Question

1. Using game theory, illustrate why it is difficult to finance public goods. Discuss the players, the strategies, and the payoff matrix. How might one solve the problem of financing public goods? Provide examples.

Answer 1

It is difficult to finance public goods because there is a free rider problem which arises, as public goods are free such as parks, law and order, consumers have an incentive to let others pay and they themselves are not inclined to pay for such goods cause if they pay or even if they don't pay for a good, they get the benefit of the public good.

Illustrating it with the help of a payoff matrix

	A contributes	A does not contribute
B contributes	B pays $2, receives $4, benefit +$2	B pays $2, receives $1, net -$1
	A pays $2, receives $4, benefit +$2	A pays $0, receives $1, net +$1
B does not contribute	B pays $0, receives $1, net +$1	B pays $0, receives $0
	A pays $2, receives $1, net -$1	A pays $0, receives $0

As can be seen from the payoff matrix, A does not pay but receives benefit of $1 but, B contributes to the public good and incurs a net benefit loss due to the good being public as there is a free rider problem.

One can solve the problem of financing public goods through direct taxation, for example a consumer buys a product and pays a certain tax on it, all consumers who buy the good have to pay the tax, thus there is no discrimination.

There can be a subsidy on consumers when they pay for the fees to enter a park, thus by making all the consumers pay a nominal charge so that the public good is consumed equally by everyone and everyone who pays for it benefits from it, one can solve the problem.