Lecture 26: Public Goods, Asymmetric Information

public goods characteristics

non-rival, non-exclusive

for public goods we add curves

vertically

non-exclusive

impossible or expensive to exlcude those who don’t pay (free-riders)

non-rival

you use of the good doesn’t affect other people’s use

for private goods we add goods

horizontally

what is the problem with public goods?

free rider problem that leads to an under supply/no supply of the good

what are the solutions to public goods

sponsorship

tying private goods to public goods

taxation

true or false: taxation is Pareto efficient

false

true or false: taxation is Kaldor-Hicks efficient

false because of the problems with democracy

what are the four problems with democracy?

1. rational abstention

2. rational ignorance

3. median vote

4. impossibility theorem

rational abstention

the expected cost of voting is greater than the expected benefit (the probability of you being the tie breaking vote is very low)

it is rational not to vote

how do you find expected benefit of voting?

benefit x probability (probability of being a tie breaking vote)

rational ignorance

most people don’t know what they are voting for

rational to be ignorant about something you will likely not have an impact on

what is an example of rational ignorance?

it is not rational to know every single member of Congress’s stance on free trade

your decision doesn’t have a high probability of impact

what does rational ignorance lead to?

commericals and advertisements providing us with information- voting on little information

true or false: it is rational for society to be ignorant

false

median voter model

the people in the middle (about 10-20% of the voting population) either get what they want or they decide what everyone else gets

politics is directed towards the median voter

the median voter decides elections

impossibility theorem

it is about how you match the choices up

individuals can be rational and rank (even groups can rank) but the public can not

the law of transitivity does not apply in public choice

why is is reasonable to say

there is no method in democracy that allows people to collectively express their preferences

adverse selection

bad, poor quality selection

what causes adverse selection?

asymmetric information

asymmetric information

one side of the transaction knows more than the other

how can asymmetric information apply to used cars?

the seller of the used cars knows more about the car than the buyer

plums can be taken off the market and you are left only with lemons

how does adverse selection arise in the used car market?

if people find out that 50% of the cars sold are lemons and 50% are plums the price will be in between the price of lemons and plums

since the price is lower than the price the plums would sell it for less and less will sell their cars causing the plums to being pulled off the market

what are the solutions to solve the adverse selection?

1. get rid of voluntary exchange- make it mandatory

2. money-back guarantee

3. warranties

4. Lemon laws

5. private institutions

6. public institutions

how does money-back guarantee and warranties get rid of adverse selection?

the informed side guarantees money back or provides a warranty to allow the uninformed side to learn that the product is good

Lemon Laws

law that requires the informed side to disclose relevant information to the uninformed side

how can private and public instituions help solve adverse selection?

public and private institutions can provide information to the uninformed side

what is an example of a public institution that can help solve asymmetric information?

DMV providing insurance companies about your driving record

what is an example of a private institution that helps solve the asymmetric information problem?

Yelp, Uber rating, Amazon