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Public Goods

Most of the goods we consume are private goods--they are goods that can be consumed by only one person at a time. When I am using my personal computer, you cannot simultaneously use it. When I drink a cup of coffee you cannot also drink it. The distinguishing feature of private goods is that their use is exclusive to the people who purchase or rent them.

There is an entire class of goods we consume that are not private goods. These goods are public goods; they can be consumed jointly by many individuals simultaneously. National defense, police protection, and the legal system are examples of public goods. When you partake of them you do not necessarily take away from anyone else's ability to consume or benefit from them.

PRIVATE VERSUS PUBLIC GOODS

There are two criteria on which economists distinguish between goods to determine whether they are private goods or public goods. The first criterion is called the principle of rival consumption. The second criterion is based upon whether or not people can be excluded from consuming the good once it is produced.

RIVAL CONSUMPTION

If you are enrolled in a course that is graded strictly on a "curve" so that only 15 percent of the class receives A's, then you and your classmates are rivals. If you receive an A, that leaves one less A for your classmates. You also have rivals for the shoes you are wearing, because when they are on your feet no one else can wear them. Private goods are goods that can be consumed by only one person at a time. Private goods are thus subject to the principle of rival consumption: Individuals are rivals in consuming private goods, because one person's consumption reduces the amount available for others to consume.

The shoes on your feet stand in sharp contrast to the missile and bomber bases that are scattered throughout the northern part of the continental United States. On these bases are located the Intercontinental Ballistic Missiles (ICBMs) and B-52 bombers that protected the U.S. during the Cold War. Each of those weapons simultaneously protected both you and your neighbors, so that your consumption of the national defense did not diminish the amount available for your neighbors to consume. National defense is thus said to be a public good, to which the principle of rival consumption does not apply. Individuals are not rivals in consuming public goods because the amount one person enjoys does not diminish the amount that can be enjoyed by the other person.

EXCLUSION

Some public goods also have the attribute that, once they are produced, it is impossible (or at least prohibitively costly) to exclude or prevent individuals from consuming them. For example, no one can be denied the benefits of national defense for failing to pay for national defense. (Although they may be denied their freedom, because they are in jail for not paying their taxes. Nevertheless, even prisoners are protected from nuclear attack by our national defense system.) We say that a public good is a pure public good if individuals cannot be excluded from consuming the public good once it has been produced.

To see the important distinction between rival consumption and exclusion, let's consider the example of television. When television was first commercially produced half a century ago, it satisfied the conditions of being a pure public good. First, the consumption of a TV program clearly does not entail any rival consumption: When you laugh at a David Letterman joke, it does not preclude your friends from laughing (or, perhaps, groaning in disgust). Moreover, the companies that broadcast television signals originally could not exclude anyone from consuming them. Note that we are not saying that it was originally costless for people to watch TV; indeed, the original TV sets were far more expensive than the average set of today. The point is rather that the television networks had no ability to restrict who watched their programs--they could not prevent anyone from consuming the television signal, once it was produced.

The development of cable television and signal scramblers have altered the nature of television. Although it remains true that TV signals simultaneously can be consumed by one person without diminishing the amount available for other persons, it is now possible for television broadcasters to exclude consumers, who must pay a fee for cable service or for usage of a descrambler. Thus, because of technological advances, television no longer satisfies both of the criteria for being a pure public good.

THE DEMAND FOR PRIVATE GOODS

Most of the goods we consume are private goods--they are not only subject to rival consumption, but are also such that their suppliers can readily exclude anyone who does not pay for consuming the good. Because private goods are so commonplace, most of the conventional demand and supply analysis focuses on them. Before going on to examine how matters differ for public goods, however, it will be useful to review briefly the nature of the demand for private goods.

In going from the individual to the market demand for private goods, the technique of horizontal summation is used: At any given price, we add up the quantities that different consumers wish to purchase.

Figure 5-1: Horizontal Summation

In Figure 5-1, for example, we assume that there are two consumers of widgets, Larry and Harry. The schedule DL shows Larry's demand for widgets, while the schedule DH shows Harry's demand. At a price of P0, Larry wants to consume Q0L, while Harry wants Q0H. Similarly, at P1, Larry demands Q1L units while Harry demands Q1H units. Given these individual demands, if we want to find the market demand for widgets, we add up the quantities that each person wants at each price. Because we are summing up horizontally along the quantity axis, this technique is called horizontal summation. Note it is essential that we keep track of how many units each individual wants to consume, because we have rival consumption: Whatever is consumed by one person cannot be consumed by anyone else.

THE DEMAND FOR PUBLIC GOODS

Because public goods are not subject to rival consumption, the market demand for them must be constructed in a manner that is different than that used with private goods. Instead of summing individual demands horizontally, we now sum them vertically. The technique is illustrated in Figure 5-2.

Figure 5-2: Vertical Summation

Suppose that Latona and Heika are the two potential consumers of the TV show Monday Night Live. Their individual demand curves for the show are shown respectively by the schedules DL and DH. Although these demand curves show at any price the amount of the TV show that each person wishes to consume, it is useful to think about them in a different way. Specifically, if Monday Night Live is broadcast for Q1 hours a week, Latona would be willing to pay L1 per hour to watch the show, while Heika would be willing to pay H1 per hour. If the show were expanded to Q2 hours per week, Latona would pay L2 per hour while Heika would pay H2 per hour.

We now face the question: What is the market demand for the TV show? To find the answer, we must add the value placed on the show by Latona to the value placed on it by Heika. Thus, if Q1 hours of the show are offered, Latona would pay L1 per hour to watch it, and Heika would be pay H1 per hour, so that the total amount per hour they would pay is given by the sum, T1 = L1 + H1. Similarly, if Q2 hours are offered, the total amount per hour they would pay is shown by T2 = L2 + H2.

This method of adding up the individual demand curves to get the market demand curve for the show is called vertical summation, because for a given quantity of the good, we sum the values they place on the good, adding up along the vertical axis. We are able to (and indeed must) add the demand curves in this manner, because the TV show does not involve rival consumption: One individual's consumption of the show does not prevent another person from consuming it.

PRICING AND ALLOCATION

Although it is easy to understand the demand for public goods, there are many difficult issues--both practical and theoretical--related to the supply of public goods. Many of these stem from the difficulties in excluding people from consuming public goods, once they are produced. Without exclusion, there is no way for private sector sup-pliers to ensure that they will be paid for their efforts, and thus no incentive for private firms to produce public goods. For this reason, governments often take over the provision of public goods, levying mandatory taxes on all citizens, and then providing the public goods at a zero or low price per unit to the citizenry. Examples include national defense, police and fire protection, and the judicial system.

The mere fact that it is difficult or impossible to exclude consumers does not always mean that government provision of the good is necessary. As we noted earlier, during most of TV's early history the networks were unable to exclude consumers from consuming their programs, and thus were unable to charge them a fee for the services rendered. Despite this, the networks were able to exclude potential advertisers from their broadcasts, and by charging them a price were able to supply the public good privately.

However the public good is supplied--privately or by the government--there are interesting contrasts between private and public goods when it comes to allocating the amounts produced and--when exclusion is feasible--the way in which those amounts are priced. It is thus useful to contrast the allocation of private and public goods under the assumption that a fixed amount of each type of good is produced.

PRIVATE GOODS

Consider Figure 5-3, which is based on Figure 5-1, but adds a fixed supply (SW) of the private good, widgets.

Figure 5-3: A Private Good in Fixed Supply

As before, the market demand curve is the horizontal summation of the individual demand curves. The equilibrium price of widgets is P*. There are three key elements of this equilibrium. First, both consumers pay the same price per unit, P*, for the units they consume. Second, if the consumers have different demands they consume different amounts of the private good (Q*L for Larry and Q*H for Harry). Third, the sum of the amounts consumed by each individual equals the total amount consumed, because rival consumption implies that what one consumes the other cannot.

PUBLIC GOODS

To examine the allocation of public goods, we shall utilize Figure 5-4, based on Figure 5-2, but with the addition of a fixed supply of the public good, ST.

Figure 5-4: A Public Good in Fixed Supply

Once again, DL is Latona's demand, DH is Heika's demand, and DT is the vertical summation of their individual demands. Clearly, TT = LT + HT is the total value per unit placed on the public good, given that ST is being supplied. If the public good is costly to provide, unless individuals can be excluded for non-payment, private provision of the public good is likely impossible. In order to illustrate the principles involved, however, we shall assume that exclusion is possible, as it is for cable television.

(Some economists would argue that to assume exclusion is possible is equivalent to assuming away the conditions that make public goods truly different from private goods. Nevertheless, there is value in examining the implications of non-rival consumption because--as the development of cable TV illustrates--private firms are always looking for ways to convert pure public goods (i.e. those for which exclusion is impossible) into goods for which exclusion is possible. Thus, the analysis in the text illuminates what such firms are attempting to accomplish, as well as some of the principles involved when a government is deciding whether to provide a pure public good and how to allocate among its citizens the costs of producing it.)

Once again there are three key elements of the equilibrium, although they differ markedly from what we observe with private goods. First, even if consumers have different demands for the good (as is the case in this example) they all end up consuming the same quantity of the public good. Second, the total amount of the public good that is consumed is equal to the amount consumed by each person, instead of being the sum of those amounts. Finally, despite consuming the same amount of the public good, if consumers place different valuations on the public good, they would end up paying different prices for what they consume if preferences were observable. Thus, in our example, Heika pays HT and Latona pays LT, implying that the supplier collects TT = HT + LT.

FREE RIDERS

Whenever exclusion is costly to accomplish, there is always the possibility that some people will not be excluded for non-payment. A free rider is someone who can share in the consumption of a good without sharing in its costs of production. For example, if you go to Daytona Beach, Florida, for spring break, you will enjoy a free ride on most of the public goods, such as police protection, provided by the government of that city. You will be able to enjoy the services without having to pay the full costs of producing those services. (You may pay higher sales taxes to finance some of these services.)

Imagine now that you were asked to pay voluntarily for those police services upon your arrival in town. You would likely reason that there was no incentive for you to comply on the ground that the contributions of other people, particularly the permanent residents, are sufficient to cover the costs of the services. Your thoughts on voluntary payment are likely to be shared even by city's the permanent residents, on the grounds that the lack of payment by one person is unlikely to have a material impact on the level of services provided. Yet if everyone thinks this way, it is clear that voluntary payments for the public good are unlikely to be sufficient to cover its costs of production.

It is the existence of the free rider problem that makes the government, with its power to levy non-voluntary taxes, the logical choice to provide police protection and other pure public goods. Even though it may be just as difficult or impossible for the government to exclude individuals from consuming the public good, the government does have the authority to coerce tax payments, and so may be able to ensure the financing of a public good in circumstances under which a private firm cannot.

PRIVATIZING PUBLIC GOODS

Although the government has an advantage over the private sector in collecting the revenues needed to pay for public goods, it has a disadvantage in the actual operation and maintenance of those public goods. The reason is that the lack of ownership of profits when there is a government operation implies reduced incentives to provide the public good in the most efficient manner. In extreme cases, the lower efficiency of government operation could be so costly that we might be better off with no provision of the good rather than high cost provision. In less extreme cases, it may make sense to separate the financing of the public good from its actual provision, using a system known as privatization.

SEPARATION OF FINANCING AND OPERATION

With privatization, the government contracts with private firms to produce the public good, negotiating either a fixed contract price or a fixed unit price. The government then uses its taxing authority to raise the funds needed to pay the private firm; this solves the free rider problem. Because the private provider is allowed to keep its cost savings, it has the incentive (lacking in government agencies) to minimize production costs; this solves the problem of the disincentives that exist when a government agency provides a public good. The chief potential disadvantage of privatization is that the private provider, in its efforts to keep costs low, may shirk on its contract by delivering less than is promised. In this case, the shirking could take the form of the private firm producing less than the contracted-for amount of public good services. Hence the government must monitor (that is, inspect and perhaps even supervise) the provision of services by the private firm, suggesting that we are likely to see privatization only where such monitoring is low cost.

PRIVATIZING PRISONS

The war on drugs and harsher prison sentences during the 1980s and early 1990s have resulting in overflowing prisons and rapidly escalating incarceration costs throughout the country. It now costs over $50,000 per bed to construct prison facilities and up to $25,000 per inmate per year to operate the facilities. As a result government officials have begun exploring ways of reducing these costs; privatization is one approach that is being tried.

Since 1980 Florida, Kentucky, Louisiana, New Mexico, and Texas have either opened privately operated prisons or contracted with private firms to operate prisons. Table 5-1 summarizes the extent of privatization in these five states.

Table 5-1 State Private Prisons

StateNumber of FacilitiesPrivate CapacityTotal CapacityPercent Private
Kentucky31,0008,28912.1
Louisiana21,22017,2577.1
New Mexico12003,0346.6
Texas42,00040,7894.9
Florida11,00039,9992.5

In addition to these state-level efforts, sixteen local governments have private jails, the largest being a 400-bed private facility in Detroit. At the federal level, private firms have been contracted to operate centers for aliens and unsentenced offenders.

Audited results from several of the states show that the private firms provide prison services at a lower cost than public prisons. Table 5-2 shows these results for eight different facilities in four different states.

Table 5-2 Government vs. Privately Operated Per Day Prison Costs

Private FacilityGovernment
Per Day
Private
Per Day
Private
Savings (%)
St. Mary's, KY$28.00$26.894.0
Beattyville, KY32.0026.8916.0
Grants, NM80.0069.7512.8
Winnfield, LA29.5026.0011.8
Cleveland, TX42.5335.2517.1
Venus, TX42.5335.2517.1
Kyle, TX42.5334.7918.2
Bridgeport, TX42.5334.7918.2

There are cost savings at every facility and these savings exceed 10 percent at all private prisons except St. Mary's in Kentucky. Indeed, the states now generally expect savings of this magnitude and, in Texas, Louisiana, and Florida, cost savings of 10 percent are written into the contracts with private firms. In Louisiana it is estimated that privatized prisons saved the state $5.9 million over a five-year period. In addition to operating-cost reductions, some state officials believe private firms lower the time costs of constructing new prisons, particularly when new prisons are required by court order. In New Mexico, for example, it took only nine months to build a private women's prison when it was expected to have taken the state 3 years.

Although the experience of these states appears to show that private firms can operate prisons at a lower cost than the government, other states have been reluctant to privatize their prisons. Some states believe that private prisons offer a lower level of safety and service compared to government-run prisons, although there is no clear evidence that this is actually the case. Other states are waiting for more complete information on cost savings. Clearly, though, cost savings at any level suggest that privatization--at least for prisons--is a way to improve the efficiency with which public goods are provided.




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