Economics of Public Goods and Common Resources Notes

The classification of goods in economics is determined by two primary characteristics: excludability and rivalry.
Excludability
- Excludable: A good is excludable if it is relatively easy to prevent someone from consuming it.
- Non-excludable: A good is non-excludable if preventing consumption is either extremely expensive or impossible.
Rivalry
- Rival (in consumption): A good is rival if, once it is provided, the additional resource cost of another person consuming it is positive (MC > 0). One person's use diminishes another person's ability to use it.
- Non-rival (in consumption): A good is non-rival if, once it is provided, the additional resource cost of another person consuming that unit is zero ( $MC = 0$ ).

Commodities can satisfy one characteristic and not the other. Classification is not absolute; it can change based on technology and market conditions.
Private Goods
- Characteristics: Excludable and Rival.
- Examples: Food, clothes.
Club Goods / Natural Monopolies
- Characteristics: Excludable and Non-rival.
- Examples: TV channels, concerts.
Common Resources
- Characteristics: Non-excludable and Rival.
- Examples: Fish in a lake, a busy (congested) road.
Public Goods
- Characteristics: Non-excludable and Non-rival.
- Examples: National defense, fireworks displays.

A road's classification depends on two variables: whether it is congested and whether it is a toll road.
Uncongested non-toll road: Defined as a Public Good because it is non-rival (no congestion) and non-excludable (no toll).
Uncongested toll road: Defined as a Club Good/Natural Monopoly because it is non-rival (no congestion) but excludable (requires a toll).
Congested non-toll road: Defined as a Common Resource because it is rival (congestion reduces utility for others) but non-excludable (no toll).
Congested toll road: Defined as a Private Good because it is rival (congestion) and excludable (toll).

Variable Valuation: Even though everyone consumes the same quantity of a public good, individuals do not necessarily value it equally. This impacts efficient provision.
- Hypothetical Scenario: Adam and Eve are considering buying rockets for fireworks. Rockets cost $10$ each.
  - Case A: Adam values a rocket at $11$ and Eve values it at $5$ . Because the good is non-rival, the total benefit ( $11 + 5 = 16$ ) exceeds the cost ( $10$ ), so they should buy it.
  - Case B: If Adam values a rocket at only $7$ and Eve at $5$ , the total benefit is $12$ . Since 12 > 10, they should still buy it.
Optimality Condition: An additional unit of a public good should be provided if its marginal benefit ( $MB$ ) is greater than or equal to its marginal cost ( $MC$ ).
- Marginal Cost ( $MC$ ): The opportunity cost of producing the unit.
- Marginal Benefit ( $MB$ ): Because the good is non-rival, the total marginal benefit is the sum of all individual consumers' benefits for that unit.
- Formula: $\sum MB = MC$

The Free-Rider Problem: A free-rider is a person who receives the benefit of a good but avoids paying for it.
- Because public goods are non-excludable, individuals have a rational incentive to be free riders.
- Firms cannot prevent non-payers from consuming, leading to a breakdown in the price mechanism.
Market Inefficiency:
- The result is that public goods are under-produced by the private market, or may not be produced at all.
- This happens even when the collective value of the good to buyers is higher than the cost of provision.
- Inefficiency arises from an externality: if one person organizes a display, they cannot charge neighbors who derive utility from it, thus the provider does not account for the external benefit to others.

If the total benefit exceeds the cost, the government can provide the good using tax revenue.
Cost-Benefit Analysis: A study used to compare the costs and benefits of providing a public good to society.
Challenges: Measuring benefit is difficult and often imprecise. Unlike private goods where price signals provide data, government officials must estimate values, making efficient provision harder than for private goods.

Characteristics: Like public goods, common resources are non-excludable (governments must ensure provision). Unlike public goods, they are rival in consumption.
The Problem of Overuse: One person's use reduces the ability of others to use the resource.
The Tragedy of the Commons Parable:
- Setting: A medieval town with common land where sheep graze.
- Mechanism: As the human and sheep population grows, the fixed amount of land is overgrazed. Graze-able grass disappears.
- Incentive Analysis: Private incentives (using the land for free) outweigh social incentives (preserving the land).
- Externality: Allowing one's flock to graze reduces land quality for others. This external cost is neglected by individuals.

To prevent overconsumption and the "tragedy," several policies can be implemented:
- Regulation: Direct command-and-control approaches to limit usage.
- Corrective Taxes: Internalizing the externality by charging for use (e.g., fishing licenses, entrance fees for congested parks).
- Permit Auctions: Auctioning off rights to use the resource (e.g., New Zealand's Radio Spectrum Management auctions).
- Privatization: Converting the common resource into a private good by dividing and selling it as parcels to individuals, giving them a direct incentive to maintain it.

Case Study: Spam Email
- Spam is non-excludable (firms cannot easily be prevented from sending it).
- Spam is rival (as the volume of spam increases, the effectiveness of any single email decreases).
- Spam is classified as a common resource and is overused for the same reasons as other common resources.
Significant Common Resources:
- Clean air and water.
- Congested roads.
- Wildlife (fish, whales).
The Role of Property Rights:
- Market failures in public goods and common resources occur because property rights are not well-established.
- Example: Nobody owns the air, so nobody can charge polluters, leading to too much pollution.
- Example: Nobody can charge for the benefits of national defense, leading to too little defense.
- Government intervention through policy can potentially correct these inefficiencies.