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191T13

# 191T13 - ECON191(Spring 2009 5.2009(Tutorial 13 Chapter 14...

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1 ECON191 (Spring 2009) 5.2009 (Tutorial 13) Chapter 14 Externalities and Public Goods (Chapter 18 of Textbook) Public goods s Public goods : goods that are jointly consumed by more than one individual b A person can derive utility from the consumption of public good without lowering the consumption and utility of others b Example: Clean environment, national defense s Total social benefit from a given amount of public good is the sum of the benefits derived by all consumers Lindahl’s solution How should the production cost of the public good shared by the individuals? Equal share is not good as consumers’ utilities from consuming a public are not the same s At X’, Person 1 is willing to pay s 1 and Person 2 is willing to pay (1 – s 2 ). The total cost is for producing X’ is not fully covered. s 1 + (1 – s 2 ) <1 s At X^, Person 1 is willing to pay s 2 and Person 2 is willing to pay (1 – s 1 ). The total cost paid for producing X’ is more than the cost required. S 2 + (1 – s 1 ) >1 X* s The societal demand curve for public good, which shows the total benefits of the public good is obtained by vertical summation of individual demand curve b (How about the market demand for private good? Horizontal summation) s Given constant MC, the optional quantity is X* MC and Demand Good X Societal demand DD 2 DD 1 MC P 2 P 1 P 1 + P 2 s s = share of total cost paid by Person 1 b s = Price of X to Person 1 (i.e. the amount Person 1 is willing to paying for X) s (1 – s) = share of total cost paid by Person 2 b (1 – s) = Price of X to Person 2 (i.e. the amount Person 2 is willing to paying for X) s Assuming both parties honestly reflect their preferences , Lindahl’s solution suggests that Person 1 pays s* and Person 2 pays 1 – s*, and both consume the same level of X* S* X 1 DD 2 DD 1 0 1 X* X 2 S 1 S 2 X’ X^

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2 s The Lindahl’s solution is arrived under the assumption that both parties truly reflect their preferences. b People have incentive to misinterpret their preferences in order to pay a lower share of the total cost b It may end up in a lower production level of the public good which is lower than the socially optimal level X*, and everybody will be worse off b Privatization would be one of the way to resolve the problem Strategic behavior: Demand revealing mechanism s In the Lindahl solution, people will have incentive to misrepresent their preferences,
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191T13 - ECON191(Spring 2009 5.2009(Tutorial 13 Chapter 14...

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