Market Failure: Public Goods

class: center, middle, inverse, title-slide

# Market Failure: Public Goods
## EC 201: Principles of Microeconomics
### Kyle Raze
### Winter 2020

---

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# Prologue

---
# Market Failure

## Causes

1. Absence of property rights.

- Externalities.
    
    - Public goods (today).

2. Market power.

- *e.g.,* monopoly (week 10).

3. Asymmetric information.

---
# Private *vs.* Public Goods

**Q.sub[1]:** Who pays?

**Q.sub[2]:** Who benefits?

.pull-left[
.center[**Private Good:** Groceries]
<img src="groceries.png" width="315" style="display: block; margin: auto;" />
]

.pull-left[
.center[**Public Good:** Park]
<img src="park.png" width="427" style="display: block; margin: auto;" />
]

---
# Excludability

## Definition

> The extent to which a consumer of a good can restrict others from using it.

**Excludable:** Access to the benefits of a good is restricted to those who pay for the good.

- *e.g.,* groceries, apartments, vehicles, *etc.*

**Non-Excludable:** Anyone can access the benefits of a good, whether she paid for it or not.

- *e.g.,* parks, national defense, sunshine, *etc.*

---
# Excludable or Non-Excludable?

.pull-left[
.center[**Podcast**]
<img src="npr.png" width="300" style="display: block; margin: auto;" />
]

.pull-right[
.center[**Phone**]
<img src="phone.png" width="367" style="display: block; margin: auto;" />
]

---
count: false
# Excludable or Non-Excludable?

.pull-left[
.center[**Podcast**]
<img src="npr.png" width="300" style="display: block; margin: auto;" />

.center[**A:** .pink[Non-excludable.]]
]

.pull-right[
.center[**Phone**]
<img src="phone.png" width="367" style="display: block; margin: auto;" />

<br>

.center[**A:** .pink[Excludable.]]
]

---
# Excludable or Non-Excludable?

.pull-left[
.center[**Clean Air**]
<img src="clean_air.png" width="306" style="display: block; margin: auto;" />
]

.pull-right[
.center[**Beach**]
<img src="beach.png" width="769" style="display: block; margin: auto;" />
]

---
count: false
# Excludable or Non-Excludable?

.pull-left[
.center[**Clean Air**]
<img src="clean_air.png" width="306" style="display: block; margin: auto;" />

.center[**A:** .pink[Non-excludable.]]
]

.pull-right[
.center[**Beach**]
<img src="beach.png" width="769" style="display: block; margin: auto;" />

.center[**A:** .pink[Depends. <br> Private .mono[-->] excludable. <br> Public .mono[-->] non-excludable.]]
]

---
# Rivalry

## Definition

> Extent to which the consumption of a good by one person reduces the ability of others to consume it.

**Rival:** Consumption by one person 1) prevents others from consuming or 2) diminishes the value of the good for others.

- *e.g.,* your lunch, your toothbrush, your laptop, *etc.*

**Non-Rival:** People can consume the good simultaneously without diminishing its value.

- *e.g.,* lighthouses, scenic views, knowledge, *etc.*

---
# Rival or Non-Rival?

.pull-left[
.center[**Podcast**]
<img src="npr.png" width="300" style="display: block; margin: auto;" />
]

.pull-right[
.center[**Phone**]
<img src="phone.png" width="367" style="display: block; margin: auto;" />
]

---
count: false
# Rival or Non-Rival?

.pull-left[
.center[**Podcast**]
<img src="npr.png" width="300" style="display: block; margin: auto;" />

.center[**A:** .pink[Non-rival.]]
]

.pull-right[
.center[**Phone**]
<img src="phone.png" width="367" style="display: block; margin: auto;" />

<br>

.center[**A:** .pink[Rival.]]
]

---
# Rival or Non-Rival?

.pull-left[
.center[**Clean Air**]
<img src="clean_air.png" width="306" style="display: block; margin: auto;" />
]

.pull-right[
.center[**Beach**]
<img src="beach.png" width="769" style="display: block; margin: auto;" />
]

---
count: false
# Rival or Non-Rival?

.pull-left[
.center[**Clean Air**]
<img src="clean_air.png" width="306" style="display: block; margin: auto;" />

.center[**A:** .pink[Non-rival.]]
]

.pull-right[
.center[**Beach**]
<img src="beach.png" width="769" style="display: block; margin: auto;" />

.center[**A:** .pink[Rival.]]
]

---
# Types of Goods

---
# Private Goods

.pull-left[
<img src="13-Public_Goods_files/figure-html/unnamed-chunk-20-1.svg" style="display: block; margin: auto;" />
]

.pull-right[

Property rights well-defined .mono[<=>] Consumer pays all costs and experiences all benefits at the margin.

Most consumer products are private goods.

- *e.g.,* jeans, watches, shoes, groceries, automobiles, notebooks, headphones, vitamins, toothbrushes, houses, *etc.*

]

---
# Private Goods

.pull-left[
<img src="13-Public_Goods_files/figure-html/unnamed-chunk-21-1.svg" style="display: block; margin: auto;" />
]

.pull-right[

Usually provided by firms in a market setting.

- Competitive markets without externalities allocate private goods efficiently.

**Q:** Can you think of an example where the government provides private goods?

]

---
# Club Goods

.pull-left[
<img src="13-Public_Goods_files/figure-html/unnamed-chunk-22-1.svg" style="display: block; margin: auto;" />
]

.pull-right[

Property rights not well-defined .mono[<=>] Consumer pays to "join the club," but does not necessarily pay for the marginal costs of using the good thereafter.

Many subscription or membership-based services are club goods.

- *e.g.,* Cable, satellite TV, Netflix, Hulu, HBO, Spotify Premium, country clubs, gyms, *etc.*
]

---
# Club Goods

.pull-left[
<img src="13-Public_Goods_files/figure-html/unnamed-chunk-23-1.svg" style="display: block; margin: auto;" />
]

.pull-right[

Often provided by firms rather than governments.

Providers of club goods usually have market power (*e.g.,* Comcast).

- Fixed cost of network is high, but marginal cost of new subscription is low.

- Firms set price where MV .mono[>] MC <br> .mono[-->] artificial scarcity <br>  .mono[-->] inefficient!

]

---
# Common-Resource Goods

.pull-left[
<img src="13-Public_Goods_files/figure-html/unnamed-chunk-24-1.svg" style="display: block; margin: auto;" />
]

.pull-right[

Property rights not well-defined .mono[<=>] Consumer experiences all marginal benefits, but does not pay all marginal costs.

Some common resources are prone to overextraction.

- *e.g.,* fish, deer or elk on public land, hors d'oeuvres at a party, booze at an open bar, *etc.*

]

---
# Common-Resource Goods

.pull-left[
<img src="13-Public_Goods_files/figure-html/unnamed-chunk-25-1.svg" style="display: block; margin: auto;" />
]

.pull-right[

Property rights not well-defined .mono[<=>] Consumer experiences all marginal benefits, but does not pay all marginal costs.

Other common resources are prone to congestion or pollution.

- *e.g.,* roads, clean water, national parks, your dorm room, *etc.*

]

---
# Common-Resource Goods

.pull-left[
<img src="13-Public_Goods_files/figure-html/unnamed-chunk-26-1.svg" style="display: block; margin: auto;" />
]

.pull-right[

Unregulated markets often fail to manage commons resources efficiently.

- Rivalry creates a sense of urgency among users to extract the resource before others.

- Non-excludability makes maintenance of the resource unattractive to users.

- **Result:** Overuse and neglect.

]

---
# Public Goods

.pull-left[
<img src="13-Public_Goods_files/figure-html/unnamed-chunk-27-1.svg" style="display: block; margin: auto;" />
]

.pull-right[

Property rights not well-defined .mono[<=>] Consumer experiences all marginal benefits, but does not pay all marginal costs.

Usually provided by governments.

- **Government:** National defense, legal system, flood control dams, autopsies, lighthouses, official statistics, fire protection, *etc.*
- **Other:** Clean air, open-source software, knowledge, *etc.*

]

---
# Public Goods

.pull-left[
<img src="13-Public_Goods_files/figure-html/unnamed-chunk-28-1.svg" style="display: block; margin: auto;" />
]

.pull-right[

Markets for public goods do not exist!

- Providing public goods is not profitable for firms and too costly for most individuals.

- **Reason:** Cannot exclude those who do not pay.

- **Result:** Too few public goods <br> .mono[-->] inefficient!

]

---
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# Collective Action Problems

---
# Collective Action Problems

.pull-left[
<img src="13-Public_Goods_files/figure-html/unnamed-chunk-29-1.svg" style="display: block; margin: auto;" />
]

.pull-right[

**Q:** Why are public goods underprovided?

- **A:** The free-rider problem!

**Q:** Why are common resources neglected or overused?

- **A:** Tragedy of the commons!

]

---
count: false
# Collective Action Problems

.pull-left[
<img src="13-Public_Goods_files/figure-html/unnamed-chunk-30-1.svg" style="display: block; margin: auto;" />
]

.pull-right[

**Q:** Why are public goods underprovided?

- **A:** The free-rider problem!

**Q:** Why are common resources neglected or overused?

- **A:** Tragedy of the commons!

**Prisoner's Dilemma, Reprise:** (.pink[Cooperate], .purple[Cooperate]) usually *Pareto dominates* (.pink[Defect], .purple[Defect]), but (.pink[Defect], .purple[Defect]) is often the Nash equilibrium!

]

---
# Free-Rider Problem

## Example: Providing Public Goods

.more-left[

Suppose that a streetlight costs $20 to install.

- Cost exceeds each neighbor's willingness to pay <br> .pink[.mono[-->] No neighbor would install the streetlight on their own!]

]

.less-right[
<table class="table" style="margin-left: auto; margin-right: auto;">
 <thead>
  <tr>
   <th style="text-align:left;"> Neighbor </th>
   <th style="text-align:center;"> Maximum WTP </th>
  </tr>
 </thead>
<tbody>
  <tr>
   <td style="text-align:left;line-height: 110%;"> Darrell </td>
   <td style="text-align:center;line-height: 110%;"> $9.00 </td>
  </tr>
  <tr>
   <td style="text-align:left;line-height: 110%;"> Zhang </td>
   <td style="text-align:center;line-height: 110%;"> $9.00 </td>
  </tr>
  <tr>
   <td style="text-align:left;line-height: 110%;"> Amani </td>
   <td style="text-align:center;line-height: 110%;"> $8.00 </td>
  </tr>
  <tr>
   <td style="text-align:left;line-height: 110%;"> Ivan </td>
   <td style="text-align:center;line-height: 110%;"> $8.00 </td>
  </tr>
  <tr>
   <td style="text-align:left;"> Saoirse </td>
   <td style="text-align:center;"> $6.00 </td>
  </tr>
  <tr>
   <td style="text-align:left;"> Lucy </td>
   <td style="text-align:center;"> $5.00 </td>
  </tr>
  <tr>
   <td style="text-align:left;"> Ibrahim </td>
   <td style="text-align:center;"> $4.00 </td>
  </tr>
  <tr>
   <td style="text-align:left;"> Maria </td>
   <td style="text-align:center;"> $2.00 </td>
  </tr>
</tbody>
</table>

]

---
count: false
# Free-Rider Problem

## Example: Providing Public Goods

.more-left[

Suppose that a streetlight costs $20 to install.

- Cost exceeds each neighbor's willingness to pay <br> .pink[.mono[-->] No neighbor would install the streetlight on their own!]

Marginal social benefit <br> `$\quad$` .mono[=] 9 .mono[+] 9 .mono[+] 8 .mono[+] 8 .mono[+] 6 .mono[+] 5 .mono[+] 4 .mono[+] 2 .mono[=] $51.

- Exceeds cost <br> .pink[.mono[-->] Efficient to install the streetlight!]

]

---
# Free-Rider Problem

## Example: Group Project

.pull-left[
<img src="13-Public_Goods_files/figure-html/unnamed-chunk-33-1.svg" style="display: block; margin: auto;" />
]

.pull-right[

**Q:** What happens in equilibrium?

]

---
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# Free-Rider Problem

## Example: Group Project

.pull-left[
<img src="13-Public_Goods_files/figure-html/unnamed-chunk-34-1.svg" style="display: block; margin: auto;" />
]

.pull-right[

**Q:** What happens in equilibrium?

**A:** Both students slack off.

- Why?

]

---
# Free-Rider Problem

## Example: Group Project

.pull-left[
<img src="13-Public_Goods_files/figure-html/unnamed-chunk-35-1.svg" style="display: block; margin: auto;" />
]

.pull-right[

**Q:** What happens in equilibrium?

]

---
count: false
# Free-Rider Problem

## Example: Group Project

.pull-left[
<img src="13-Public_Goods_files/figure-html/unnamed-chunk-36-1.svg" style="display: block; margin: auto;" />
]

.pull-right[

**Q:** What happens in equilibrium?

**A:** One student does all the work.

- Why?

]

---
# Free-Rider Problem

## Example: Group Project

.pull-left[
<img src="13-Public_Goods_files/figure-html/unnamed-chunk-37-1.svg" style="display: block; margin: auto;" />
]

.pull-right[

**Q:** What happens in equilibrium?

]

---
count: false
# Free-Rider Problem

## Example: Group Project

.pull-left[
<img src="13-Public_Goods_files/figure-html/unnamed-chunk-38-1.svg" style="display: block; margin: auto;" />
]

.pull-right[

**Q:** What happens in equilibrium?

**A:** Student 1 does all the work.

- Why?

]

---
# Free-Rider Problem

## Example: Unions

.pull-left[
<img src="13-Public_Goods_files/figure-html/unnamed-chunk-39-1.svg" style="display: block; margin: auto;" />
]

.pull-right[

Unions use dues to fund collective bargaining efforts.

- Better CBA .mono[-->] Higher compensation and safer working conditions.

- By law, CBA cannot exclude non-union members.

- To overcome the free-rider problem, unions could charge "fair-share" dues to non-members.

]

---
count: false
# Free-Rider Problem

## Example: Unions

.pull-left[
<img src="13-Public_Goods_files/figure-html/unnamed-chunk-40-1.svg" style="display: block; margin: auto;" />
]

.pull-right[

Unions use dues to fund collective bargaining efforts.

- Better CBA .mono[-->] Higher compensation and safer working conditions.

- By law, CBA cannot exclude non-union members.

- To overcome the free-rider problem, unions could charge "fair-share" dues to non-members.

]

---
# Free-Rider Problem

## Example: Unions

.pull-left[
<img src="13-Public_Goods_files/figure-html/unnamed-chunk-41-1.svg" style="display: block; margin: auto;" />
]

.pull-right[

Policy changes have reintroduced a free-rider problem.

- Many states now have "right-to-work" laws that prohibit unions from collecting fair-share dues.

- The Supreme Court's decision in *Janus v. AFSCME* prohibits public-sector unions from collecting fair-share dues.

]

---
count: false
# Free-Rider Problem

## Example: Unions

.pull-left[
<img src="13-Public_Goods_files/figure-html/unnamed-chunk-42-1.svg" style="display: block; margin: auto;" />
]

.pull-right[

Policy changes have reintroduced a free-rider problem.

- Many states now have "right-to-work" laws that prohibit unions from collecting fair-share dues.

- The Supreme Court's decision in *Janus v. AFSCME* prohibits public-sector unions from collecting fair-share dues.

]

---
# Free-Rider Problem

## Example: Columbia River Crossing

Bridge connects Portland, OR with Vancouver, WA.

- Built in 1917, decades before scientists discovered plate tectonics.
- Bottleneck for traffic, transit, and freight.
.pull-left[
.center[**Current Bridge**]
<img src="crc.png" width="315" style="display: block; margin: auto;" />
]
.pull-right[
.center[**Proposed Replacement**]
<img src="crc2.png" width="387" style="display: block; margin: auto;" />
]

---
# Free-Rider Problem

## Example: Columbia River Crossing

.pull-left[
<img src="13-Public_Goods_files/figure-html/unnamed-chunk-45-1.svg" style="display: block; margin: auto;" />
]

.pull-right[

Several governments, one expensive bridge.

**Q:** What happened?

]

---
count: false
# Free-Rider Problem

## Example: Columbia River Crossing

.pull-left[
<img src="13-Public_Goods_files/figure-html/unnamed-chunk-46-1.svg" style="display: block; margin: auto;" />
]

.pull-right[

Several governments, one expensive bridge.

**Q:** What happened?

**A:** The replacement bridge was never built.

]

---
# Tragedy of the Commons

## Example: Common Pasture

.pull-left[
<img src="13-Public_Goods_files/figure-html/unnamed-chunk-47-1.svg" style="display: block; margin: auto;" />
]

.pull-right[

**Q:** What happens in equilibrium?

]

---
count: false
# Tragedy of the Commons

## Example: Common Pasture

.pull-left[
<img src="13-Public_Goods_files/figure-html/unnamed-chunk-48-1.svg" style="display: block; margin: auto;" />
]

.pull-right[

**Q:** What happens in equilibrium?

**A:** Both herders overgraze.

]

---
# Tragedy of the Commons

## Example: Common Pasture

.pull-left[
<img src="13-Public_Goods_files/figure-html/unnamed-chunk-50-1.svg" style="display: block; margin: auto;" />
]

.pull-right[

**Solution:** Give each herder property rights to part of the common.

**Example:** England's Enclosure Acts.

]

---
class: clear-slide

**Podcast Question:** What do farmers do when their wells run dry?

> **A.** They stop farming.

> **B.** They dig deeper wells.

> **C.** They plant different crops.

---
count: false
class: clear-slide

**Podcast Question:** What do farmers do when their wells run dry?

> **A.** They stop farming.

> .pink[**B.** They dig deeper wells.]

> **C.** They plant different crops.

---
class: clear-slide

**Podcast Question:** Which of the following best describes Elinor Ostrom's idea that small groups of people can work together to solve the tragedy of the commons?

> **A.** Pigouvian taxes.

> **B.** Government regulation.

> **C.** Unregulated markes.

> **D.** Coase theorem.

> **E.** Property is theft.

---
count: false
class: clear-slide

**Podcast Question:** Which of the following best describes Elinor Ostrom's idea that small groups of people can work together to solve the tragedy of the commons?

> **A.** Pigouvian taxes.

> **B.** Government regulation.

> **C.** Unregulated markes.

> .pink[**D.** Coase theorem.]

> **E.** Property is theft.

---
# Tragedy of the Commons

## Example: Aquifers

Since 2000, farmers in California's Central Valley have experienced several severe droughts.

Groundwater from aquifers .mono[=] substitute for rainwater.
.pull-left[

- **Difference:** Many farmers share a single aquifer.

- California does not yet regulate groundwater use <br> .pink[.mono[-->] Undefined property rights!]

]
.pull-right[
<img src="well.png" width="563" style="display: block; margin: auto;" />
]

---
# Tragedy of the Commons

## Example: Aquifers

.pull-left[
<img src="13-Public_Goods_files/figure-html/unnamed-chunk-53-1.svg" style="display: block; margin: auto;" />
]

.pull-right[

Without rainwater, farmers must rely on groundwater.

- **Choice:** Keep pumping water from aquifer or cut back.

]

---
count: false
# Tragedy of the Commons

## Example: Aquifers

.pull-left[
<img src="13-Public_Goods_files/figure-html/unnamed-chunk-54-1.svg" style="display: block; margin: auto;" />
]

.pull-right[

Without rainwater, farmers must rely on groundwater.

- **Choice:** Keep pumping water from aquifer or cut back.

Farmers know that they would earn higher profits if everyone cut back, but incentives are such that .green[**everyone keeps pumping!**]

]

---
# Tragedy of the Commons

## Example: Aquifers

**Solutions?**

1. Agreements to cut back water consumption with neighbors?

- Difficult to enforce!
    
2. Coase theorem?

- Requires property rights and low transaction costs. Neither exist here!
    
3. Regulation or Pigouvian taxes?

- Maybe. Requires costly monitoring system, though.

---
# Tragedy of the Commons

## Example: *Deadliest Catch*

Before 2005, Alaska had a derby for king crab fishing.

- Short window each season to catch as much crab as possible.

---
# Tragedy of the Commons

## Example: *Deadliest Catch*

.pull-left[
<img src="13-Public_Goods_files/figure-html/unnamed-chunk-56-1.svg" style="display: block; margin: auto;" />
]

.pull-right[

**Q:** How do fishers compete in a derby?

]

---
count: false
# Tragedy of the Commons

## Example: *Deadliest Catch*

.pull-left[
<img src="13-Public_Goods_files/figure-html/unnamed-chunk-57-1.svg" style="display: block; margin: auto;" />
]

.pull-right[

**Q:** How do fishers compete in a derby?

**A:** They overfish.

- Smaller payoffs .mono[+] more fatalities.

- As the game repeats over time, payoffs decrease from increasingly small crab populations.
]

---
# Tragedy of the Commons

## Example: *Deadliest Catch*

**Solution:** Alaska adopted an .pink[individual fishing quota] system in 2005.

- Each boat receives quota to be filled over a longer period of time.

**Results:**

- Fewer fatalities.

- Smaller fleets.

- Higher crab prices .mono[-->] higher profits.

---
# Tragedy of the Commons

## Example: Climate Change

.pull-left[
<img src="13-Public_Goods_files/figure-html/unnamed-chunk-58-1.svg" style="display: block; margin: auto;" />
]

.pull-right[

The US and China could reduce the severity of climate change if both countries restrict carbon emissions.

**Q:** The current equilibrium is (.pink[Ignore], .purple[Ignore]). How could the US and China reach (.pink[Restrict], .purple[Restrict])?

]

---
# Tragedy of the Commons

## Example: Roommates .mono[+] Kitchen Sink

.pull-left[
<img src="13-Public_Goods_files/figure-html/unnamed-chunk-59-1.svg" style="display: block; margin: auto;" />
]

.pull-right[

**Q:** How can you and your roommates prevent this tragedy?

]

---
# Collective Action Problems

## Solutions?

1. Assign property rights.

- *e.g.,* private property, enforceable contracts, conditions for Coase theorem, *etc.*

2. Pigouvian taxes/subsidies.

- *e.g.,* Oregon's Bottle Bill, water pricing, *etc.*

3. Regulation.

- *e.g.,* anti-littering laws, individual fishing quotas, *etc.*