GPP 501 Microeconomic Analysis for Public Policy Fall 2017 Given - PowerPoint PPT Presentation

GPP 501 Microeconomic Analysis for Public Policy Fall 2017 Given by Kevin Milligan Vancouver School of Economics University of British Columbia Lecture November 1 st Public Goods: Theory GPP501: Lecture Nov. 1st 1 of 18

Review: What are the two elements of a “public good”? GPP501: Lecture Nov. 1st 2 of 18

Agenda 1. The Samuelson model 2. Private provision of a public good GPP501: Lecture Nov. 1st 3 of 18

The Samuelson model Paul Samuelson: “…one [person]’s consumption does not reduce some other [person] ’s consumption.” The focus is on the rivalry aspect. GPP501: Lecture Nov. 1st 4 of 18

The Samuelson model For regular private goods, how do we decide how much to produce? p  Look at costs of production (supply curve) Demand Supply  Is any one person willing to pay what it costs to produce (demand curve) p 0  Why does this not work well for public goods? Q Q 0 Q 0 GPP501: Lecture Nov. 1st 5 of 18

The Samuelson model The key insight: we need to add everyone’s willingness to pay. Why?  Because we all get to enjoy each others’ consumption, so i t is as if we can sum what everyone is consuming. Let’s try this on a graph…. GPP501: Lecture Nov. 1st 6 of 18

The Samuelson model Cost or Benefit Imagine a public good G that has a marginal cost curve looking like this. Marginal Cost Q: why does MC curve slope up? 𝐻 GPP501: Lecture Nov. 1st 7 of 18

The Samuelson model Cost or Benefit Now imagine person 1 enjoys a marginal benefit from each unit of G that looks like MB 1 (marginal benefit for person 1) curve. Marginal Cost Q: why does this slope down? Q: how much public good would person 1 choose to MB 1 buy? 𝐻 GPP501: Lecture Nov. 1st 8 of 18

The Samuelson model Cost or Benefit Now imagine person 2 also is on the scene. Q: If there is just person 2, how much G would be Marginal Cost purchased? Q: if both person 1 and person 2 are there, how MB 2 much G would be purchased? (Tricky….) MB 1 𝐻 GPP501: Lecture Nov. 1st 9 of 18

The Samuelson model Cost or Benefit Now imagine there is also person 3 on the scene. MB 1 + MB 2 + MB 3 Since we all benefit from anything that is Marginal Cost consumed, the Samuelson rule says we should add our marginal benefit curves together to find the MB 3 efficient amount of G . MB 2 MB 1 𝐻 ∗ 𝐻 GPP501: Lecture Nov. 1st 10 of 18

The Samuelson model: Financing The model so far tells us what is the right amount of G , but how do we pay for it? Let’s consider two ideas:  Taxation: if we have to use distortionary taxation to fund the public good, would that push up or down the optimal amount of G ?  Lindahl pricing: Everyone pays according to his/her marginal benefit. o But how do we find out the prices? o Mechanism design / the ‘preference revelation problem’… GPP501: Lecture Nov. 1st 11 of 18

Private provision: game theory Setup:  Discrete public good costs $10.  Each of two people value it privately at $8.  If either agrees to purchase it, it is purchased. If neither, it is not.  If they both contribute, they each pay $5. If only one contributes, he pays $10. Let’s represent this in a payoff matrix. The left-hand number is what Todd gets; the right- hand number is what Sally gets. Todd Don’t contribute Contribute Sally Contribute 3,3 8,-2 Don’t contribute -2,8 0,0 GPP501: Lecture Nov. 1st 12 of 18

Private provision: game theory Q: What should Todd choose? Q: What should Sally choose? Q: What would a ‘social planner’ choose? Q: What is this game called? Todd Don’t contribute Contribute Sally Contribute 3,3 8,-2 Don’t contribute -2,8 0,0 GPP501: Lecture Nov. 1st 13 of 18

How to overcome the prisoners’ dilemma ? Option #1: Government provision… Upside? Downside? GPP501: Lecture Nov. 1st 14 of 18

How to overcome the prisoners’ dilemma ? Option #2: Repeated play… What needs to happen for this to work? GPP501: Lecture Nov. 1st 15 of 18

How to overcome the prisoners’ dilemma ? Option #3: Bundle a private good and a public good… Example: driver ’s license bundled with jury duty. Example: get a gift when you make a charitable donation. Other examples? GPP501: Lecture Nov. 1st 16 of 18

How to overcome the prisoners’ dilemma ? Option #4: Social pressure  Social norms: religion, politesse, etc.  What happens in this (  ) scene in the movie ‘ Reservoir Dogs ’?  Does community size make any difference? GPP501: Lecture Nov. 1st 17 of 18

Example Problem: 3 roommates, deciding on a Netflix subscription that everyone in their apartment can use.  Addyson values it at $5 a month.  Betty values it at $8 a month.  Chuck values it at $3 a month.  The cost is $9.99 a month. Q’s to consider.  Is this a public good?  Would a ‘social planner’ advocate this purchase?  How would Lindahl pricing work here?  Imagine everyone knows all the valuations and they use the following mechanism: o They all write secret bids on a piece of paper, then reveal bids all at once. o Each person assumes the others will be truthful, then chooses own bid to minimize cost. o What does each bid? Do they have enough for the Netflix subscription? o What is a way they can get around the prisoners’ dilemma? GPP501: Lecture Nov. 1st 18 of 18