Textbook examples of public goods are lighthouses, television entertainment, and national
Without dwelling on the examples, they are defined in terms of the absence of two key
characteristics: rivalry and excludability.
Rivalry implies that one person’s consumption
precludes consumption by anyone else. Excludability implies that suppliers (providers,
producers, owners) can withhold a private good from any potential consumer, typically those
who do not pay for it.
These two properties characterize private
They relate directly to
the basic question of why a price mechanism is efficient or important.
Prices serve three broad
purposes: (1) a rationing mechanism; (2) an incentive structure, and (3) a source of information.
Rivalry, Non-rivalry, and Rationing
The rationing purpose relates directly to the notion of rivalry and merits strong emphasis:
ration scarce goods to their highest valued uses
The economic assumptions embodied in this
proposition are that prices are competitively determined and that value is synonymous with
willingness to pay.
Accordingly, price will rise to a level such that high- and low-value
consumers identify themselves naturally and voluntarily by the simple acts of buying and
refusing to buy or by accepting and declining offers.
Without prices as a rationing device, some
potential value is lost as low-value replaces high-value.
Moreover, alternative means of
rationing (e.g., waiting in lines) may be far more costly.
All of this changes if the commodity is
Using a price mechanism as a means of rationing becomes totally pointless.
Nonrivalry + Pricing = Deadweight Loss
Pricing generates revenue (up to $2500), but discourages
beneficial use that could be generated without additional cost.
The classic economic example, first analyzed by Jules Dupuit in 1844, is a bridge.
bounds set by physical dimensions, large numbers of vehicles can utilize the bridge at negligible
cost – hence it is nonrival.
At relatively low cost, a barrier can be erected, enabling a controlling
authority to monitor and regulate use – thus, the bridge is excludable.
The simple purpose of the
barrier is to impose a price and collect revenues.
Given the hypothetical demand conditions
underlying Figure 4.1, a toll of $5 per person could generate revenues of $2500 (say, per day),
which might be sufficient to finance construction of the bridge.
Moreover, the 500 people who
use the bridge are the ones who place the most value upon using it.
The dilemma is that the toll also discourages use – 500 of the 1000 potential users choose to
forego the benefits.
At a user charge of zero, 1000 people would use the bridge, for an economic