Chapter 5: Public Goods, Public Choice, and Government Failure Comprehensive Study Notes
Public Goods and Market Failures
Demand-Side Market Failures: These occur when it is impossible to charge consumers for a product. Because some people can enjoy the benefits without paying, firms are unwilling to produce these goods as they cannot cover their costs.
Private Goods: Goods produced in the market system by private firms.
Rivalry: Consumption of the good by one person precludes consumption of the good by another. If one person buys and consumes a bottle of water, that specific bottle is unavailable for someone else.
Excludability: Sellers can keep people who do not pay for a product from obtaining its benefits. Only those willing and able to pay the market price can acquire the good.
Public Goods: Goods provided by the government, often offered for free to the end user.
Nonrivalry: One person's consumption of a good does not preclude or reduce the availability of that good for others. Everyone can simultaneously obtain the benefit (e.g., national defense or street lighting).
Nonexcludability: There is no effective way of excluding individuals from the benefit of the good once it exists, regardless of whether they paid for it.
Free-Rider Problem: Because of nonexcludability, people can receive the benefit of a good without contributing to its cost. This leads to a situation where the market fails to provide the good because profit-seeking firms cannot capture enough revenue.
Demand for Public Goods and Collective Willingness to Pay
Determining Demand: The demand for a public good is found by vertically summing the individual willingness to pay of all consumers at each possible quantity.
Optimal Quantity: The optimal quantity of a public good occurs where the collective demand curve () intersects the supply curve (). In the graphical model provided, the optimal quantity is units at a price of .
Cost-Benefit Analysis for Public Projects
Fundamental Concept: Government must decide whether or not to provide a public good by comparing the marginal costs and marginal benefits.
Costs: These include resources diverted from private good production and the private goods that will subsequently not be produced.
Benefit: The extra satisfaction derived from the output of more public goods.
Quasi-Public Goods and Reallocation
Quasi-Public Goods: These are goods that could be provided through the market system (as they are excludable), but because they generate significant positive externalities, the government provides them to ensure they are not underproduced. Examples include education, streets, and museums.
The Reallocation Process:
The government uses taxes to collect funds from individuals and businesses.
These funds are then spent on the production of public and quasi-public goods, effectively shifting resources from the private sector to the public sector.
Public Choice Theory and Voting Paradoxes
Public Choice Theory: The economic analysis of government decision-making, politics, and elections to understand how the public sector operates compared to the market sector.
The Paradox of Voting: A situation where society cannot rank its preferences consistently through paired-choice majority voting. The outcome depends entirely on the order in which votes are taken.
Example Preferences:
Garcia: Defense (1st), Road (2nd), Weather (3rd).
Johnson: Road (1st), Weather (2nd), Defense (3rd).
Lee: Weather (1st), Defense (2nd), Road (3rd).
Scenarios:
National Defense vs. Road: National Defense wins (preferred by Garcia and Lee).
Road vs. Weather System: Road wins (preferred by Garcia and Johnson).
National Defense vs. Weather System: Weather System wins (preferred by Johnson and Lee).
Median-Voter Model: Suggests that the voter holding the middle position on an issue is likely to determine the election outcome.
Reality: People may remain dissatisfied with the median, may "vote with their feet" (move to a different jurisdiction), or preferences may shift over time.
Alternative Mechanisms: Quadratic Voting allows voters to purchase and cast as many votes as they desire, expressing the intensity of their preferences.
Government Failure and Inefficiency
Government Failure: Inefficient outcomes caused by the government itself. Major causes include:
Voting Problems: Inefficiencies like those seen in the paradox of voting.
Principal-Agent Problem: Conflict of interest between those who make decisions (agents/politicians) and those for whom the decisions are made (principals/citizens).
Special-Interest Effect: A small group of people (interest group) gains at the expense of a much larger group.
Collective-Action Problem: The difficulty in organizing a large group to act in its own interest when individual benefits are small.
Pork-Barrel Politics and Earmarks: Appropriations for local projects that are often not economically justified but are used to secure votes.
Rent Seeking Behavior: Appealing to government for special benefits at the taxpayers' or someone else's expense.
Limited and Bundled Choice: Voters face 2 or 3 candidates with "bundled" platforms, forcing them to accept undesirable policies to get desirable ones.
Bureaucracy and Inefficiency: Public agencies lack the profit-and-loss test that disciplines private firms. Bureaucrats often seek to justify their existence and gain political clout, leading to overallocation of resources.
Inefficient Regulation and Intervention:
Regulatory Capture: When a government agency, created to act in the public interest, instead advances the commercial or political concerns of special interest groups that dominate the industry it is charged with regulating (e.g., pharmaceutical industry, Wall Street, federal land leasing).
Deregulation: A potential solution to remove the burdens of captured regulations.
Ethical and Practical Implications: Corporate Relocation
Case Study: Amazon Subsidies: Local and state governments competed to court Amazon for new headquarters using massive subsidies.
Outcomes: Evidence suggests that the final locations may have been chosen regardless of the subsidies. The return on investment (ROI) for these government subsidies typically does not meet the initial expectations or the opportunity cost of that public money.
Imperfect Institutions: Both markets and governments have flaws. It is often a complex task to determine whether a good should be assigned to the public or private sector, as neither is guaranteed to produce a perfectly efficient result.