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

GPP501: Lecture Nov. 1st 1 of 18

GPP 501 Microeconomic Analysis for Public Policy Fall 2017

Given by Kevin Milligan Vancouver School of Economics University of British Columbia Lecture November 1st Public Goods: Theory

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Review: What are the two elements of a “public good”?

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Agenda

• 1. The Samuelson model
• 2. Private provision of a public good

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The Samuelson model

Paul Samuelson: “…one [person]’s consumption does not reduce some other [person]’s consumption.” The focus is on the rivalry aspect.

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The Samuelson model

For regular private goods, how do we decide how much to produce?  Look at costs of production (supply curve)  Is any one person willing to pay what it costs to produce (demand curve)  Why does this not work well for public goods?

Q p Q0 Q0 p0 Supply Demand

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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 it is as if we can sum what everyone is consuming. Let’s try this on a graph….

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The Samuelson model

Imagine a public good G that has a marginal cost curve looking like this. Q: why does MC curve slope up?

𝐻

Marginal Cost Cost or Benefit

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The Samuelson model

Now imagine person 1 enjoys a marginal benefit from each unit of G that looks like MB 1 (marginal benefit for person 1) curve. Q: why does this slope down? Q: how much public good would person 1 choose to buy?

𝐻

Marginal Cost MB 1 Cost or Benefit

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The Samuelson model

Now imagine person 2 also is on the scene. Q: If there is just person 2, how much G would be purchased? Q: if both person 1 and person 2 are there, how much G would be purchased? (Tricky….)

𝐻

Marginal Cost MB 1 MB 2 Cost or Benefit

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The Samuelson model

Now imagine there is also person 3 on the scene. Since we all benefit from anything that is consumed, the Samuelson rule says we should add

• ur marginal benefit curves together to find the

efficient amount of G.

𝐻 𝐻∗

Marginal Cost MB 1 MB 2 MB 3 MB 1 + MB 2 + MB 3 Cost or Benefit

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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.

• But how do we find out the prices?
• Mechanism design / the ‘preference revelation problem’…

GPP501: Lecture Nov. 1st 12 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 Contribute Don’t contribute Contribute 3,3 8,-2 Don’t contribute -2,8 0,0 Sally

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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 Contribute Don’t contribute Contribute 3,3 8,-2 Don’t contribute -2,8 0,0 Sally

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How to overcome the prisoners’ dilemma?

Option #1: Government provision… Upside? Downside?

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How to overcome the prisoners’ dilemma?

Option #2: Repeated play… What needs to happen for this to work?

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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?

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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?

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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:

• They all write secret bids on a piece of paper, then reveal bids all at once.
• Each person assumes the others will be truthful, then chooses own bid to

minimize cost.

• What does each bid? Do they have enough for the Netflix subscription?
• What is a way they can get around the prisoners’ dilemma?