esk@wucs.UUCP (Paul V. Torek) (10/30/84)
[Replies to Stuart Glosser, Scott Renner]
A "public good" is a special case of an externality, in which one
person's consumption of the good does not preclude others from enjoying
similar benefits. Once produced, a public good is available to additional
consumers at zero additional cost. More generally, a "nonprivate" good
is one such that the amount available to one individual does not reduce
that available to others by an equal amount. An externality occurs
when market prices deviate from marginal social costs -- the total mar-
ginal cost to everyone -- because some goods and 'disgoods' are provided
other than through a market mechanism. That is, an externality is a
benefit (or cost) given to (imposed on) others without the others giving
(receiving) anything in exchange for the benefit (cost). [Griffin and
Steele:41; Clarke:45; Pearce:1,10.]
Externalities can occur in both consumption or production. A good
example of a production externality is a polluting electric utility.
While the private cost of the electricity (the firm's cost) may be
2 cents per kilowatt-hour, the social cost may be much higher, perhaps
3 cents per kwh. The difference is due to health costs imposed on
local residents by increased pollution concentration in the air. The
externality is called a "negative" externality because it is a cost that
is imposed on the residents; if the residents prefered polluted air, it
would be a "positive" externality.
Externalities cause market failure. Market failure is defined by
Pareto-inefficiency, which is the existence of an unrealized,
technologically possible combination of production and consumption that
would make at least one person better off without making anyone worse
off. Pareto-efficient outcomes occur when the social benefits of a
good minus the social costs of producing it is maximized. When
marginal benefits and marginal costs are continuous functions of
quantity, this occurs at the quantity for which marginal social cost
equals marginal social benefit.
Market failure is illustrated in the figures below. In figure 1, the
socially optimal output of electricity is Q(s), where marginal social
benefit equals the marginal social cost of electricity. Unfortunately,
since the private cost of production is 2 cents/kwh, the utility
sets a 2-cent price and output is Q(p). In figure 2, we consider what
would probably happen if national defense were supplied entirely through
voluntary contributions (no taxes). Hardcore patriots contribute some,
but others prefer to "ride free" on the contributions of the former.
The demand curve D(p) reflects the private benefits to the patriots;
where it intersects the marginal cost curve will determine the amount
of defense provided (Q(p)). The demand schedule D(s) reflects the
social benefits of consumption, which include private benefits plus
positive externalities (D(x)). Because no coercive mechanism is used
to prevent free-riding, the amount of defense provided falls far short
of the socially optimal (i.e., efficient) quantitiy.
| MPC + MXC = \ MSC $ |\ \
c 3|---------------\--------- | \ \
e | . \ | \ \
n | MPC . \ |------\---------\-----MC=MSC
t 2|---------------.-----\--- | . \ . \
s | . . \ | . \ . D(s)=D(p)+D(x)
/kwh| . . D | . D(p) .
---------------------------- ----------------------------
electr. Q(s) Q(p) Q(p) Q(s) defense
Fig. 1 Negative externality Fig. 2 Positive externality
It is important to note that in the context of economics, a "benefit" or
"cost" depends entirely on the preferences of the person(s) on the
receiving end. To assert, then, that a negative production externality
occurs in the polluting activities of a utility, is to assert that the
residents whose air is polluted would prefer that it not be. If the
polluter and residents are sufficiently well-informed about the effects
of the polluting activities on each other's welfare, *and* they care
enough about these effects, there will be no externality (because their
preferences will agree). However, it is obvious that this rarely or
never happens under present social conditions.
Eliminating situations in which externalities occur improves markets'
efficiency. There are severe limits to the extent to which this can be
done without using coercion, however. For any large and diverse enough
group who benefit from a public or quasi-public (non-private) good, any
attempt at negotiating a (contractual) solution will fail due to the
free-rider problem [Frohlich and Oppenheimer]. Essentially, the
incentives are the same as those in an N-person "prisoner's dilemma".
Therefore, Pareto-inefficiencies will result.
Of course, there is no guarantee at this point that coercive measures (by
government) would be efficient either. But some of the main problems in
achieving efficiency through government intervention, *including the problem
of demand revelation*, can be solved in many cases [Clarke].
It will also be noted that the number of Pareto-optimal ways of producing
a good is greater than one (because of different possible distributions
of costs: e.g., flat taxation vs. progressive taxation to pay for national
defense). Thus, even though there is a possible arrangement that would make
*everybody* better off than they would be under laissez-faire, it is not
likely that government will hit on it, because of wealth redistribution
effects. These effects can be minimized, but not eliminated [Clarke].
However, those who would eschew government interference altogether on
grounds of principle should note that even if the government *did* hit on
such a universally-beneficial arrangement, their principles require them
to oppose it. This puts them in the position of saying (assuming they hold
their principles to have some rational basis) that it could be rational to
oppose a policy that we would all benefit from. That is certainly a strange
-- and dubious -- position.
References:
Clarke, Edward. 1980. *Demand Revelation and the Provision of
Public Goods*. Cambridge: Ballinger Publ. Co.
Frohlich, Norman and Oppenheimer, Joseph. 1978. *Modern Political
Economy*. Englewood Cliffs, N.J.: Prentice-Hall.
Griffin, James and Steele, Henry. 1980. *Energy Economics and
Policy*. New York: Academic Press.
Pearce, David, ed. 1978. *The Valuation of Social Cost*. London:
George Allen & Unwin.
--The respiring (thanks to pollution regulations) iconoclast,
Paul V Torek, ihnp4!wucs!wucec1!pvt1047
Please send any mail directly to this address, not the sender's. Thanks.laura@utzoo.UUCP (Laura Creighton) (11/05/84)
Paul, Only a consequentialist would worry about whether the disired consequences would arise from his political philosophy. Non-consequentialists do not find this dubious at all -- as you well know. This does not answer the real question of public goods -- how to decide whether we should produce any at all. Under laissez-faire capitalism there is no particular problem with this decision; somebody just decides to produce these goods or doesn't as the case may be. When you get into government production of public goods, however, the case of ``what to produce'' is of great importance. Even if a government production of nuclear weapons is most ``pareto economical'' this fact will mean little to those who are totally opposed to nuclear weapons of all sorts. Calculating the benefit of a public good may be impossible. Saying that ``the actual benefit of an electrical company is XX due to pollution effects'' is misleading. In any pollution talks there are always people who think that they have been damaged a great deal and other people who feel that the damage is slight. Still others feel that the damage is significant, but well worth paying because of the other effects of the industry. Any figure that you come up with will have to be some person's opinion of the value of the public good. Assuming that I have the pollution rights to my own land, I could make an industry pay when their pollution increased beyond what I felt was acceptable. (This, of course, assumes that I can objectively prove that they are polluting that much in the first place. Crying wolf is not allowed.) If I do not have the pollution rights of my own land, I may get stuck with what somebody else's opinion. Given that opinions can be bought, either by cash or by votes, this prospect does not please me. Laura Creighton utzoo!laura