Dominick Salvatore Schaums Outline of Microeconomics, 4th edition Schaums Outline Series 2006

CHAP. 14] GENERAL EQUILIBRIUM AND WELFARE ECONOMICS 319
14.14 PUBLIC GOODS
Market failures also arise from the existence of public goods. Public goods are those that are nonrival in
consumption. That is the use of the good or service by someone does not reduce its availability to others. For
example, if one individual watches regular television there is no interference with the reception of the same TV
program by others. Some public goods (such as cable TV) are exclusive (i.e., the service can be confined to
those paying for it), while others, such as national defense are nonexclusive (i.e., it is impossible to limit the
benefit to only those paying for it).
Public goods that are nonexclusive lead to a free-rider problem, i.e., the unwillingness of people to help pay
for the public goods in the belief that the goods would be provided anyway. Less than the optimal amount of
these goods would then be provided without the government’s raising money to pay for them through general
taxation. Even this does not entirely eliminate the problem because individuals have no incentive to accurately
reveal their preferences, or demand, for the public good. Since a given amount of a public good can be consumed
by more than one individual at the same time, the aggregate or total demand for the public good is
obtained by the vertical summation of the demand curves for all of those who consume the public good.
EXAMPLE 11. In Fig. 14-9, d A and d B are, respectively, the demand curves for public good X of individuals A and B.IfA
and B are the only individuals in the market, the aggregate demand curve for public good X, D T , is obtained by the vertical
summation of d A and d B . The reason is that each unit of the good can be consumed by both individuals at the same time.
Given market supply curve S x for public good X, the optimal amount of X is 4 units per time period (indicated by the
intersection of D T and S x at point E). At point E, the sum of the individual’s marginal benefits equals the marginal cost
of producing the 4 units of the public good (i.e., AB þ BC ¼ AE).
Fig. 14-9
Glossary
Consumption contract curve The locus of points where one individual’s indifference curve is tangent to the other
individual’s indifference curve.
Externality and market failure Refers to a divergence either between private costs and social costs or between private
gains and social gains.
Free-rider problem The unwillingness of people to help pay for an optimal amount of a public good in the belief that it
will be provided anyway.
General equilibrium analysis Studies the behavior of all individual decision-making units and of all individual
markets simultaneously.