Relay-Version: version B 2.10 5/3/83; site utzoo.UUCP Posting-Version: version B 2.10.2 9/5/84; site wucs.UUCP Path: utzoo!watmath!clyde!burl!ulysses!mhuxj!ihnp4!wucs!esk From: esk@wucs.UUCP (Paul V. Torek) Newsgroups: net.politics Subject: Public Goods--econ lesson for renner, glosser Message-ID: <450@wucs.UUCP> Date: Mon, 29-Oct-84 21:48:15 EST Article-I.D.: wucs.450 Posted: Mon Oct 29 21:48:15 1984 Date-Received: Wed, 31-Oct-84 00:27:16 EST Distribution: net Organization: Washington U. in St. Louis, CS Dept. Lines: 117 [Replies to Stuart Glosser, Scott Renner] A "public good" is a special case of an externality, in which one person's consumption of the good does not preclude others from enjoying similar benefits. Once produced, a public good is available to additional consumers at zero additional cost. More generally, a "nonprivate" good is one such that the amount available to one individual does not reduce that available to others by an equal amount. An externality occurs when market prices deviate from marginal social costs -- the total mar- ginal cost to everyone -- because some goods and 'disgoods' are provided other than through a market mechanism. That is, an externality is a benefit (or cost) given to (imposed on) others without the others giving (receiving) anything in exchange for the benefit (cost). [Griffin and Steele:41; Clarke:45; Pearce:1,10.] Externalities can occur in both consumption or production. A good example of a production externality is a polluting electric utility. While the private cost of the electricity (the firm's cost) may be 2 cents per kilowatt-hour, the social cost may be much higher, perhaps 3 cents per kwh. The difference is due to health costs imposed on local residents by increased pollution concentration in the air. The externality is called a "negative" externality because it is a cost that is imposed on the residents; if the residents prefered polluted air, it would be a "positive" externality. Externalities cause market failure. Market failure is defined by Pareto-inefficiency, which is the existence of an unrealized, technologically possible combination of production and consumption that would make at least one person better off without making anyone worse off. Pareto-efficient outcomes occur when the social benefits of a good minus the social costs of producing it is maximized. When marginal benefits and marginal costs are continuous functions of quantity, this occurs at the quantity for which marginal social cost equals marginal social benefit. Market failure is illustrated in the figures below. In figure 1, the socially optimal output of electricity is Q(s), where marginal social benefit equals the marginal social cost of electricity. Unfortunately, since the private cost of production is 2 cents/kwh, the utility sets a 2-cent price and output is Q(p). In figure 2, we consider what would probably happen if national defense were supplied entirely through voluntary contributions (no taxes). Hardcore patriots contribute some, but others prefer to "ride free" on the contributions of the former. The demand curve D(p) reflects the private benefits to the patriots; where it intersects the marginal cost curve will determine the amount of defense provided (Q(p)). The demand schedule D(s) reflects the social benefits of consumption, which include private benefits plus positive externalities (D(x)). Because no coercive mechanism is used to prevent free-riding, the amount of defense provided falls far short of the socially optimal (i.e., efficient) quantitiy. | MPC + MXC = \ MSC $ |\ \ c 3|---------------\--------- | \ \ e | . \ | \ \ n | MPC . \ |------\---------\-----MC=MSC t 2|---------------.-----\--- | . \ . \ s | . . \ | . \ . D(s)=D(p)+D(x) /kwh| . . D | . D(p) . ---------------------------- ---------------------------- electr. Q(s) Q(p) Q(p) Q(s) defense Fig. 1 Negative externality Fig. 2 Positive externality It is important to note that in the context of economics, a "benefit" or "cost" depends entirely on the preferences of the person(s) on the receiving end. To assert, then, that a negative production externality occurs in the polluting activities of a utility, is to assert that the residents whose air is polluted would prefer that it not be. If the polluter and residents are sufficiently well-informed about the effects of the polluting activities on each other's welfare, *and* they care enough about these effects, there will be no externality (because their preferences will agree). However, it is obvious that this rarely or never happens under present social conditions. Eliminating situations in which externalities occur improves markets' efficiency. There are severe limits to the extent to which this can be done without using coercion, however. For any large and diverse enough group who benefit from a public or quasi-public (non-private) good, any attempt at negotiating a (contractual) solution will fail due to the free-rider problem [Frohlich and Oppenheimer]. Essentially, the incentives are the same as those in an N-person "prisoner's dilemma". Therefore, Pareto-inefficiencies will result. Of course, there is no guarantee at this point that coercive measures (by government) would be efficient either. But some of the main problems in achieving efficiency through government intervention, *including the problem of demand revelation*, can be solved in many cases [Clarke]. It will also be noted that the number of Pareto-optimal ways of producing a good is greater than one (because of different possible distributions of costs: e.g., flat taxation vs. progressive taxation to pay for national defense). Thus, even though there is a possible arrangement that would make *everybody* better off than they would be under laissez-faire, it is not likely that government will hit on it, because of wealth redistribution effects. These effects can be minimized, but not eliminated [Clarke]. However, those who would eschew government interference altogether on grounds of principle should note that even if the government *did* hit on such a universally-beneficial arrangement, their principles require them to oppose it. This puts them in the position of saying (assuming they hold their principles to have some rational basis) that it could be rational to oppose a policy that we would all benefit from. That is certainly a strange -- and dubious -- position. References: Clarke, Edward. 1980. *Demand Revelation and the Provision of Public Goods*. Cambridge: Ballinger Publ. Co. Frohlich, Norman and Oppenheimer, Joseph. 1978. *Modern Political Economy*. Englewood Cliffs, N.J.: Prentice-Hall. Griffin, James and Steele, Henry. 1980. *Energy Economics and Policy*. New York: Academic Press. Pearce, David, ed. 1978. *The Valuation of Social Cost*. London: George Allen & Unwin. --The respiring (thanks to pollution regulations) iconoclast, Paul V Torek, ihnp4!wucs!wucec1!pvt1047 Please send any mail directly to this address, not the sender's. Thanks.