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public_goods2-ho (3)

# public_goods2-ho (3) - Optimal level of public goods Demand...

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Optimal level of public goods Demand Revelation Public Goods 2 (Chapter 36) March 9, 2010

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Optimal level of public goods Demand Revelation What is the optimal level of public goods provision? Recall: a non-rival, non-excludable good is a public good Last time: individuals have incentive to free-ride so market does not provide the efficient level of public goods What is the optimal level of provision? How can we get people to reveal demand, so we (govt.) can provide efficiently? ( mechanism design )
Optimal level of public goods Demand Revelation A public good with variable quantity Suppose there are two goods, x (private, i.e. money) and G (public) Cost of producing the public good: c ( G ) Two individuals A and B , with private consumption x A and x B Budget: x A + x B + c ( G ) = ω A + ω B

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Optimal level of public goods Demand Revelation A public good with variable quantity For each person, what is marginal benefit to switching some consumption from private to public good? MRS A , MRS B Each person separate equates marginal benefit with marginal cost. But because G is non-rival, 1 extra unit is fully consumed by both A and B So condition for socially-optimal (Pareto efficient) provision is MRS A + MRS B = MC ( G ) More generally: X i MRS i = MC ( G )
Optimal level of public goods Demand Revelation How can we determine efficient provision level? We use a revelation mechanism : a scheme that makes it rational for individuals to truthfully reveal their private valuations of a public good Example: Vickrey-Groves-Clarke (VCG) mechanism (or Groves-Clarke tax, Clarke tax) How does it work?

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