Public good

In economics, a public good is a good that is hard or even impossible to produce for private profit, because the market fails to account for its large beneficial externalities. By definition, a public good possesses two properties:

Possible solutions to the Free Rider problem

Dominant Assurance Contracts

Assurance contracts are contracts in which participents make a binding pledge to contribute to a contract for building a public good, contingent on a quorum of a predetermined size being reached. Otherwise their money is refunded. A dominant assurance contract is a variation in which an entrepreneur creates the contract and refunds the initial pledge plus an additional sum of money if the quorum is not reached. In game theory terms this makes pledging to build the public good a dominant strategy: the best move is to pledge to the contract regardless of the actions of others.

Related Topics:
Assurance contracts - Dominant assurance contract

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Coasian solution

The coasian solution, named for the economist Ronald Coase and unrelated to the Coase theorem, proposes a mechanism by which potential beneficiaries of a public good band together and pool their resources based on their willingness to pay to create the public good. Coase argued that if the transaction costs between potential beneficiaries of a public good are sufficiently low, and it is therefore easy for beneficiaries to find eachother and pool their money based on the public good's value to them, then an adequate level of public goods production can occur even under competitive free market conditions.

Related Topics:
Ronald Coase - Coase theorem - Transaction cost

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A similar alternative for arranging funders of public goods production is to produce the public good but refuse to release it into the public until some form of payment to cover costs is met. Author Stephen King, for instance, authored chapters of a new novel downloadable for free on his website while threatening not to release subsequent chapters unless a certain amount of money was raised. Sometimes dubbed holding for ransom, this method of public goods production is a modern application of the street performer protocol for public goods production.

Related Topics:
Stephen King - Ransom - Street performer protocol

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In some ways, the formation of goverments and government-like communities such as homeowners associations can be thought of as applied instances of practicing the coasian solution by creating institutions to reduce the transaction costs.

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Government provision

If voluntary provision of public goods will not work, then the obvious solution is making their provision involuntary. (Each of us is saved from our own individualistic short-sightedness, our tendency to be a free rider.) One general solution to the problem is for governments or states to impose taxation to fund the production of public goods. The difficulty is to determine how much funding should be allocated to different public goods, and how the costs should be split (see resource allocation mechanisms, public finance). Ideally, these decisions should be made democratically following advice informed by economic theory.

Related Topics:
Government - State - Taxation - Resource allocation mechanism - Public finance

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Sometimes the government provides public goods using "unfunded mandates". An example is the requirement that every car be fit with a catalytic converter. This may be executed in the private sector, but the end result is predetermined by the state: the individually involuntary provision of the public good clean air. Unfunded mandates have also been imposed by the U.S. federal government on the state and local governments, as with the Americans with Disabilities Act, for example.

Related Topics:
Car - Catalytic converter - Private sector - Clean air - Americans with Disabilities Act

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Subsidies

A government may subsidize production of a public good in the private sector. Unlike government provision, subsidies may result in some form of competitive market. The potential for cronyism (for example, an alliance between political insiders and the businesses receiving subsidies) can be limited with secret bidding for the subsidies or application of the subsidies following clear general principles. Depending on the nature of a public good and a related subsidy, principal agent problems can arise between the citizens and the government or between the government and the subsidized producers; this effect and counter-measures taken to address it can diminish the benefits of the subsidy.

Related Topics:
Subsidize - Private sector - Competitive - Cronyism - Principal agent problem

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Subsidies can also be used in areas with a potential for non-individualism: For instance, a state may subsidize devices to reduce air pollution and appeal to citizens to cover the remaining costs.

Related Topics:
Non-individualism - Air pollution

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Privileged group

The study of collective action shows that public goods are still produced when one individual benefits more from the public good than it costs him to produce it; examples include benefits from individual use, intrinsic motivation to produce, and business models based on selling complement goods. A group that contains such individuals is called a privileged group. A historical example could be a downtown entrepreneur who erects a street light in front of his shop to attract customers; even though there are positive external benefits to neighboring businesses that aren't paying from the street light, the added customers to the paying shop provide enough revenue to cover the costs of the street light.

Related Topics:
Collective action - Intrinsic motivation - Business model - Complement good - Street light

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The existence of privileged groups is not a complete solution to the free rider problem, however, as underproduction of the public good can still result. The street light builder, for instance, would not consider the added benefit to neighboring businesses when determining whether to erect his street light, making it possible that the street light isn't built when the cost of building is too high for the single entrepreneur even when the total benefit to all the businesses combined exceeds the cost.

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An example of the privileged group solution could be the Linux community, assuming that users derive more benefit from contributing than it costs them to do it. For more discussion on this topic see also Coase's Penguin.

Related Topics:
Linux - Coase's Penguin

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Merging of free riders

Another method of overcoming the free rider problem is to simply eliminate the profit incentive for free riding by buying out all the potential free riders. A property developer that owned an entire city street, for instance, would not need to worry about free riders when erecting street lights since he owns every business that could benefit from the street light without paying. Implicitly, then, the property developer would erect street lights until the marginal social benefit met the marginal social cost, since in this case they are equivalent to the private marginal benefits and costs.

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While the purchase of all potential free riders may solve the problem of underproduction due to free riders in smaller markets, it may simultaneously introduce the problem of underproduction due to monopoly. Additionally, some markets are simply too large to make a buyout of all beneficiaries feasible - this is particularly visible with public goods that affect everyone in a country.

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Legislated exclusion

Another solution, which has evolved for information goods, is to create intellectual property laws, such as copyright or patents, covering the public goods. These laws attempt to remove the natural non-excludability by prohibiting reproduction of the good. Although they can solve the free rider problem, the downside of these laws is that they imply private monopoly power and thus are not Pareto optimal. For example, in the United States, the patent rights given to pharmaceutical companies encourage them to charge high prices (above marginal cost), to advertise to convince patients to nag their doctors to prescribe the drugs, to sue even mild imitators in court, and to lobby for the extension of patent rights. (See rent seeking.)

Related Topics:
Intellectual property - Copyright - Patent - Pareto optimal - Marginal cost - Rent seeking

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This near-ubiquitous problem arises because the underlying marginal cost of giving the good to more people is low or zero, but, because of the limits of price discrimination (including both arbitrage and a lack of incentives to provide cheap, high quality copies to those with little ability to pay), those who are unwilling or unable to pay a profit-maximising price, do not get access to the good.

Related Topics:
Marginal cost - Price discrimination - Arbitrage

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Joseph Schumpeter claimed that the "excess profits" generated by the copyright or patent monopoly will attract competitors that will make technological innovations and thereby end the monopoly. This is a continual process referred to as "Schumpeterian creative destruction", and its applicability to different types of public goods is a source of some controversy. The supporters of the theory point to the case of Microsoft, for example, which has been increasing its prices (or lowering its products' quality), and predict that these practices will make increased market shares for Linux and Macintosh largely inevitable.

Related Topics:
Joseph Schumpeter - Creative destruction

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Non-individualism

If enough people do not think like free-riders, the private and voluntary provision of public goods may be successful. A free rider might litter in a public park, but a more public-spirited individual would not do so, getting an inherent pleasure from helping the community. In fact, a public-spirited person might voluntarily pick up some of the existing litter. If enough people do so, the role of the state in using taxes to hire professional maintenance crews is reduced. This might imply that even a free-rider would not litter, since his or her action would have such an obvious cost.

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Public spirit may be encouraged by non-market solutions to the economic problem, such as tradition and decentralized democracy. The centralized government may play only a supporting role here.

Related Topics:
Tradition - Democracy

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In turn, this kind of public spirit – involving nationalism, patriotism, or national chauvinism or sometimes religious or ethnic unity – has been part of most successful war efforts, complementing the roles of taxation and conscription. To some extent, public spiritedness of a more limited type is the basis for voluntary contributions that support public radio and TV. Contributions to online collaborative media like Wikipedia and many other projects utilising wiki technology can also be seen to represent an example of such public spiritedness, since they provide a public good (information) freely to all readers.

Related Topics:
Nationalism - Patriotism - Chauvinism - Religious - Ethnic - Public radio - TV - Wikipedia - Wiki

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