Chapter Summary

Public goods are like other goods in that their value can be measured by what people would be willing to pay to have more of them. But whereas the aggregate demand curve for a private good is formed by adding the individual demand curves horizontally, the aggregate marginal willingness-to-pay curve for a public good is the vertical summation of the corresponding individual curves. This difference exists because the quantity of a public good must be the same for every consumer, and because public goods are characterized by nondiminishability. In the private case, in contrast, the price is the same for different buyers, who then select different quantities.

There is a clear analogy between the demand for public goods and the demand for jointly produced private goods. To produce additional chicken wings, it is necessary to produce additional drumsticks. Just as the quantity of a public good must be the same for all consumers, so must the quantity of chicken wings consumed be exactly equal to the quantity of drumsticks consumed. And just as the price one person is willing to pay for a given quantity of a public good can differ from what another is willing to pay, so will the price of drumsticks generally be different from the price of wings.

As with private goods, the supply curve of a public good is simply the marginal cost of producing it. The optimal quantity of a public good is the level for which the aggregate marginal willingness-to-pay curve intersects the supply curve. In order to pay for the optimal quantities of public goods, it will generally be necessary for individual tax payments to vary directly with the amounts that individuals are willing to pay for public goods. To the extent that people with higher incomes demand higher quantities of public goods and that these goods are provided through government, both rich and poor will favour a tax system that places a larger share of the total tax burden on the rich.

The mere fact that a good has the characteristics of a public good does not mean that it must necessarily be provided by government. There are a number of schemes, ranging from free commercial television to highly structured collective legal contracts, whereby public goods are provided with little direct government involvement.

Problems similar to those that arise in connection with public goods are encountered whenever there are significant indivisibilities or economies of scale in the production of private consumption goods. In such situations, we saw, clubs can form in which members share the costs of important consumption goods. The tradeoff confronting a potential member of such a club can be viewed as one between cost savings and reduced privacy in the use of the good.

Majority voting sometimes produces intransitive rankings among projects. When it does, the power to choose the order in which different pairs of alternatives are considered is often tantamount to the power to determine the final outcome. There is a special class of issues in which majority voting is not vulnerable to agenda manipulation. With respect to single issues in which each voter ranks every alternative in terms of its distance from his ideal choice, the final outcome will be the one most preferred by the median voter, no matter what order the votes are taken in. This result is known as the median voter theorem.

Cost-benefit analysis is a simple but very powerful alternative to majority voting. Applied in the proper way to a sufficiently large number of small decisions, it almost always satisfies the Pareto criterion.

A problem that plagues all mechanisms of public decision making is that self-interested parties have an incentive to influence outcomes in their own favour. This problem goes by the name of rent seeking and has become an increasingly serious threat to our social welfare.

The primary mechanism for distributing income in market economies is the factor market. People sell their labour in return for a payment equal to the value of its marginal product. And they invest their savings at interest rates that are similarly linked to the marginal productivity of capital. This method of income distribution has several desirable properties on efficiency grounds-in particular, it rewards effort and the willingness to incur risk. But critics, notably John Rawls, have argued that people would never voluntarily choose to live under a process that yields such highly unequal outcomes as we see in untempered factor markets.

In addition to the moral argument Rawls offered, there are at least two practical reasons for income redistribution. First, the rich would favour paying more than an equal share of the total tax burden because otherwise they would end up with an inefficiently small provision of public goods. And second, redistribution may be necessary to maintain a voluntary sense of social cohesion, something as much in the interests of the rich as of the poor.

Our current array of welfare programs is costly, not only because of bureaucratic duplication, but also because of its indirect effects on work incentives and on public policies with respect to private markets. The reform of redistributive programs requires attention to both fairness and efficiency.