I'm going to skip responding to your longer post and respond to this, since it captures the essence of your concerns there anyway. If you don't think an individual can have accurate knowledge of his willingness to pay for a good, you basically can't claim that the market works, but that's another story.

Take your example of a contractor and a businessman negotiating over a contribution toward building a road. Suppose the contractor starts will an absurdly high price (to which the businessman will surely say no), and slowly brings the price down. At some point, the businessman will go from saying no to saying yes. There is some price point that is his maximum willingness to pay (perhaps the addition of that word will help clarify the concept?).

Right, because it's equally easy for an individual to value a tangible candy bar exactly like a hundred others he has eaten and an intangible public good that does not even exist yet.

Sure. But there is also some price where the assurance firm will tell him to **** off. And if the assurance firm has a better idea of what the good will actually be worth, they will have an advantage in the negotiations.

mjkidd,

you're adding a lot of issues that aren't germane to the discussion. Actually, both Scolar and I have noted that the price does not affect the welfare of society. In fact, what is going on is that in your situation, the two parties have reservation prices (you seem to be indicating this is so, from your "some price where the assurance firm will tell him to **** off" line)

As far as this complication goes, who is better at negotiations and get the more favorable price does not affect the efficiency of the market.

But imperfect information is a fact of life. You still haven't shown why we should be particularly concerned in the arena of public goods. Many public goods are actually very tangible goods that people have experience with (e.g. a park, a police force, firefighters). Whereas many things that are the basis of capitalism, such as R&D into new technologies are huge gambles that we have much difficulty in evaluating.

How is this true? If the assurance firm is able -- through appealing to notions of pride, civic mindedness, outdoing your neighbor, etc -- to get people to contribute more to the project than it is actually worth to them, wouldn't it lead to overproduction of the public good? The contributor is giving for dual reasons, gaining pride and production of the public good. If he gives double what he might if the assurance contract was anonymous, it seems clear to me that it would lead to overproduction of the good.

This is true. Again, though, I'm not sure how this is a problem exclusive to public goods. If an advertiser, say Axe or Old Spice, appeals to notion of manliness and makes false promises of sex appeal, doesn't this lead to over-production of their products? Sure. The solution is to try to give one another the tools to better evaluate the utility of goods and services, because that's all we can do short of trying to ban deceptive advertising practices.

I initially thought in your negotiations you were just talking about the price of the transaction.

I recall some work on advertising, where a similar question came up--it was trying to figure out the welfare effects on society of advertising. Question was, which demand curve to use, the one pre-advertising or post-. It came down to a question of what was really represented in the demand curves. But in this case, I think it's obvious what should be used. The question I would ask to show you which should be used is: why are you placing a distinction between two things that gives the consumer some benefit? I am taking the stance that I shouldn't tell the consumer what the consumer ought to value. So if the consumer gains some benefit from having his name attached to something, that is a benefit to the public good, just like being able to use the public good.

I was mostly just saying that it is silly to think that the individual contracting with the assurance firm would necessarily have better knowledge than the firm, and that people duping the firm by underreporting their valuation is of significant concern. Particularly for goods like roads or firefighting where the value is not as subjective as some other goods might be.

Right. I initially brought this up because someone said that even if everyone who used a good enters into an assurance contract, this doesn't eliminate the free rider problem. I objected to calling systematic underpayment of the assurance contractor a free rider problem. It is just the assurance firm asking it's clients for a price that is other than the socially perfect one.

There is no 'socially optimal price'.

Edit to add: thinking about this in terms of price will just lead to mistakes.

I'm still not sure I understand. If the firm providing firefighting services is a in a better position to judge their worth, isn't that an argument for just taxing people and using the money to provide firefighters? That's a practical, brute force solution to the problem of public goods, but I doubt it's one that would find much support around here.

The problem with strategic underreporting is underproduction. The fact that people are not very good at judging the value does not necessarily change this, because some people might undervalue it in their own minds, and thus their underreporting would cause even more severe underproduction. Now you are trying to argue that people will be more likely to overvalue the public good, rather than undervalue it, but I'm not yet persuaded. If you want to continue taking this up, I do think it's pretty interesting.

Can you quote me some of this discussion? I didn't read the LC thread portion, so I may be missing something here. If everyone who uses the good pays for it, I agree that this eliminates the "free rider" problem, though I also agree that it does not necessarily eliminate the problem of many people paying less than they are willing, leading to underproduction (someone termed this the "easy rider" problem, I believe).

Is there a socially optimal amount of the public good being produced? Because different prices will result in different amounts of the good. Put another way, assume all parties who will use a public good enter into an assurance contract. In one scenario the bids on the assurance contract are private. In another they are public, and some of the participants are actually more interested in showing up their neighbors than bidding a fair price for the good. Now, in the latter case more of the good is produced. Has the socially optimal amount of the good changed.

In the two cases you've provided, one could say the good has changed. The first is just the public good. The second is the public good *plus* the acknowledgment of the contributed amount. Or you're buying a bundle of goods--the public good and the acknowledgment of the amount, which is a private good. I don't think it is a good idea to just ignore the extra benefits (from the private good of your name on a list of significant contributors) given to the contributors of large (or any) amounts.

People will try to pay as little as possible, sure. But my point is that the assurance firm isn't going to be all "oh this good is worth five cents to you? Swell, thanks for paying your share!". They might say, look, this is how we determined your share, based on what we project your benefit to be. If you contribute, we will apply the same model to others, and will only build when we've convinced x others.

Well in that case there is no free rider problem, since you are ignoring the joy I get from free riding, which exceeds the value I place on the public good. There are two goods here, the public good and the joy I get from sticking it to suckers who pay their fair share.

I guess if you want to redefine everything so that it works out for you, go ahead. As I said, maybe it's a way to think about the issue.

But in any case, you could have underproduction or overproduction depending on how the good is funded. It's still a problem that needs to be addressed. I could go on to be just as ridiculous as the above by saying I gain a huge amount of happiness from making you pay whatever the hell I feel like.

Ok. Not really seeing the problem here.

I thought that you were saying that the optimal amount of the public good changed between the secret and public bids, sorry if that's not what you meant.

But you're right that there are two goods being purchased in the public bid assurance contract. However this is irrelevant, as there are two goods with the free rider as well. The free rider gets to keep his money. In both cases the wrong amount of public good is being produced.

some of these issues are complicated. I was thinking that might be a good way of thinking about it, but it turns out not to be. The mechanism that you described just happens to make the public good overproduced.

I think I now agree with this.

.

I'm not really saying there is a problem, I'm saying that I think the solution to the problem of individuals having incentives to try to undersell their true valuation of public goods to assurance firms is the assurance firm doing market research. Research which may in fact give the firm more knowledge about how much an individual would benefit from the public good than the individual himself has.

I think it's worthwhile though to try to just analyze the utility that directly flows from a given public good as opposed to secondary effects from the act of paying or avoiding paying. So when we look at, say, a charitable organization that works with troubled youths and helps them become productive and fulfilled individuals, the direct effect is that society benefits from having less discontent, less crime, less moral anxiety over people in prison, and so forth. The indirect benefit that an individual gains from the knowledge that they have donated to a worthy cause, or that another individual gains from the knowledge that he is cleverly avoiding donation, can be satisfied in any number of ways. In fact, so long as any social work is done, the donor and sneak both would appear to achieve their utility.

Now the question that we are trying to answer in this thread is how to achieve the optimal level of social work for troubled youth. And this is not the same as asking what level of social work will society be best off with, because the imperfection of information means that we are necessary gambling with any course of action, as you have astutely pointed out. Rather, if some information aggregator were to give a best estimate for the amount of social work that we should have going forward, will we achieve that level? Shane and Sholar are arguing that there will be systemic underproduction of social work because many individuals will choose not to donate, or will donate less than they think they would benefit from having social work be done.

What I am suggesting is essentially that if we look at the world in a more continuous fashion, the underreporting problem is less of a problem, because people will pledge money little by little. And because most projects are not either/or propositions, underreporting may only lead to some fractional underproduction, but it shouldn't generally lead to no production or massive underproduction. I haven't actually worked this out in a game theoretic sense, but it seems plausible to me. I'm actually much more concerned with the fact that people don't recognize the inordinate benefit that could or is derived from various public goods, because the cause-and-effect of having a clean environment or a healthy and happy populace is quite difficult to trace. The cause-and-effect of a cheeseburger is relatively simple, so people consume goods that immediately satisfy their desires rather than invest in public goods. This is, however, a sociological or cultural problem, not an economic one, strictly speaking.

Exactly.

A rational person does not pay more for a good than what it is worth to him. If pride matters, then that's just something else being sold. Think of it as part of the good.

Exactly. How the surplus is split doesn't matter. When surplus isn't generated because the transaction doesn't happen -- that's the problem.

And yes, I did say that even if there is no externality, there is still the problem of underproduction.

Good post. But I don't know how to measure the "actual value" of the good to a person, other than through their private valuation. Otherwise the result is someone else telling me that he knows better than I do what a candy bar is worth to me. That road leads to madness.

Price doesn't matter. Levels of production do. If a buy something from you, we are both better off. What price we settle on impacts how much better off we are individually (a higher price means that you capture more of the surplus).

If you value the object less than I do, and I buy if from you, we reach the socially optimal result, regardless of price (in particular, even if I pay more than what the good is worth to me). Otherwise (i.e., no transaction), the outcome is inefficient.

At any rate, we aren't talking about public goods. Time for a "Markets, Efficiency, and Rationality: Containment Thread".