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Unformatted text preview: r consumers to be a free rider in an economy that includes public goods. How do we solve this free rider problem? Since the source of the free rider problem comes from the fact that there are economic incentives for consumers to hide their true valuations of public goods, the solution concept is to create an economic incentive mechanism that will give consumers the incentive to report their true valuations (such as some sort of penalty for mis-reporting). In the presence of this incentive mechanism, there would be a cost to consumers for not revealing their true valuations of public goods. The consumer decision to lie or reveal their true valuation becomes a cost/benefit problem of the individuals' economic welfare calculations. The design of incentive mechanisms is a technically difficult subject in microeconomic theory and is of particular interest to public economists. We will not explore this theoretical construct in any further detail (leaving this for ECON 341). For the purposes of this course, what we need to understand is that the free rider problem exists, what it is, and that there is some advanced theoretical models designed to induce consumers to truthfully report their valuations of public goods. 250 Supplement to Lecture #14 Detailed Lindahl Pricing Example Consider the "square root economy" with square root functions for both consumers and producers UA = XA1/2YA1/2 UB = XB1/2YB1/2 QX = KX1/2LX1/2 QY = KY1/2LY1/2 and the following initial factor endowment distribution: Consumer A Consumer B Total Capital (K) KA = 0.2 KB = 0.8 KT = 1 Labour (L) LA = 0.6 LB = 0.4 LT = 1 We want to find the equilibrium prices (PX, PY, r, w) that clear all markets simultaneously. CONSUMER A Consumer A has the following data on utility function and endowment income: MRSA = YA XA MA = r KA + w LA = 0.2 r + 0.6 w Utility Maximization maximize UA = XA1/2YA1/2 subject to PX XA + PY YA = MA Consumer Equilibrium Analytically, the two conditions for consumer equilibrium must be satisfied: CONSUMER B Consumer B...
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This note was uploaded on 05/25/2010 for the course ECON 301 taught by Professor Sning during the Spring '10 term at University of Warsaw.
- Spring '10