Chapter 6: Problems
1. Which of the following would be classified as a public good and why?
a. Clean air.
b. Universities.
c. National defense.
d. Loaf of bread.

In order to classify each of the following as a public or private good, the term public good must first be defined. A public good is a good possessing two characteristics: a) Once the good is provided it is difficult to exclude or prevent others from consuming the good, even if they do not pay for it. b) Consumption of the good by one individual does not reduce the amount available for others to consume. Given these characteristics the above goods can be classified.

Clean air and national defense both satisfy the characteristics of a public good. Once these goods are made available to one person, it is not possible to prevent another from consuming the good. Further, it is obvious that one persoffs consumption does not affect either the quantity of air or the quantity of national defense available for another to consume.

A loaf of bread would not be classified as a public good. If an individual is unwilling to pay the bakery for a loaf of bread, the bakery can prevent the individual from consuming it. Further, if a few slices of a loaf of bread are consumed, the quantity of bread that is available for others to consume is decreased.

Universities are a good that satisfy one, but not both characteristics of a public good. Such goods are sometimes referred to as "mixed" goods. It is obvious that it is possible to exclude individuals from consuming a university education. Every year there are numerous students who do not attend a university simply because they cannot afford it. However, once the good is provided, consumption by one individual does not (at least up to a point) affect the quantity that would be available for another individual to consume. For example, when one individual listens to a lecture on the economics of drug abuse, this consumption does not affect the quantity of the lecture available for others to consume.

Although universities are not pure public goods they often receive a great deal of support from government. This occurs because some people feel that an education offers benefits not only to the individual who consumes it, but also to society as a whole. It is felt that without government support, too litfie of the good would be consumed and society would be made worse off. A second reason for such support is found in the philosophy that individuals should not be denied an education simply because they cannot afford to purchase it.

2. Why are public goods generally provided by the government rather than by private firms?

There are several reasons why government generally provides a public good. First is the fact that it is costly to exclude individuals from consuming a good that exhibits the characteristics of a public good. For example, suppose a private firm provides police protection to a certain area of a city. In order to receive payment for the service rendered, the firm would have to identify all individuals using the service and then bill them for the protection. Further, ff the price paid to the firm is to vary with the quantity of the service consumed, then the firm must also know the quantity of protection consumed by each individual. Finally, in order to ensure that payment is received, the firm must be given the ability to prevent those individuals unwilling to pay from entering the section of the city protected by the firm. While it may be theoretically possible for a private firm to perform these feats it would be quite costly. Further, there may be privacy and freedom of movement issues involved. For example, some individuals may not wish others to know that they entered a particular section of the city. Further, if indMduals wish to enter a particular section of the city should the firm have the right to impede their freedom of movement simply because they are unwilling to pay for the protection the firm provides?

The fact that market provision of a public good may result in inefficiency is another factor accounting for government provision. In order to maximize efficiency, production and consumption should occur at the point where marginal benefit and marginal cost are equal. The cost of providing a public good to an additional user is zero. This means that additional units should be provided free of charge. A firm, however, is in business to make money. In order to remain open, it must charge some positive price for the good. This price means that consumption will occur at a point where marginal benefit exceeds marginal cost. Inefficiency will result, and a loss will be imposed on society.

A final reason for government provision relates to the free rider problem. Because of this problem, the market will provide a quantity of the public good that is less than the efficient quantity. Recall that once a public good is provided it is available for all to consume. This means that people have an incentive to hide their true preferences for the good. As more and more individuals engage in this preference-hiding behavior, efficient market provision will fail. For example, suppose a neighborhood consisting of ten homes has had problems with theft. Residents decide to hire a private security guard to patrol the neighborhood. The cost of the guard to each person is $50 per month. Now suppose that one neighbor, Gus, decides not to pay. The other nine residents still des'tre protection so they each pay an extra amount each month in order to continue the service. Gus, who no longer pays for the service, still receives protection. He becomes a free rider. Barbara sees that Gus pays nothing and still receives the benefits of the guard. She engages in the same behavior. As thi.~ behavior spreads throughout the neighborhood eventually no one is left to pay. This occurs because once the good is provided all will benefit. Everyone hides the'Lr preferences for the good hoping someone else will foot the bill. Thus, an insufficient quantity of the good is provided by the market.

8. Briefly discuss why the cost of drugs is likely to increase and the demand for drugs is likely to decrease in the face of prohibition.

The prohibition of drugs will result in both an increase in the cost of drugs (thereby decreasing supply) and a decrease in the demand for drugs. The increase in cost arises from two sources: restriction of output and risk. When drugs are prohibited, the method of supply is to have a cartel (such as the Colombian cocaine cartel) buy the drug in other countries and export it to foreign customers. Like any cartel, the drug cartel will restrict output in an effort to maximize profits. This will decrease quantity and drive up price.

Risk also works to increase the cost of the drug. This risk arises from two sources. First, there is the risk of prosecution associated with supplying an illegal drug. Second, smaller suppliers run the_ risk associated with a lack of government-enforced property rights. Because no property rights are associated with the drug, territories for selling are often won through bloody street wars. Further, there is no protection if someone wishes to steal the drug from you. Each deal to sell carries with it the possibility of being shot in order for the buyer to obtain what he or she wants. Suppliers of chug must be compensated for the possibility of jail time and the possibility of bodily injury and death. This raises cost and decreases supply.

Prohibition will also affect demand. Several factors will work to decrease demand. People may feel that it is improper to consume an illegal good. This will lead to a decrease in the number of buyers. (In some instances there may be individuals who receive a "thrill" from minor law violations and thereby increase demand due to prohibition.) Second, because prohibition increases the price of the drug, people will turn to substitutes such as alcohol. This will increase the demand for the substitutes and decrease the quantity of drugs demanded. Third, the nonprice costs of buying drugs will increase with prohibition (you must develop a reliable connection, perhaps travel to parts of town you would prefer to avoid, etc.) thereby decreasing demand. Finally, risk will work to decrease demand. This risk results both from buying an illegal product (the possibility of jail time) and from buying the product in an irregular market (the possibility of receiving an impure substance). Thus, prohibition will work to both increase the cost of supplying drugs and decrease the demand for drugs.

Return to Textbook Materials Page