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public_goods2-ho_002 - Optimal level of public goods Demand...

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Optimal level of public goods Demand Revelation Public Goods (cont.) (Chapter 36)
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Optimal level of public goods Demand Revelation Today Optimal level of a public-goods provision Evaluations Demand revelation: the VCG mechanism
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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 If market failure means govt. should provide the public good How much should it provide (if the quantity is variable)? Indiv. demand is private—how might govt. actually calculate optimal level? How do we know much to make each person pay? Potential solutions: create incentives for people to reveal demand truthfully. ( mechanism design ) Then govt. knows whether/how much to provide and how should pay how much.
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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 )
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Optimal level of public goods Demand Revelation How can we determine efficient provision level?
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