitive market (with a private good) they are--there are mechanisms built into such markets that ensures this happens. But in the example with Alice and Bob paying $5.50, they aren't. And that's the crux of the problem...not that they're paying the same or different amounts. Rather, the price that they are paying is not equal to that good's marginal benefit, and in the public goods problem there are incentives making this better for the individual. In a Perfectly competitive market, the incentives cause the price to be equal to the marginal benefit of the last good. |
Re: Public Goods, Externality, and Free Riders: Containment Thread
First, let me make an important general comment: how the costs are distributed are completely irrelevant to whether the level of production is allocatively efficient (e.g. no Kaldor–Hicks improvement is possible).
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To recap: in the original example, the fifth hour would be produced in an efficient outcome because the marginal benefit (A=10, B=4) equals the marginal cost (C=14). (The total cost of provisioning all five hours would be 2+5+8+11+14=40.) However, if A had a marginal benefit of $7 less in each case (as she was representing), only the fourth hour would be produced in an efficient outcome (A' = 12-7=5, B=6, C=11). In total, the first four hours cost 26. If A and B paid the same amount, they would pay 13 each. How the costs are distributed are completely irrelevant to whether the marginal production was efficient. (In addition, the phrasing that they each pay 5.50 for the fourth hour is a bit unfortunate, as paying 5.50 violates the declared incentive constraints for A', who expressed a marginal benefit of 5. I prefer not to complicate the discussion by elaborating.) |
Re: Public Goods, Externality, and Free Riders: Containment Thread
As I predicted, Sholar's explanations are better than mine were. This is not super easy to grasp or to explain. I hope this thread is helpful for you, mjkidd (no sarcasm).
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Re: Public Goods, Externality, and Free Riders: Containment Thread
Scholar and ShaneP:
Have you read that book yet? |
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IE, I agree with everything Scolar wrote about the example above. So if you were confused by something I miswrote or erred slightly, and you understand what Scolar wrote, well, just go with him, since we are saying the same thing. Or at least trying to :) Edit: I was also assuming that A and B will pay the firm the same in aggregate to the firm for each hour purchased. Thus, the price per hour would be determined by the last hour provided, and every hour would cost that amount. In the case of truth telling, the fifth hour would be the last, and the price per hour would be $14. But as you said (and I said earlier as well) regardless of how the price is determined, the welfare gain of society increases. If A and B own the firm (government) and they only pay the firm's cost, then all the gain is by consumers. If the firm is a perfectly price discriminating firm and charges $28 for the first hour, $25 for the second and so on, then all the gain is by the producers. But as long as 5 hours are provided, the producer plus consumer surplus is maximized and will be unaffected by the price. |
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BTW, I think/hope the book just falls under my third alternative (figure out what to do about the public goods/free rider problem). From what you said about it, it does. |
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