Cyberlecture

This chapter introduces you to the role of government in our economy, and why it provides certain goods and services but not others. You will also learn how much of these goods and services the government should supply, and which privately provided goods and services it should tax.

What is a public good?
Public goods are, in general, nonrival and nonexcludable. Consumption of a nonrival good does not decrease the amount that can be consumed by someone else. It is difficult to keep someone who has not paid for a nonexcludable good from consuming it anyway.

• pure public goods are highly nonrival and nonexcludable
  • for example, provision of military protection to a geographical area
  • these goods are usually provided by the government

A collective good is one that, once produced, has a marginal cost of zero for additional units. It is therefore inefficient to charge for additional units of a collective good. These goods are sometimes provided by the government and sometimes by the private sector.

• for example, cable television service

A pure private good is one that decreases as it is consumed (rival) and can be limited to only those people who pay for it. These goods will usually be provided by the private sector.

• most consumption goods are pure private goods

A pure commons good is one that decreases as it is consumed (rival), but cannot be limited to only those who pay for it.

• for example, the fish in the ocean

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When should the government provide public goods?
The government should continue to provide, or make available, public goods until the marginal benefit of their provision just equals the marginal cost.

• marginal benefit is how much people collectively are willing to pay for the product

Who pays for public goods?
The government raises revenue to pay for public goods by taxing households and businesses. Each potential user of the public good has an incentive to be a free rider: if you cannot be excluded from consuming a public good, and if is going to be provided anyway, there is an incentive for you not to pay for your share of the good.
      A tax that collects the same amount of revenue from every person is a head tax. A head tax is regressive because both the wealthy and the poor are taxed the same amount, even though their ability to pay is different.
      A proportional income tax is a flat tax: all taxpayers pay the same percentage of their incomes in taxes. A progressive income tax is a tax which collects a larger percentage of a wealthy person's income than of a poor person's income.

• the Canadian income tax system is progressive

The Canadian Taxpayers Federation represents 80,000 Canadians who want to keep a close eye on government spending and taxation. You can visit their website at http://www.taxpayer.com/ to find out what they are currently doing.

What is the optimal quantity of a public good?
The government should continue to provide a public good until the demand for that good just equals the marginal cost. The demand for the public good is the vertical summation of each citizen's reservation price for each quantity of the good.

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The optimal quantity of a public good is where the demand and marginal cost are equal. In the case of an upward sloping marginal cost curve, the optimal amount would be determined as in the figure below.

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When are public goods provided by the private sector?
Some public goods are provided by the private sector when revenues can be raised to cover the cost of producing the goods. Some examples of private provision of public goods are:

• funding by donation
  • coaches of youth sports teams
• development of new technology
  • privately provided radio broadcasts are available to everyone
• private contracting
  • gated communities that contract for their own garbage collection services
• sale of by-products
  • internet sites that sell advertising space in their margins

Practice Activity 1 Try answering some questions about paying for public goods.

Many Canadians volunteer to work in other countries, and agencies abound to help them find a place to work. Canadian University Services Oversees (CUSO) was founded in 1961 to coordinate the overseas volunteer services of Canadian universities. Visit their website at http://www.cuso.org/english_home.htm to find out what activities they are sponsoring today.

Do externalities and property rights call for intervention of government?
If a transaction produces negative externalities (for example, pollution), the government will regulate that transaction to reduce the effect on everyone. If a transaction produces positive externalities (for example, education), the government will subsidize that transaction for the benefit of all.
      If property rights are poorly defined, the government will define them more clearly. An example is a fishery where, without government-enforced quotas, fishers would catch too many fish and the health of the fishery would be threatened.

What are the three major levels of government?
In Canada, there is a federal government that oversees matters of interest to all Canadians. There are also provincial and territorial governments that oversee matters of interest to the people who live in their geographical jurisdiction. Finally there are municipal governments that deal with strictly local issues.

Why is government involved in providing education and health care?
Education and health care are not pure public goods because both can be obtained through the private sector. However, if education were only provided by the private sector, many Canadian children would not be able to afford to go to school. Since education has substantial positive externalities attached to it, the government subsidizes both K-12 and post-secondary education.
      Similarly there are positive externalities attached to health care, as well as efficiencies in the provision of public health care. Because of these, it is rational for governments to subsidize health care.

Practice Activity 2 Try answering some questions about lost economic surplus.

What is rent seeking?
When governments ask for bids for a project that will yield benefits in excess of their costs, many people or firms will spend resources on trying to put in the successful bid. The bidders are hoping to earn the excess benefits, or rents. The process of spending resources is called rent-seeking, and is socially inefficient because the efforts of all but the winner are unproductive.

Economic Naturalist Why do provinces with lotteries generally prefer large prizes?

What goods should government tax?
Taxes are used to raise revenue, and also to discourage certain activities by changing their relative costs. Discouraging production of goods with negative externalities benefits society, but discouraging production of goods with no externalities just reduces the economic surplus that would have been obtained.
      The reduction of economic surplus is minimized if the products being taxed have price inelastic demands or supplies.

Understanding Questions Do I understand this chapter? As a check to your understanding of the material in this chapter, you should be able to answer our questions.