3._Public_Goods - Public Goods Textbook examples of public...

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Public Goods Public Goods Textbook examples of public goods are lighthouses, television entertainment, and national defense. 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 goods. 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: prices 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 nonrival. Using a price mechanism as a means of rationing becomes totally pointless.    Maximum Revenue $/user 500 1000 users Nonrivalry + Pricing = Deadweight Loss Marginal Benefit 5 Figure 4.1 Pricing generates revenue (up to $2500), but discourages beneficial use that could be generated without additional cost. 10 User Charge Lost Benefit The classic economic example, first analyzed by Jules Dupuit in 1844, is a bridge. Within 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
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surplus of 5000 (area under the marginal benefit curve). Surplus is reduced by 1250 if the 500 marginal users do not use the bridge. Although the people who comprise this group are clearly
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This note was uploaded on 05/09/2008 for the course ECN 212 taught by Professor Nancy during the Fall '07 term at ASU.

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3._Public_Goods - Public Goods Textbook examples of public...

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