Principles of Microeconomics - Public Goods and Tax Policies

The government can increase efficiency by:
- Regulating industries to overcome market failures (e.g., curbing negative externalities, monopolies).
- Providing critical public goods and services (e.g., delineating and enforcing property rights, national defense).

A public good is nonrival and nonexcludable.
- Nonrival good: Consumption by one person does not diminish its availability to others.
- Non-excludable good: Difficult or costly to exclude non-payers from consuming.
  - Examples: Fresh air, fireworks displays, street lighting, national defense.
- A pure public good is, to a high degree, both nonrival and nonexcludable.

Classification of goods based on excludability and rivalry:
- Rival and Excludable: Private Goods (e.g., ice cream).
- Rival and Non-Excludable: Common Resources (e.g., tuna in the ocean).
- Non-Rival and Excludable: Collective Goods (e.g., cable TV, Wi-Fi).
- Non-Rival and Non-Excludable: Public Goods (e.g., national defense, asteroid deflection).

Public goods are not provided in sufficient quantities by the market due to:
- The free-rider problem: Non-payers cannot easily be excluded from consuming.
  - Difficult for private firms to cover costs and make a profit.
How much of a public good should be provided?
- Cost-Benefit Principle: Provide it up to the point where Marginal Benefit (MB) equals Marginal Cost (MC) (difficult to implement).
  - Costs are calculated as for private goods.
  - Benefits are hard to estimate in practice.
- Demand for Public Good differs from Demand for Private Good.

The optimal quantity is where the demand curve (marginal benefit) intersects the marginal cost curve.

Horizontal Summation of Individual Demand Curves
- All buyers face the same price and each choose the quantity they want.
Example:
- Individual 1's demand (D1):
- Individual 2's demand (D2):
- Total Market Demand (D) = D1 + D2

Vertical Summation of Individual Demand Curves
- All buyers are provided with the same quantity, although they might value it differently.
Example:
- Individual 1's demand (D1):
- Individual 2's demand (D2):
- Total Market Demand (D) = D1 + D2

Examples of private provision (which doesn’t rely on markets):
- Funding by donation: Volunteer action and funding. Non-profit NGOs, e.g., National Public Radio (NPR), Public Broadcasting Services (PBS), American Alliance for Museums, the Getty Foundation, the Central Park Conservancy (NY–land preservation) etc.
- Sale of by-products: e.g., Air broadcasting T.V., financed by the sale of advertisement; National parks selling branded merchandise, etc.
- Private contracting: Gated communities and homeowners’ associations.

Benefit principle: Those who benefit from public spending should bear the cost.
- e.g., those who benefit from a road should pay for that road’s upkeep.
- Practical considerations make it impossible to rely on this approach exclusively.
  - Main issue: ability to pay.
  - Potential option: Progressive Tax System, we all pay but according to our ability to pay.

Imagine sharing a water well with a neighbor. A new device costs $1,000$ . You both value it, but you earn twice as much.
- You're willing to pay $800$ , neighbor's reservation price is $400$ .
- Individually, neither will buy it (not willing to pay $1,000$ ).
- Efficient to share: Total Value = 800 + 400 = $1,200. Cooperative Surplus = 200 = (1,200 - $1,000).
- Will efficient solution be obtained? Depends on transaction costs. Unlikely for large groups.

Would you accept government providing the device based on:
- Equal Tax Rule (Head Tax): Tax of $500$ each. Neighbor's reservation price is too low (400). No.
- Proportional Income Tax: Tax under which all taxpayers pay the same proportion of their incomes in taxes. Yes.
  - You earn twice as much, so pay twice as much.
  - You earn $66,700$ a year, neighbor earns 33,350 $a year. A proportional tax to cover the device will charge you both 1% of your income…</li>\n<li>You pay$ $667$ , neighbor 333. You both are better off!

Wealthy individuals tend to assign higher reservation prices for public goods than low-income people.
A head tax would result in society getting smaller amounts of public goods than it wants.
A proportional taxation or a progressive taxation [a tax under which the proportion of income paid in taxes rises as income rises] are more effective at achieving efficient outcomes!

It is costly to maintain a bureaucracy.
Taxes necessary to finance public goods can create deadweight losses.
Major incentive problems get in the way of efficiency enhancing policies: People who act in their own self-interest in market situations do not stop doing so once they step into public office!

Nate and 9 friends share a restaurant bill.
Dessert time: Nate only orders dessert when he shares the bill, due to the reduced cost to 10% of its menu price. Consumer surplus for Nate: $3$ surplus from pudding (4 - $1 $) and$ $2.40$ from mousse (3 - $0.6). He chooses pudding.
Nate's friends follow same logic the total restaurant bill higher than it would otherwise be…Nate ends up paying the full $10$ and losing 6 = ($10 - $4).
Pumpkin Bread Pudding
- Menu Price $10$
  *Reservation Price 4
Chocolate Mousse
- Menu Price $6$
  *Reservation Price 3

Pork barrel spending: Inefficient projects supported by a legislator because the benefits to their district exceed the costs to their district.
- Ex. Project creates $100$ million in benefits to a specific district with total costs of 150 million.
- Inefficient to go for this project.
- But, if the district has only 1% of the taxpayers, the district's share of the cost is $1.5$ million; 98.5$$ million surplus for the district. Its representative will propose this bill.
- Legislators from other districts support this bill because of logrolling (exchanging favors).

Rent-seeking: Groups or individuals spending resources to use the government to redistribute wealth in their favor.
- Example: Lobbying government to get tariff exemptions.
Rent-seeking produces inefficient outcomes because:
- It diverts resources from productive activities to redistributive ones.
Rent-seeking is costly to curb because:
- Public officials enjoy donations from rent-seekers (for political or personal gain).
- Groups hurt by such outcomes (e.g., consumers) often fail to organize due to high transaction costs.