tr

Private or Public? Public Goods and Services

Our Economic System

An economic system is the way in which people and societies organize economic life to answer three
basic questions: What goods and services will be produced? How wlll they be produced? For whom will
they be produced?

In many countries, most production decisions-what, how, and for whom to produce-are made in
the marketplace through interactions of buyers and sellers. This is called the private sector of the economy.
Other decisions are made by different levels of government. This is called the public sector of the economy.
Many economic systems are called mixed systems since they produce a combination of private and public
goods and services.

What Goods and Services Should Governments Provide?

While many goods and services can be provided by the private or the public sector, a few can be
provided effectively only by governments. Generally governments try to provide the goods and
services that are necessary but that individual consumers might not purchase directly on their
own. There are two criteria that can be used in judging whether something should be provided by
government s: nonexclusion and nonrivalrous (shared consumption).

Nonexclusion
In some situations people cannot be excluded from the benefits of a good or service even if they do
not pay for it. If only some of the people paid for national defense, for example, others could not be
excluded from the benefits of national defense if it is provided. The nonpurchasers of national defense
would be protected just as much as the purchasers. People who receive the benefit of a good but don't
pay for it are calTed free riders.

Nonrivalrous (Shared Consumption or loint Use)

In some situations one person's use or consumption of a good or service does not reduce its usefulness
to others. The security one person receives from a street light is not diminished by a neighbor
receiving the same security. The protection the street light provides is not reduced by additional
people using it.

will not produce things that people are not willing to buy, and individual
Private businesses
consumers are reluctant to pay for goods and services from which others who do not pay will reap the
benefits: "Why should I be the one to buy the street light if everyone else also is getting the benefits?"
Governments therefore must provide some goods and services such as national defense, flood control,
and judicial and legal systems that are characterized by shared consumption and are necessarily or
should be nonexclusive. Public goods are goods that are provided by government and will not be
provided by the private sector.

Advanced Placement Economics Microeconomics: Student Resource Manual @ Council for Economic Education, New York, N.Y 273
 Private and Public Goods
Pure private goods are subject to exclusion and rivalry. Nonbuyers cannot consume the good, and if
one person consumes a unit of the good, someone else cannot consume that unit. They are purchased
directly in the marketplace. Pure public goods are subject to nonexclusion and shared consumption.
They are purchased indirectly through tax dollars.

Some goods have elements of both private goods and public goods. Fishing in the ocean, for example,
is generally not subject to exclusion; but once one person catches a fish, it is not available to others.
Likewise, it is sometimes possible to exclude people from theaters, national parks, or even roads by charging
admission fees or tolls. But one person camping in a park or driving on a highway usually does not reduce
the usefulness of these places to others. Controversy often arises over how these mixed goods-sometimes
called common-pool resources and toll goods-should be provided and who should pay for them. Some
goods do not fall into neat boxes, but show degrees of nonexclusion and shared consumption.

r Thble 5-1.1
Combinations of Exclusion and Shared Consumption

Shared consumption

No Yes

Yes Pure private goods: haircuts, Toll goods: theaters, cable TV

c bread, ice cream parks, toll roads
.9
o No Common-pool resources: fish Pure public goods: national
f
E
x taken from the ocean, irrigation defense, flood control, street lights,
uJ
water taken from a river, mosquito abatement, judicial and
congested roads legalsystem

1. What is the difference between the private and public sectors of our economy?

2. What are the characteristics of a pure private good?

3. What are the characteristics of a pure public good?

274 Advanced Placement Economics Microeconomics: Student Resource Manual @ Council for Economic Education, New York, N.Y,
 4. Place each of the goods and services in the list below into one of the four boxes in Table 5- 1.2.

Circle the box that contains pure private goods. Then draw two circles around the box that
contains pure public goods.
(A) A college education (G) Cable television (L) Police and fire protection
(B) Electric power (H) Canine rabies shots (M)Health care
(C) A haircut (I) Street lights (N) National forest
campgrounds
(D) National defense (l) The Panama Canal
(o) Potato chips
(E) A private amusement park (K) Public toll roads and
(F) spraying for mosquitoes
bridges (P) Auto airbags

ffi Thble 5-1.2

Determining Combinations of Exclusion and Shared Consumption

Shared consumption

No Yes

Yes
c
.o
U'
f
E
x
t -rJ

No

5. What is a free rider? Select three goods from the list in Question 4 that could have free riders.

Advanced Placement Economics Microeconomics: Student Resource Manual @ Council for Economic Education, NewYork, N.Y 275
 Property Rights and Market Failure

A key requirement of a well-functioning market economy is the establishment and enforcement of

well-defined property rights. When individuals, rather than central governments, own the land and
physical capital, many important economic incentives are created. When a person owns property, he or
she has the right to use, sell, or trade with another person for mutual gain. For example, a homeowner
has an incentive to keep that home in nice condition whether he wants to continue to live in the home
or if he thinks that the home might eventually be sold. If the person living in that home doesn't own
the home, he may not have a very strong incentive to keep the home in tip-top condition.

If the owner of a restaurant owns the capital used by the firm, she has a profit incentive to produce a
high-quality product that is demanded by consumers. After all, if the firm is not profitable, the firm will go
bankrupt and the owner's physical capital may be lost.

In the case of the homeowner and the restaurateur, property rights allow for the housing and restaurant
markets to exist and to function reasonably well. This of course begs the question: what would happen to a
market if property rights were not very well established or were absent altogether?

Many cities and towns are located along a river for two reasons: the river proved to be an excellent source
of water for residential and industrial usage, and it was an excellent way of disposing of residential and
industrial wastes. A river is an example of a nation's natural resources, but it is owned by nobody. As a result
of the absence of property rights to the water (either for consumption or for disposal purposes), it tends to
be overused and polluted. We can see this with another example of a negative externality.

Suppose that many chemical companies are located on the banks of the lovely Bohio River. The Bohio is
a source of drinking water for many cities, it is a source of recreation for swimmers and boaters, a fishing
industry exists on the Bohio, and the river serves a pivotal role in the ecosystem throughout the watershed.

Like all firms, these companies incur marginal production costs for each ton of chemicals that is
produced. These marginal costs that accrue to the chemical companies are referred to as marginal private
costs (MPC) of production and are assumed to increase as more tons of chemicals are produced. In fact,
it is the marginal private cost curve that represents the market supply of chemicals. Suppose that the
chemical companies can discharge toxic waste into the Bohio River, a common resource that is critical
to everyone but owned by no one. This toxic waste requires cities to install additional water purification
equipment, causes swimmers to develop skin rashes, hurts the profitability of the firms in the fishing
industry, and threatens the viability of the ecosystem. These negative by-products of producing another
ton of chemicals are additional external costs to society. When we add the marginal private cost to the
external cost of producing chemicals, we get a higher dollar amount, the marginal social cost (MSC). Figure
2-8.1 shows both the MSC and MPC curves in the market for chemicals. The vertical distance between the
two represents the external costs, or negative externality, imposed upon society because nobody owns the
Bohio River.

The graph also shows the downward sloping marginal social benefit (MSB) curve that represents the
demand for chemicals in this market. Assuming that all the benefits of the chemicals are received by the
buyers of the chemicals, the demand curve also represents the marginal private benefit (MPB) curve.

Advanced Placement Economics Microeconomics: Student Resource Manual @ Council for Economic Education, New York, N.Y 101
 ,t
z
l. The market for chemicals will ignore the external costs to society. Businesses seeking to maximize
their total profit will produce the output level where their marginal private benefit equals their
marginal private cost (MPB = MPC). In Figure 2-8.1,label the market equilibrium quantity of
chemicals and the equilibrium price of chemicals as Q, and Pnn.

ffiffi Figure 2-8.1

The Market for Chemicals

a
J
MSC
MPC=S
I
u.J
I
o External cost
Lr per ton
o
tu
It
o-

D = MPB -_ MSB

QUANTITY OF CHEMICALS (tons)

2. From society's perspective, the optimal or socially efficient output level of chemicals is the one
where marginal social benefit equals marginal social cost (MSg = MSC). In the graph,label the
socially efficient quantity of chemicals and socially efficient price of chemicals as Qu and Pu.

3. Which output level is greater: the one produced by firms in the market or the one desired by
society? Does this indicate that the negative externality caused by pollution results in an over-
allocation or an under-allocation of society's scarce resources to the chemical market? Explain.

4. What impact did the absence of property rights for the Bohio River have on the outcome of the
chemical market?

t02 Advanced Placernent Economics Microeconomics: Student Resource Manual @ Council for Economic Education, New York, N.Y