Chapter 3
Public goods and externalities
3.1 Private goods & the benchmark model
Efficiency achieved in benchmark model because:
Preferences for goods and services revealed by consumers → consumers are
willing to put a price on a product → tells producers the type and quantity of
goods they prefer.
Competition amongst producers ensures minimum cost-model → producers
produce at the minimum turning point of the average cost curve.
Perfect information ensures general equilibrium → everyone has all
information on market conditions.
Competitive markets → fail if there are no satisfactory mechanisms by means of
which consumers can reveal their preferences → existence of these mechanisms
depends on the nature or characteristics of goods and services.
Private good characteristics:
Rivalry in consumption → one person’s consumption of a good reduces its
availability to other consumers → e.g. nobody else can eat the same apple as
you did → nobody else benefits from your consumption.
Excludability → consumption of a good is restricted to particular people
(typically those who pay the indicated price) → e.g. apple cannot be eaten by
anyone else because it is your property, and you don’t have to share it.
Benefits of consuming private goods are restricted to individual who reveal their
preferences for good → rivalry and excludability of private goods force consumers to
reveal preferences → sets in motion the competitive processes that cause allocative
efficiency.
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,Graph Analysis:
Db and Dj → individual demand curve for two consumers.
o Assumptions of the bench-mark model in chapter 2 are used.
Db+j → gives the market demand curve (sum of the individual quantities
demanded at each price)
Market equilibrium at point E → market demand = market supply → yields a
single equilibrium at P
o Consumers cannot affect the equilibrium price they pay for their coffees
→ therefore they are price takers.
The graph highlights characteristics of private goods:
o Marginal utility (MU) = marginal cost (MC) for each consumer
o Area underneath demand curve gives total utility derived from
consumption and area under supply curve gives the sum of marginal
costs of producing each coffee.
o Therefore, at equilibrium price 0P → marginal utilities of the two
consumers = marginal cost QE
This is a condition for the efficient supply of a private good.
o Price of a private good = marginal cost of that good
This is the efficient pricing rule for private goods.
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, 3.2 Pure public goods – definition:
Pure public goods/pure social goods → non-excludable and non-rival → e.g.
streetlights (you cannot exclude person A from using the streetlight if they did not
pay for it and the same amount if light is provided to every person who uses it)
Non-rivalry in consumption has two important implications:
- One person’s consumption does not reduce the quantity available to other
consumers implies that marginal cost (the cost of admitting another user) is
zero.
- It would be Pareto-inefficient to exclude anyone from consuming a non-rival
good → even if it were feasible.
o Allowing person C to use the light will not detract from person A and
B’s utility from using the same light.
Non-excludability → it is impossible to exclude a person from consuming the goods
→ it is not possible to assign specific property rights to public goods and enforce
them → e.g. streetlights (you cannot exclude A from using the light if they have not
paid for it).
Pure public goods → very few good qualify and pure public goods → e.g. the army’s
protection becomes less effective as more people or larger areas need protection →
debatable if national defence is a fully non-rival at all levels of provision.
Few goods are classified as non-excludable → costly to place officers to chase non-
payers away from streetlights → new technologies may be developed that make
exclusion viable in financial terms → e.g. a lighthouse sending an electrical signal to
ships that pay towards it, rather than having it in for every ship that passes
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Public goods and externalities
3.1 Private goods & the benchmark model
Efficiency achieved in benchmark model because:
Preferences for goods and services revealed by consumers → consumers are
willing to put a price on a product → tells producers the type and quantity of
goods they prefer.
Competition amongst producers ensures minimum cost-model → producers
produce at the minimum turning point of the average cost curve.
Perfect information ensures general equilibrium → everyone has all
information on market conditions.
Competitive markets → fail if there are no satisfactory mechanisms by means of
which consumers can reveal their preferences → existence of these mechanisms
depends on the nature or characteristics of goods and services.
Private good characteristics:
Rivalry in consumption → one person’s consumption of a good reduces its
availability to other consumers → e.g. nobody else can eat the same apple as
you did → nobody else benefits from your consumption.
Excludability → consumption of a good is restricted to particular people
(typically those who pay the indicated price) → e.g. apple cannot be eaten by
anyone else because it is your property, and you don’t have to share it.
Benefits of consuming private goods are restricted to individual who reveal their
preferences for good → rivalry and excludability of private goods force consumers to
reveal preferences → sets in motion the competitive processes that cause allocative
efficiency.
Gauke Buyl DO NOT DISTRIBUTE
,Graph Analysis:
Db and Dj → individual demand curve for two consumers.
o Assumptions of the bench-mark model in chapter 2 are used.
Db+j → gives the market demand curve (sum of the individual quantities
demanded at each price)
Market equilibrium at point E → market demand = market supply → yields a
single equilibrium at P
o Consumers cannot affect the equilibrium price they pay for their coffees
→ therefore they are price takers.
The graph highlights characteristics of private goods:
o Marginal utility (MU) = marginal cost (MC) for each consumer
o Area underneath demand curve gives total utility derived from
consumption and area under supply curve gives the sum of marginal
costs of producing each coffee.
o Therefore, at equilibrium price 0P → marginal utilities of the two
consumers = marginal cost QE
This is a condition for the efficient supply of a private good.
o Price of a private good = marginal cost of that good
This is the efficient pricing rule for private goods.
Gauke Buyl DO NOT DISTRIBUTE
, 3.2 Pure public goods – definition:
Pure public goods/pure social goods → non-excludable and non-rival → e.g.
streetlights (you cannot exclude person A from using the streetlight if they did not
pay for it and the same amount if light is provided to every person who uses it)
Non-rivalry in consumption has two important implications:
- One person’s consumption does not reduce the quantity available to other
consumers implies that marginal cost (the cost of admitting another user) is
zero.
- It would be Pareto-inefficient to exclude anyone from consuming a non-rival
good → even if it were feasible.
o Allowing person C to use the light will not detract from person A and
B’s utility from using the same light.
Non-excludability → it is impossible to exclude a person from consuming the goods
→ it is not possible to assign specific property rights to public goods and enforce
them → e.g. streetlights (you cannot exclude A from using the light if they have not
paid for it).
Pure public goods → very few good qualify and pure public goods → e.g. the army’s
protection becomes less effective as more people or larger areas need protection →
debatable if national defence is a fully non-rival at all levels of provision.
Few goods are classified as non-excludable → costly to place officers to chase non-
payers away from streetlights → new technologies may be developed that make
exclusion viable in financial terms → e.g. a lighthouse sending an electrical signal to
ships that pay towards it, rather than having it in for every ship that passes
Gauke Buyl DO NOT DISTRIBUTE
