blanchard_ch15 - 9160335_CH15_p335-350.qxp 6/22/09 9:07 AM...

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: 9160335_CH15_p335-350.qxp 6/22/09 9:07 AM Page 335 15 Public Goods and Common Resources After studying this chapter, y ou will be able to: ■ Distinguish among private goods, public goods, and common resources ■ Explain how the free-rider problem arises and how the quantity of public goods is determined ■ Explain the tragedy of the commons and its possible solutions What’s the difference between the Los Angeles Police Department and Brinks Security, between fish in the Pacific Ocean and fish produced by a Seattle fish farm, and between a live U2 concert and a show on network television? Why does government provide some goods and services such as the enforcement of law and order and national defense? Why don’t we let private firms produce these items and let people buy the quantities that they demand in the marketplace? Is the scale of species? Must the price of fish inevitably keep rising? What provision of these government-provided services correct? Or do can be done to conserve the world’s fish stocks? governments produce either too much or too little of these items? These are the questions that we study in this chapter. We More and more people with ever-increasing incomes demand begin by classifying goods and resources. We then explain ever greater quantities of most goods and services. One of these what determines the scale of government provision of public items is fish grown wild in the ocean. The fish stocks of the services. Finally, we study the tragedy of the commons. In world’s oceans are not owned by anyone. They are common Reading Between the Lines at the end of the chapter, we resources, and everyone is free to use them. Are our fish stocks look at a pressing tragedy of the commons in the world being overused? Are we in danger of bringing extinction to some today: the problem of overuse of the tropical rainforests. 335 9160335_CH15_p335-350.qxp 336 6/22/09 9:07 AM Page 336 CHAPTER 15 Public Goods and Common Resources ◆ Classifying Goods and Resources Goods, services, and resources differ in the extent to which people can be excluded from consuming them and in the extent to which one person’s consumption rivals the consumption of others. FIGURE 15.1 Private goods Rival A good is rival if one person’s use of it decreases the quantity available for someone else. A Brinks’s truck can’t deliver cash to two banks at the same time. A fish can be consumed only once. A good is nonrival if one person’s use of it does not decrease the quantity available for someone else. The services of the LAPD and a concert on network television are nonrival. One person’s benefit doesn’t lower the benefit of others. A Fourfold Classification Figure 15.1 classifies goods, services, and resources into four types. Private Goods A private good is both rival and excludable. A can of Coke and a fish on East Point Seafood’s farm are examples of private goods. Public Goods A public good is both nonrival and nonexcludable. A public good can be consumed simultaneously by everyone, and no one can be excluded from enjoying its benefits. National defense is the best example of a public good. Common Resources A common resource is rival and nonexcludable. A unit of a common resource can be used only once, but no one can be prevented from using what is available. Ocean fish are a common resource. They are rival because a fish taken by one person isn’t available for anyone else, and they are nonexcludable because it is difficult to prevent people from catching them. Common resources Food and drink Fish in ocean Car Atmosphere House Rival Excludable A good is excludable if it is possible to prevent someone from enjoying its benefits. Brinks’s security services, East Point Seafood’s fish, and a U2 concert are examples. People must pay to consume them. A good is nonexcludable if it is impossible (or extremely costly) to prevent anyone from benefiting from it. The services of the LAPD, fish in the Pacific Ocean, and a concert on network television are examples. When an LAPD cruiser enforces the speed limit, everyone on the highway benefits; anyone with a boat can fish in the ocean; and anyone with a TV can watch a network broadcast. Fourfold Classification of Goods National parks Natural monopolies Public goods Internet National defense Cable television The law Bridge or tunnel Nonrival Air traffic control Excludable Nonexcludable A private good is one for which consumption is rival and from which consumers can be excluded. A public good is one for which consumption is nonrival and from which it is impossible to exclude a consumer. A common resource is one that is rival but nonexcludable. A good that is nonrival but excludable is produced by a natural monopoly. animation Natural Monopolies In a natural monopoly, economies of scale exist over the entire range of output for which there is a demand (see p. 246). A special case of natural monopoly arises when the good or service can be produced at zero marginal cost. Such a good is nonrival. If it is also excludable, it is produced by a natural monopoly. The Internet and cable television are examples. Review Quiz ◆ 1 2 Distinguish among public goods, private goods, common resources, and natural monopolies. Provide examples of goods (or services or resources) in each of the four categories that differ from the examples in this section. Work Study Plan 15.1 and get instant feedback. ◆ Public Goods Why does the U.S. government provide our national defense? Why don’t we buy our national defense from North Pole Protection, Inc., a private firm that competes for our dollars in the marketplace in the same way that McDonald’s does? The answer is that 9160335_CH15_p335-350.qxp 6/22/09 9:07 AM Page 337 Public Goods Marginal Social Benefit of a Public Good Lisa and Max (the only people in an imagined society) value national defense. Figures 15.2(a) and 15.2(b) graph their marginal benefits from a defense satellite system as MBL for Lisa and MBM for Max. A person’s marginal benefit from a public good, like that from a private good, diminishes as the quantity of the good increases—the marginal benefit curves slope downward. Figure 15.2(c) shows the marginal social benefit curve, MSB. Because everyone gets the same quantity of a public good, its marginal social benefit curve is the sum of the marginal benefits of all individuals at each quantity—it is the vertical sum of the individual marginal benefit curves. So the curve MSB in part (c) is the marginal social benefit curve for the economy made up of Lisa and Max. For each satellite, Lisa’s marginal benefit is added to Max’s marginal benefit. Contrast the marginal social benefit curve for a public good with that of a private good. To obtain the marginal social benefit curve for a private good, we sum the quantities demanded by all individuals at each price—we sum the individual marginal benefit curves horizontally (see Chapter 5, p. 105). Marginal Social Cost of a Public Good The marginal social cost of a public good is determined in exactly the same way as that of a private good—see p. 111. The principle of increasing marginal cost applies to the marginal cost of a public good and the marginal social cost curve of a public good slopes upward. Efficient Quantity of a Public Good To determine the efficient quantity of a public good, we use the same principles that you learned in Chapter 5 Marginal benefit (dollars per satellite) A free rider enjoys the benefits of a good or service without paying for it. Because a public good is provided for everyone to use and no one can be excluded from its benefits, no one has an incentive to pay his or her share of the cost. Everyone has an incentive to free ride. The free-rider problem is that the market would provide an inefficiently small quantity of a public good. Marginal social benefit from the public good would exceed its marginal social cost and a deadweight loss would arise. Let’s look at the marginal social benefit and marginal social cost of a public good. Benefits of a Public Good 80 60 40 20 MB L 0 1 2 3 4 5 Quantity (number of satellites) (a) Lisa's marginal benefit Marginal benefit (dollars per satellite) The Free-Rider Problem FIGURE 15.2 60 40 20 0 MB M 1 2 3 4 5 Quantity (number of satellites) (b) Max's marginal benefit Marginal benefit (dollars per satellite) national defense is a public good—nonexcludable and nonrival—and it has a free-rider problem. 337 140 120 100 80 60 Lisa 40 Max 20 0 MSB 1 2 3 4 5 Quantity (number of satellites) (c) Economy’s marginal social benefit The marginal social benefit at each quantity of the public good is the sum of the marginal benefits of all individuals. The marginal benefit curves are MBL for Lisa and MBM for Max. The economy’s marginal social benefit curve is MSB. animation 9160335_CH15_p335-350.qxp 338 6/22/09 9:07 AM Page 338 CHAPTER 15 Public Goods and Common Resources and have used repeatedly: Find the quantity at which marginal social benefit equals marginal social cost. Figure 15.3 shows the marginal social benefit curve, MSB, and the marginal social cost curve, MSC, for defense satellites. (We’ll now think of society as consisting of Lisa and Max and 300 million others.) If marginal social benefit exceeds marginal social cost, as it does when fewer than 2 satellites are provided, resources can be used more efficiently by increasing the quantity. The extra benefit exceeds the extra cost. If marginal social cost exceeds marginal social benefit, as it does when more than 2 satellites are provided, resources can be used more efficiently by decreasing the quantity. The saving in cost exceeds the loss of benefit. If marginal social benefit equals marginal social cost, as it does when exactly 2 satellites are provided, resources cannot be used more efficiently. To provide more than 2 satellites would cost more than the additional coverage is worth, and to provide fewer satellites lowers the benefit by more than its cost saving. Resources are allocated efficiently. Inefficient Private Provision Could a private firm—North Pole Protection, Inc.— deliver the efficient quantity of satellites? Most likely, it The Efficient Quantity of a Public Good Marginal cost and marginal benefit (billions of dollars per satellite) FIGURE 15.3 30 25 MSC 20 MSC < MSB MSC > MSB 10 0 Private underproduction 1 Efficient quantity 2 MSB 3 4 Quantity (number of satellites) With fewer than 2 satellites, marginal social benefit, MSB, exceeds marginal social cost, MSC. With more than 2 satellites, MSC exceeds MSB. Only with 2 satellites is MSC equal to MSB and the quantity is efficient. animation ◆ Common Resources Atlantic Ocean cod stocks have been declining since the 1950s, and some marine biologists fear that this species is in danger of becoming extinct in some regions. The whale population of the South Pacific has been declining also, and some groups are lobbying to establish a whale sanctuary in the waters around Australia and New Zealand to regenerate the population. Logging, cattle-ranching, mining, oil extraction, and damming rivers are destroying the tropical rainforests of Southeast Asia, Africa, and Central and South America at an alarming rate. At the present rate of destruction, most will be gone by 2030. These situations involve common property, and the problem that we have identified is called the tragedy of the commons. The Tragedy of the Commons MSC = MSB 15 5 couldn’t because no one would have an incentive to buy his or her share of the satellite system. Everyone would reason as follows: “The number of satellites provided by North Pole Protection, Inc., is not affected by my decision to pay my share or not. But my own private consumption will be greater if I free ride and do not pay my share of the cost of the satellite system. If I don’t pay, I enjoy the same level of security and I can buy more private goods. I will spend my money on private goods and free ride on the public good.” Such reasoning is the free-rider problem. If everyone reasons the same way, North Pole Protection, Inc., has no revenue and so provides no satellites. Because the efficient level is two satellites, private provision is inefficient. The tragedy of the commons is the absence of incentives to prevent the overuse and depletion of a commonly owned resource. If no one owns a resource, no one considers the effects of her or his use of the resource on others. The Original Tragedy of the Commons The term “tragedy of the commons” comes from fourteenth century England, where areas of rough grassland surrounded villages. The commons were open to all and used for grazing cows and sheep owned by the villagers. Because the commons were open to all, no one had an incentive to ensure that the land was not over grazed. The result was a severe overgrazing situation. Because the commons were overgrazed, the quantity of cows and sheep that they could feed kept falling. 9160335_CH15_p335-350.qxp 6/22/09 9:07 AM Page 339 Common Resources During the sixteenth century, the price of wool increased and England became a wool exporter to the world. Sheep farming became profitable, and sheep owners wanted to gain more effective control of the land they used. So the commons were gradually privatized and enclosed. Overgrazing ended, and land use became more efficient. A Tragedy of the Commons Today One of today’s pressing tragedies of the commons is overfishing. To study the tragedy of the commons, let's look at what has been happening to Atlantic Cod—just one species of fish that has been seriously overfished. Sustainable Production Sustainable production is the rate of production that can be maintained indefinitely. In the case of ocean fish, the sustainable production is the quantity of fish (of a given species) that can be caught each year into the indefinite future without wiping out the species. This production rate depends on the existing stock of fish and the number of boats that go fishing. For a Sustainable Production: Total, Average, and Marginal Catch Total catch Average catch given stock of fish, sending more boats to sea increases the quantity of fish caught. But sending too many boats to sea depletes the stock. So as the number of boats increases, the quantity of fish caught increases as long as the stock is maintained. But above some crucial level, as more boats go fishing, the stock of fish decreases and the number of fish caught also decreases. Table 15.1 provides some numbers that illustrate the relationship between the number of boats that go fishing and the quantity of fish caught. The numbers in this example are hypothetical. Total Catch The total catch is the sustainable rate of production. The numbers in the first two columns of Table 15.4 show the relationship between the number of fishing boats and the total catch, and Fig. 15.4 illustrates this relationship. You can see that as the number of boats increases from zero to 5,000, the sustainable catch increases to a maximum of 250,000 tons a month. As the number of boats increases above 5,000, the sustainable catch begins to decrease. By the time 10,000 boats are fishing, the fish stock is depleted to the point at which no fish can be caught. Marginal catch Boats (thousands of (tons per (tons per (thousands) tons per month) boat) boat) A 0 1 C 2 D 3 E 4 F 5 G 6 H 7 I 8 J 9 K 10 ......... 90 ......... 80 ......... 70 ......... 60 ......... 50 ......... 40 ......... 30 ......... 20 ......... 10 ......... 0 . . . . . . . 90 B 0 . 90 . 160 . 210 . 240 . 250 . 240 . 210 . 160 . 90 . 0 . . . . . . . 70 . . . . . . . 50 . . . . . . . 30 . . . . . . . 10 . . . . . . 10 . . . . . . 30 Sustainable Production of Fish FIGURE 15.4 Sustainable catch (thousands of tons per month) TABLE 15.1 339 Overfishing 250 200 Maximum sustainable catch 150 100 50 . . . . . . 50 . . . . . . 70 0 1 2 3 4 . . . . . . 90 As the number of fishing boats increases, the quantity of fish caught increases up to the maximum sustainable catch and then decreases. The average catch and marginal catch decrease as the number of boats increases. 5 6 7 8 9 10 Boats (thousands) As the number of boats increases, the sustainable catch increases up to a maximum. Beyond that number, more boats will diminish the fish stock and the sustainable catch decreases. Overfishing occurs when the maximum sustainable catch decreases. animation 9160335_CH15_p335-350.qxp 9:07 AM Page 340 CHAPTER 15 Public Goods and Common Resources With more than 5,000 boats, there is overfishing. Overfishing arises if the number of boats increases to the point at which the fish stock begins to fall and the remaining fish are harder to find and catch. Average Catch The average catch is the catch per boat and equals the total catch divided by the number of boats. The numbers in the third column of Table 15.1 show the average catch. With 1,000 boats, the total catch is 90,000 tons and the catch per boat is 90 tons. With 2,000 boats, the total catch is 160,000 tons, and the catch per boat is 80 tons. As more boats take to the ocean, the catch per boat decreases. By the time 8,000 boats are fishing, each boat is catching just 20 tons a month. The decreasing average catch is an example of the principle of diminishing returns. Marginal Catch The marginal catch is the change in the total catch that occurs when one more boat joins the existing number. It is calculated as the change in the total catch divided by the increase in the number of boats. The numbers in the fourth column of Table 15.1 show the marginal catch. For example, in rows C and D of the table, when the number of boats increases by 1,000, the catch increases by 50,000 tons, so the increase in the catch per boat equals 50 tons. In the table, we place this amount midway between the two rows because it is the marginal catch at 2,500 boats, midway between the two levels that we used to calculate it. Notice that the marginal catch, like the average catch, decreases as the number of boats increases. Also notice that the marginal catch is always less than the average catch. When the number of boats reaches that at which the sustainable catch is a maximum, the marginal catch is zero. At a larger number of boats, the marginal catch becomes negative—more boats decrease the total catch. An Overfishing Equilibrium The tragedy of the commons is that common resources are overused. Why might the fish stock be overused? Why might overfishing occur? Why isn’t the maximum number of boats that take to the sea the number that maximizes the sustainable catch— 5,000 in this example? To answer this question, we need to look at the marginal cost and marginal private benefit to an individual fisher. Suppose that the marginal cost of a fishing boat is the equivalent of 20 tons of fish a month. That is, to cover the opportunity cost of maintaining and operating a boat, the boat must catch 20 tons of fish a month. This quantity of fish also provides the boat owner with normal profit (part of the cost of operating the boat), so the boat owner is willing to go fishing. The marginal private benefit of operating a boat is the quantity of fish the boat can catch. This quantity is the average catch that we’ve just calculated. The average catch is the marginal private benefit because that is the quantity of fish that the boat owner gets by taking the boat to sea. The boat owner will go fishing as long as the average catch (marginal private benefit) exceeds the marginal cost. And the boat owner will maximize profit when marginal private benefit equals marginal cost. Figure 15.5 shows the marginal cost curve, MC, and the marginal private benefit curve, MB. The MB curve is based on the numbers for the average catch in Table 15.1. You can see in Fig. 15.5 that with fewer than 8,000 boats, each boat catches more fish than it costs to catch them. Because boat owners can gain from fishing, the number of boats is 8,000 and there is an overfishing equilibrium. FIGURE 15.5 Sustainable catch per boat (tons per month) 340 6/22/09 Why Overfishing Occurs 100 Catch per boat 80 60 Overfishing equilibrium Marginal cost per boat 40 MC 20 MB 0 1 2 3 4 5 6 7 8 9 10 Boats (thousands) The average catch decreases as the number of boats increases. The average catch per boat is the marginal private benefit, MB, of a boat. The marginal cost of a boat is equivalent to 20 tons of fish, shown by the curve MC. The equilibrium number of boats is 8,000—an overfishing equilibrium. animation 9160335_CH15_p335-350.qxp 6/22/09 9:07 AM Page 341 C ommon Resources If one boat owner stopped fishing, the overfishing would be less severe. But that boat owner would be giving up an opportunity to earn an economic profit. The self-interest of the boat owner is to fish, but the social interest is to limit fishing. The quantity of fish caught by each boat decreases as additional boats go fishing. But when individual boat owners are deciding whether to fish, they ignore this decrease. They consider only the marginal private benefit. The result is an inefficient overuse of the resource. Sustainable catch per boat (tons per month) F IGURE 15.6 The Efficient Use of the Commons What is the efficient use of a common resource? It is the use of the resource that makes the marginal cost of using the resource equal to the marginal social benefit from its use. a boat is the boat’s marginal catch—the increase in the total catch that results from an additional boat. The reason is that when an additional boat puts to sea, it catches the average catch but it decreases the average catch for itself and for every other boat. The marginal social benefit is the increase in the quantity of fish caught per boat, not the average number of fish caught. We calculated the marginal catch in Table 15.1 and we repeat part of that table for convenience in Fig. 15.6. The figure also shows the marginal private benefit curve, MB, and the marginal social benefit curve, MSB. Notice that at any given number of boats, marginal social benefit is less than marginal private benefit. Each boat benefits privately from the average catch, but the addition of one more boat decreases the catch of every boat, and this decrease must be subtracted from the catch of the additional boat to determine the social benefit from the additional boat. Efficient Use With no external costs, the marginal social cost equals marginal cost. In Fig. 15.6, the marginal cost curve is also the marginal social cost curve, MC MSC. Efficiency is achieved when MSB equals MSC with 4,000 boats, each catching 60 tons of fish a month. You can see in the table that when the number of boats increases from 3,000 to 4,000 (with 3,500 being the midpoint), marginal social benefit is 30 tons, which exceeds marginal social cost. When the number of boats increases from 4,000 to 5,000 (with 4,500 being the midpoint), marginal social benefit is 10 tons, which is less than marginal social cost. At 4,000 boats, marginal social benefit is 20 tons, which equals marginal social cost. Efficient Use of a Common Resource 100 Efficient use 80 60 40 Marginal social benefit MC = MSC 20 MSB 0 Marginal Social Benefit The marginal social benefit of 341 1 2 3 4 Total catch Boats (thousands of 5 MB 6 7 Marginal private benefit (thousands) tons per month) 8 9 10 Boats (thousands) Marginal social benefit (tons per boat) A 0 0 B 1 90 90 C 2 160 80 D 3 210 70 E 4 240 60 F 5 250 50 . . . . . . . . . . . . . . . . . . . . 90 . . . . . . . . . . . . . . . . . . . . 70 . . . . . . . . . . . . . . . . . . . . 50 . . . . . . . . . . . . . . . . . . . . 30 . . . . . . . . . . . . . . . . . . . . 10 The marginal social benefit of a fishing boat is the change in total benefit that results from an additional boat. The table shows that when the number of boats increases from 2,000 to 3,000 (from row C to row D ), the total catch increases from 160,000 to 210,000 tons a month and marginal catch and marginal social benefit is 50 tons. The figure graphs the marginal social benefit curve, MSB, and the marginal private benefit curve, MB. Marginal social benefit is less than marginal private benefit and decreases as the number of boats increases. The efficient number of boats is 4,000—the number at which marginal social benefit equals marginal social cost of 20 tons per month. The common resource is used efficiently. animation 9160335_CH15_p335-350.qxp 9:07 AM Page 342 CHAPTER 15 Public Goods and Common Resources Achieving an Efficient Outcome Defining the conditions under which a common resource is used efficiently is easier than generating those conditions. To use a common resource efficiently, it is necessary to design an incentive mechanism that confronts the users of the resource with the marginal social consequences of their actions. The same principles apply to common resources as those that you met when you studied externalities in Chapter 14. Three main methods might be used to achieve the efficient use of a common resource. They are ■ ■ ■ Property rights Production quotas Individual transferable quotas (ITQs) Property Rights A common resource that no one owns and that anyone is free to use contrasts with private property, which is a resource that someone owns and has an incentive to use in the way that maximizes its value. One way of overcoming the tragedy of the commons is to remove the commons and make the resource private property. By assigning private property rights, each owner faces the same conditions as society faces. The MSB curve of Fig. 15.6 becomes the marginal private benefit curve, and the use of the resource is efficient. The private property solution to the tragedy of the commons is available in some cases. It was the solution to the original tragedy of the commons in England’s Middle Ages. It is also a solution that has been used to prevent overuse of the airwaves that carry our cell phone service. The right to use this space—called the frequency spectrum—has been auctioned by governments to the highest bidders, and the owner of a particular part of the spectrum is the only one permitted to use it (or to license someone else to use it). But assigning private property rights is not always feasible. It would be difficult, for example, to assign private property rights to the oceans. It would not be impossible, but the cost of enforcing private property rights over thousands of square miles of ocean would be high. And it would be even more difficult to assign and protect private property rights to the atmosphere. In some cases, there is an emotional objection to assigning private property rights. When private property rights are too costly to assign and enforce, some form of government intervention is used, and production quotas are the simplest. Production Quotas You studied the effects of a pro- duction quota in Chapter 6 (pp. 137–138) and learned that a quota can drive a wedge between marginal social benefit and marginal social cost and create deadweight loss. In that earlier example, the market was efficient without a quota. But in the case of the use of a common resource, the market is inefficient. It is overproducing, so a quota that limits production can bring a move toward a more efficient outcome. A quota might be placed either on the number of boats or on the catch. In our example, the catch is determined by the number of boats, so placing a quota on the number of boats is equivalent to placing a quota on the catch. We’ll define the quota in terms of the number of boats permitted to fish. Figure 15.7 shows a quota that achieves an efficient outcome. The quota limits the number of boats to 4,000, the number that catches the efficient quantity at which marginal social benefit, MSB, equals marginal social cost, MSC. If the boats allocated the right to fish are the only ones to do so, the outcome is efficient. Implementing a production quota has two problems. First, it is in every boat owner’s self-interest to cheat and send out more boats than the number permitted. The reason is that marginal private benefit exceeds marginal cost, so by using more boats, each boat owner gets a higher income. If enough boat A Production Quota to Use a Common Resource Efficiently FIGURE 15.7 Sustainable catch per boat (tons per month) 342 6/22/09 Quota on number of boats 100 80 Efficient outcome 60 40 MC = MSC 20 MSB 0 1 2 3 4 5 MB 6 7 8 9 10 Boats (thousands) A quota on the number of boats permitted to fish is set at 4,000, the number that catches the quantity of fish at which marginal social benefit, MSB, equals marginal social cost, MSC. If the quota is successfully enforced, the outcome is efficient. animation 9160335_CH15_p335-350.qxp 6/22/09 9:07 AM Page 343 Common Resources Individual Transferable Quotas Where producers are difficult to monitor or where marginal costs differ across producers, a more sophisticated quota system can be effective. It is an individual transferable quota (ITQ), which is a production limit that is assigned to an individual who is then free to transfer (sell) the quota to someone else. A market in ITQs emerges and ITQs are traded at their market price. The market price of an ITQ is the highest price that someone is willing to pay for one. That price is marginal benefit minus marginal cost. The price of an ITQ will rise to this level because the boat owners who don’t have a quota would be willing to pay this amount to get one. A boat owner with an ITQ could sell it for the market price, so by not selling the ITQ the boat owner incurs an opportunity cost. The marginal cost of fishing, which now includes the opportunity cost of the ITQ, equals the marginal social benefit of the efficient quantity. Figure 15.8 illustrates how ITQs work. Each boat has a marginal cost equivalent to 20 tons per month. The efficient outcome is achieved with 4,000 boats, each catching 60 tons per month. The market price of an ITQ equals the equivalent of 40 tons of fish per month. The marginal cost of fishing rises from MC0 to MC0 + price of ITQ, 4,000 boats go fishing, and each boat catches 60 tons of fish. The outcome is efficient. Individual differences in marginal cost do not prevent an ITQ system from delivering the efficient outcome. Boat owners with a low marginal cost are willing and able to pay more for a quota than are boat owners with a high marginal cost. The market FIGURE 15.8 Sustainable catch per boat (tons per month) owners break the quota, overfishing returns and the tragedy of the commons remains. Second, marginal cost is not, in general, the same for all producers—as we’re assuming here. Some producers have a comparative advantage in using a resource. Efficiency requires that the quota be allocated to the producers with the lowest marginal cost. But the government department that allocates quotas does not have information about the marginal cost of individual producers. Even if the government tried to get this information, producers would have an incentive to lie about their costs so as to get a bigger quota. So a production quota can work, but only if the activities of every producer can be monitored and all producers have the same marginal cost. Where producers are difficult or very costly to monitor or where marginal costs vary across producers, a production quota cannot achieve an efficient outcome. 343 ITQs to Use a Common Resource Efficiently 100 Efficient outcome 80 MC0 + price of ITQ 60 Market price of an ITQ 40 MC0 20 MB 0 1 2 3 4 5 6 7 8 9 10 Boats (thousands) ITQs are issued on a scale that keeps output at the efficient level. The market price of an ITQ equals the marginal private benefit minus marginal cost. Because each user of the common resource faces the opportunity cost of using the resource, self-interest achieves the social interest. animation price of an ITQ will equal 60 tons minus the marginal cost of the marginal producer. Boat owners with higher marginal costs will not go fishing. Review Quiz ◆ 1 2 3 What is the tragedy of the commons? Give two examples, including one from your state. Describe the conditions under which a common resource is used efficiently. Review three methods that might achieve the efficient use of a common resource and explain the obstacles to efficiency. Work Study Plan 15.3 and get instant feedback. ◆ Reading Between the Lines on pp. 344–345 looks at the overuse of tropical rainforests. The next chapter begins a new part of your study of microeconomics and examines the third big question of economics: For whom are goods and services produced? We examine the markets for factors of production and discover how wage rates and other incomes are determined. 9160335_CH15_p335-350.qxp 6/22/09 9:07 AM Page 344 READING BETWEEN THE LINES Rainforests: A Tragedy of the Commons Puerto Rico Rainforest on Edge http://www.latimes.com April 23, 2006 The scent of flowering tropical plants fills the moist air amid a chorus of whistling birds and singing frogs. The only other sound for a mile in any direction is the roar of a 100-foot waterfall. Despite 28,000 acres of such lovely scenes, the tropical rainforest that Puerto Rico’s prehistoric Taino Indians called El Yunque, or “Land of the White Clouds,” is in grave danger. Thousands of acres of forests and green lands ... are being cleared at a torrid pace. ... There are consequences to clearing these lands, beyond harm to hundreds of rare plants and wildlife in El Yunque. The rainforest ... provides one-third of the island’s fresh drinking water. ... Tropical forests such as El Yunque constitute about 6% of Earth’s surface and account for 50% to 80% of the world’s plant species. Rainforests once covered 14% of the planet’s land surface, but have shrunk due to development and deforestation. ... “I’d like to think we live in harmony with El Yunque,” said Martha Herrera, 69, who bought a two-story house next to the rainforest a decade ago. “Some people say I’m hurting El Yunque. But how am I hurting anything?” she asked as her three dogs and flock of chickens roamed in and out of the park one recent morning. About a quarter-mile away, construction crews were pouring concrete as they rushed to finish a 20-acre condominium complex. “People who buy these units want the views of the rainforest,” said Hecter Ramirez, 35, a construction worker at the site. “I have a job. That’s important to my family and me. People tell me this isn’t going to damage anything.” El Yunque is home to 240 native tree species—more than any other national forest. Federally listed endangered plants grow in the forest too, such as the miniature orchid and palo de jazmin. ... © 2006 The Los Angeles Times via Tribune Media Services. All Rights Reserved. Reprinted with permission. Essence of the Story ■ Puerto Rico’s El Yunque tropical rainforest has 240 native tree species—more than any other national forest. ■ Puerto Rico’s tropical rainforest is being cleared at a torrid pace. ■ Tropical forests, which have shrunk from 14 percent to 6 percent of Earth’s surface, account for 50 to 80 percent of the world’s plant species. ■ Condominium construction is taking place close to the rainforest. ■ ■ The rainforest near San Juan provides one third of the island’s fresh drinking water. Construction workers and people who buy condominiums say they aren’t doing any damage. 344 6/22/09 9:07 AM Page 345 Economic Analysis ■ The tropical rainforests of Puerto Rico grow on land that some people want to build on. ■ These forests are home to many rare species of tree, a source of drinking water, and a carbon-dioxide sink that helps to maintain Earth’s atmosphere. ■ The forests are common property. ■ The private incentive to exploit these forest resources is strong. ■ Sustainable production (tons per year) 9160335_CH15_p335-350.qxp Maximum sustainable production in self-interest with private ownership Because no one owns the forests, there is no incentive to conserve the resources and use them on a sustainable basis. Depletion in self-interest with common property The result is overuse, just like the overuse of the commons of England in the Middle Ages. ■ The figures illustrate the tragedy of the commons in a tropical rainforest. ■ Figure 1 shows the relationship between the sustainable production of wood from a rainforest and the number of lumber producers working the forest. ■ Figure 2 shows the marginal private benefit and marginal private cost of a producer and the marginal social benefit and marginal social cost of wood. ■ The producer’s marginal cost of felling a tree is assumed to be zero. ■ For a common resource, the marginal private benefit received by a producer is MB and LD lumber producers acting in their self-interest deplete the resource. Sustainable production decreases to zero. ■ For a privately owned resource, the marginal social benefit curve, MSB, becomes the marginal private benefit curve. Self-interest results in LP lumber producers who maximize the sustainable output of the rainforest. ■ If the only benefit from the rainforest were its timber, maximum sustainable timber output would be efficient. ■ Lumber producers Figure 1 Rainforest timber production MSB = MSC MB = 0 MSC 0 LS LP MSB = 0 MC MB LD Lumber producers MSB Figure 2 Marginal benefits and marginal costs But external benefits arise from the diversity of the wildlife supported by the forest, so marginal social cost exceeds the zero marginal private cost. ■ 0 Marginal social benefit and cost (dollars per ton) ■ Efficient production in social interest Production in the social interest—the efficient level of production—is achieved with LS lumber producers and is less than the maximum sustainable production. 345 9160335_CH15_p335-350.qxp 346 6/22/09 9:07 AM Page 346 CHAPTER 15 Public Goods and Common Resources SUMMARY ◆ Key Points Classifying Goods and Resources (p. 336) ■ ■ ■ A private good is a good or service that is rival and excludable. A public good is a good or service that is nonrival and nonexcludable. A common resource is a resource that is rival but nonexcludable. Public Goods (pp. 336–338) ■ ■ ■ ■ Common Resources (pp. 338–343) ■ Because a public good is a good or service that is nonrival and nonexcludable, it creates a free-rider problem: No one has an incentive to pay their share of the cost of providing a public good. The efficient level of provision of a public good is that at which marginal social benefit equals marginal social cost. Competition between political parties, each of which tries to appeal to the maximum number of voters, can lead to the efficient scale of provision of a public good and to both parties proposing the same policies—the principle of minimum differentiation. Bureaucrats try to maximize their budgets, and if voters are rationally ignorant, public goods might be provided in quantities that exceed those that are efficient. ■ ■ Common resources create a problem that is called the tragedy of the commons—no one has a private incentive to conserve the resources and use them at an efficient rate. A common resource is used to the point at which the marginal private benefit equals the marginal cost. A common resource might be used efficiently by creating a private property right, setting a quota, or issuing individual transferable quotas. Key Figures Figure 15.1 Figure 15.2 Figure 15.3 Fourfold Classification of Goods, 336 Benefits of a Public Good, 337 The Efficient Quantity of a Public Good, 338 Figure 15.5 Figure 15.6 Why Overfishing Occurs, 340 Efficient Use of a Common Resource, 341 Key Terms Common resource, 336 Excludable, 336 Free-rider problem, 337 Individual transferable quota (ITQ), 342 Nonexcludable, 336 Nonrival, 336 Private good, 336 Public good, 336 Rival, 336 Tragedy of the commons, 338 9160335_CH15_p335-350.qxp 6/22/09 9:07 AM Page 347 P roblems and Applications PROBLEMS and APPLICATIONS 347 ◆ Work problems 1–7 in Chapter 15 Study Plan and get instant feedback. Work problems 8–16 as Homework, a Quiz, or a Test if assigned by your instructor. Marginal social benefit and marginal social cost (dollars per person) 1. Classify each of the following items as excludable, nonexcludable, rival, nonrival, a public good, a private good, or a common resource. ■ Gettysburg National Military Park ■ A Big Mac ■ Brooklyn Bridge ■ The Statue of Liberty ■ Air ■ Police protection ■ Sidewalks ■ U.S. Postal Service ■ FedEx courier service ■ The MyEconLab Web site 2. For each of the following goods, explain whether there is a free-rider problem. If there is no such problem, how is it avoided? ■ July 4th fireworks display ■ Interstate 81 in Virginia ■ Wireless Internet access in hotels ■ Sharing downloaded music ■ The public library in your city 3. The figure provides information about a sewage disposal system that a city of 1 million people is considering installing. MSC 100 80 60 40 20 MSB 0 1 2 3 4 5 Capacity (millions of gallons per day) a. What is the capacity that achieves an efficient outcome? b. How much will each person have to pay in taxes to pay for the efficient capacity level? c. What is the political equilibrium if voters are well informed? d. What is the political equilibrium if voters are rationally ignorant and bureaucrats achieve the highest attainable budget? 4. The table shows the value of cod caught in the North Atlantic Ocean by American, Canadian, and European fishing boats. The marginal cost of operating a boat is $80,000 a month. Value of c od caught Number of b oats 0 10 20 30 40 50 60 70 (thousands of dollars per month) 0 2,000 3,400 4,200 4,400 4,000 3,000 1,400 a. What is the marginal private benefit of a fishing boat at each quantity of boats? b. What is the marginal social benefit of a fishing boat at each quantity of boats? c. With no regulation of cod fishing, what is the equilibrium number of boats and the value of cod caught? d. Is the equilibrium in c an overfishing equilibrium? e. What is the efficient number of boats? f. What is the efficient value of the cod catch? g. Do you think that the consumers of fish and the fishing industry will agree about how much cod should be caught? h. If the United States, Canada, and the European Union imposed a production quota to limit the catch to the efficient quantity, what would the total value of the catch be under the quota? i. If the United States, Canada, and the European Union issued ITQs to fishing boats to limit the catch to the efficient quantity, at what price would ITQs be traded? 9160335_CH15_p335-350.qxp 348 6/22/09 CHAPTER 15 9:07 AM Page 348 Public Goods and Common Resources 5. “Free Riders” Must be Part of Health Debate [Barack] Obama insists that “the reason people don’t have health insurance isn’t because they don’t want it, it’s because they can’t afford it. …” A free rider is someone who can afford a health insurance policy but won’t buy any. Obama wants to give Americans the freedom to not buy insurance but the right to get government-subsidized coverage when they get sick. The inevitable result is that a lot of healthy people will avoid contributing to the insurance pool. … Why should they buy insurance at any price if they can glom on to a government program should disaster strike? There are 47 million uninsured people in the United States, and 16 percent have a family income above $75,000. Another 15 percent make between $50,000 and $75,000. … About 16 percent of the patients who received “free” medical care in 2004 came from families making at least four times the federal poverty level. … They racked up $5.8 billion in uncompensated care, which others had to pay for. Los Angeles Times, March 4, 2008 a. Explain why government-subsidized coverage can create a free-rider problem in the healthcare market. b. Explain the evidence this article presents to contradict the argument that “the reason people don’t have health insurance isn’t because they don’t want it, it’s because they can’t afford it.” 6. The Wonder Fish Our oceans are being drained of food. Doctors tell us to eat more fish. … To meet this growing appetite, commercial fishermen are scooping up everything that’s edible (and a lot of what’s not). Couple that trend with the effects of global warming, and the situation has become so dire that some scientists think seafood stocks will totally collapse by 2048. … A former fisheries researcher in the Cook Islands, [Kona Blue cofounder Neil] Sims was disgusted by how locals ravaged marine life there. But the scene also inspired his idea for a new (patents pending) style of deepwater fish farming. … So just what is Kona Kampachi? Think of it as a more versatile cousin of hamachi. It’s not genetically engineered in any way, just well bred. … Sims fastidiously controls every variable in the life of a fish. Kona Blue houses 150 brood stock on shore a few miles north of Kona. These breeders are continually refreshed with deep-ocean water and left to do nothing but eat, swim, and procreate. Every few days a female lays as many as 300,000 eggs, which are harvested and transferred to a nursery. … When the fish reach an inch in length, they head to the ocean. In the wild the survival of two eggs would ensure sustainability for the species. Kona Blue does far better. “We get survival rates of 5% to 10%,” says Sims. Fortune, April 21, 2008 a. Why is the fish stock being overused? b. How does Kona Blue help prevent overfishing, while at the same time allowing a greater amount of fish to be caught? c. Use a model of the sustainable production of fish to illustrate your explanation. d. Draw a graph to illustrate your answers to b and c. 7. A Bridge Too Far Gone The gas taxes that paid for much of America’s post-war freeway system have been eaten away by inflation and higher fuel efficiency. The federal tax has not been raised since 1993. California’s 18-cent tax has remained unchanged since 1994. Motorists now pay about one-third in gas taxes to drive a mile as they did in the early 1960s. Yet raising such taxes is politically tricky. This would matter less if private cash was flooding into infrastructure, or if new ways were being found to control demand. Neither is happening. … A new toll road in Texas, which is being built by a Spanish company, raised howls of outrage. The Economist, August 9, 2007 a. Why is it “politically tricky” to raise gas taxes to finance infrastructure? b. What in this news clip points to a distinction between public production of a public good and public provision? Give examples of three public goods that are produced by private firms but provided by government and paid for with taxes. 9160335_CH15_p335-350.qxp 6/22/09 9:07 AM Page 349 P roblems and Applications 8. For each of the following goods, explain whether there is a free-rider problem. If there is no such problem, how is it avoided? ■ Fire protection ■ New Year’s Eve celebrations in Times Square, New York ■ Interstate 80 in rural Wyoming ■ The Grand Canyon ■ Street lighting in urban areas ■ Flood control in the Mississippi watershed ■ The beach at Santa Monica 9. The table provides information about a mosquito control program. Quantity sprayed (square miles per day) Marginal social cost Marginal social benefit (dollars per day) 0 0 0 1 1,000 5,000 2 2,000 4,000 3 3,000 3,000 4 4,000 2,000 5 5,000 1,000 a. What quantity of spraying would a private mosquito control program provide? b. What is the efficient quantity of spraying? c. Two political parties, the Conservers and the Eradicators, fight an election in which the only issue is the quantity of spraying to undertake. The Conservers want no spraying and the Eradicators want to spray 5 square miles per day. The voters are well-informed about the benefits and costs of mosquito control programs. What is the outcome of the election? d. Draw a graph to illustrate the outcome of the election. 10. In problem 9, the government sets up a Mosquito Control Unit and appoints a bureaucrat to run the department. a. Would the mosquito spraying most likely be underprovided, overprovided, or provided at the efficient quantity? b. How do rational voters behave and why do they enable bureaucrats to behave in the way you described in a? c. Draw a graph to illustrate the outcome when bureaucrats achieve their objective. 349 11. An oil reserve runs under plots of land owned by seven people. Each person has the right to sink a well on her or his land and take oil from the reserve. The amount of oil that is produced depends on the number of wells sunk and is shown in the table. The marginal private cost of a well is the equivalent of 4 gallons a day. Number of wells Oil output (gallons per day) 0 0 2 12 4 22 6 30 8 36 10 40 12 42 14 42 a. What is the marginal private benefit at each quantity of wells? b. What are the equilibrium number of wells and quantity of oil produced? c. What is the marginal social benefit at each quantity of wells? d. What are the efficient number of wells and quantity of oil to produce? e. If the common reserve were owned by only one person, how many wells would be sunk and how much oil would be produced? f. How much would someone offer the seven owners to rent the rights to all the oil in the common reserve? (Use gallons of oil as the unit.) 12. If hikers and others were required to pay a fee to use the Appalachian Trail, a. Would the use of this common resource be more efficient? b. Would it be even more efficient if the most popular spots had the highest prices? c. Why do you think we don’t see more market solutions to the tragedy of the commons? 13. Who’s Hiding under Our Umbrella? Students of the Cold War learn that, to deter possible Soviet aggression, the United States placed a “strategic umbrella” over NATO Europe and Japan, declaring it would fight if their independence was threatened by the Soviet Union. … European and Japanese allies have been taking 9160335_CH15_p335-350.qxp 350 6/22/09 CHAPTER 15 9:07 AM Page 350 Public Goods and Common Resources economic advantage of the fact that the United States was providing for most of their own national security. Under President Ronald Reagan, approximately 6 percent of the GDP of the United States was spent on defense, whereas the Europeans tended to spend only 2 to 3 percent and the Japanese a miserly 1 percent, although all faced a common enemy. Thus the American taxpayer bore a disproportionate burden for the overall defense spending, whereas those sheltering under its umbrella spent more on social or consumer goods, or saved while the U.S. went further into debt. … Today, the United States, like Rome and Britain in their time, is the provider of international public goods. … International Herald Tribune, January 30, 2008 a. Explain the free-rider problem described in this news clip. b. Does the free-rider problem in international defense mean that the world has too little defense against aggression? c. How do nations try to overcome the free-rider problem among nations? 14. Commuting More than Pain at Pump … [T]he daily drive causes a large number of commuters everything from increased stress and anger to sleep deprivation and loss of productivity at work. … Nearly half (45 percent) of the 4,091 respondents polled in 10 major metropolitan areas said that traffic congestion increased their stress levels. Another 28 percent said it heightened their feelings of anger. Almost one in five said commuting problems cut down on their productivity at work and in school and a full 12 percent said they were sleep deprived. … The two biggest culprits: start-and-stop traffic and rude drivers. Because traffic delays are typically random, commuters have to budget a larger amount of time to get from here to there. … [IBM’s Institute for Electronic Government] has been devising ways to help cities deal with increased traffic congestion, and has helped deploy automated tolling, congestion pricing plans and real-time traffic modeling in cities such as Brisbane, London, Singapore and Stockholm. … To help alleviate traffic problems, drivers said they wanted more options to work from home, improved public transportation, and better road condition information. CNN, May 30, 2008 a. Are congested public roadways excludable or nonexcludable and rival or nonrival? Explain. b. As a result of this classification, explain the problem associated with congested public roadways that results in an inefficient usage. c. Draw a graph to illustrate the inefficient equilibrium. d. How could government policies be used to achieve an efficient usage of roadways? 15. Where the Tuna Roam … to the first settlers, the Great Plains posed the same problem as the oceans today: It was a vast, open area where there seemed to be no way to protect animals against relentless human predators. … But animals thrived in the West once the settlers divvied up the land and ingeniously devised new ways to protect their livestock. … Today the ocean is still pretty much an open range, and the fish are suffering the consequences. … Fishermen have a personal incentive to make as much as they can this year, even if they’re destroying their own profession in the process. They figure any fish they don’t take for themselves will just be taken by someone else. … The New York Times, November 4, 2006 a. What are the similarities between the problems faced by the earliest settlers in the West and today’s fishers? b. Can the tragedy of the commons in the oceans be eliminated in the same manner used by the early settlers on the plains? c. How can ITQs change the short-term outlook of fishers to a long-term outlook? 16. After you have studied Reading Between the Lines on pp. 344–345, answer the following questions: a. What is happening in Puerto Rico that is causing the depletion of the country’s tropical rainforests? b. How would the creation of private property rights in Puerto Rico’s rainforests change the way in which the forest resources are used? c. Would private ownership solve all the problems of resource overuse? If not, why not? ...
View Full Document

This note was uploaded on 02/07/2010 for the course ECON 251 taught by Professor Blanchard during the Fall '08 term at Purdue University-West Lafayette.

Ask a homework question - tutors are online