Public Goods and Free Rider Problem

Overview

This lecture discusses public goods, focusing on the free rider problem, why markets underprovide such goods, and how government intervention solves these issues.

Private vs. Public Goods

• Private goods are rival (one person's use reduces availability) and excludable (only those who pay can use).
• Free markets efficiently provide private goods because individuals only buy if the benefit exceeds the price.
• Public goods are non-rival (one's use doesn't reduce availability) and non-excludable (can't prevent non-payers from benefitting).
• Markets fail to efficiently provide public goods due to lack of profit motive and inability to exclude free riders.

The Free Rider Problem

• The free rider problem occurs when individuals benefit from a public good without contributing to its cost.
• This leads to under-provision or no provision of the good, even if everyone would be better off if it existed.
• Example: Lighthouse—shipowners benefit regardless of payment, so few contribute.

Game Theory & Public Goods Dilemma

• Rachel and Samuel example: Each can pay $400 for a public park or nothing.
• If both contribute, each nets $200; if only one contributes, that person loses $100 and the other gains $300.
• Both have a dominant strategy to not contribute, resulting in no park, despite mutual benefit.
• In small groups, negotiation may work, but with large groups, free riding prevails.

Government’s Role

• Government solves under-provision by taxing and directly providing public goods.
• Efficient if total social benefit exceeds the cost.
• Even those who oppose government intervention often agree it is necessary for true public goods.

Application Example: Roommates & HBO

• Moritz and Melchior have different willingness to pay for HBO but both can enjoy it.
• HBO, in this setting, is non-rival and non-excludable between roommates.
• Total willingness to pay exceeds subscription cost, but both have incentive to understate their true value (free ride).
• If both understate, the group may miss out on HBO, despite mutual benefit.

Key Terms & Definitions

• Rival Good — A good where one person’s use lessens availability for others.
• Excludable Good — A good that only paying consumers can access.
• Public Good — Non-rival and non-excludable; use by one does not reduce others’ use, and non-payers can’t be excluded.
• Free Rider Problem — When individuals benefit from a good without paying, leading to under-provision.
• Dominant Strategy — The best choice for a player, regardless of what others do.
• Nash Equilibrium — Situation where no player has incentive to change strategy, given others' strategies.
• Market Failure — When the market fails to provide an efficient level of goods/services.

Action Items / Next Steps

• Complete the chapter quiz by Sunday.
• Prepare for assignment #3, which includes questions similar to the public good examples discussed.