Question

In: Economics

QUESTION ONE We add the demands of private goods horizontally but add the demands of public...

QUESTION ONE

We add the demands of private goods horizontally but add the demands of public goods vertically when determining the associated marginal benefit to society. Why do we do this, and why are the procedures different for public and private goods? [6 Marks]
Individual A’s demand for Bread (a private good) is
1. Q = 21 - 6P
2. and Individual B’s demand is
3. Q = 6 - 3P.
Write down an equation for the social marginal benefit of the of Bread consumption.
1. [4 Marks]
Now suppose that Bread is a public good. Write down an equation for the social
marginal benefit of Bread consumption. [4 Marks]
People in your neighbourhood pay annual dues to a neighbourhood association. This association refunds neighbourhood dues to selected home owners who do a particularly nice job of beautifying their yards. At the most recent home owners’ association meeting, home owners voted to end this practice because they felt that it was unfair that some people would not have to pay their share of the costs of maintaining the neighbourhood. What is likely to happen to the overall level of neighbourhood beautification? Explain.
1. [6 Marks]
Consider the rival and excludable properties of public goods. To what degree is radio broadcasting a public good? To what degree is a highway a public good? [5 Marks]

Solutions

Expert Solution

Answer 1 [6 Marks]

The procedure is different for public goods and private goods because of the characteristics of:

Non-Excludibility
Non-Rivalryness

For a public good, it is non-excludable and non-rival. The Marginal Cost for producing the public good to another person is zero. Thus, there is a vertical summation to get the demand curve. All Individuals can together pay and everyone can enjoy and reap the benefits of a public good as the MC to provide that good to another additional person is zero.

On the other hand, private goods are excludable and rival. This means the person who pays for it enjoy and reaps its benefits. Thus, every individual who pays it only gets the benefit. Thus there is a horizontal summation to get the market demand curve of a private good.

For a Public Good: The Marginal Benefits of all individuals are added. MB₁ + MB₂ + MB₃ = MB of the Public Good.

For a Private Good: The Marginal Benefits of Individuals are equated. MB₁ = MB₂ = MB₃ = MB of the Private Good

Answer 2 [4 Marks]

Bread is a Private Good. Thus we do a horizontal summation. We sum the Quantities.

Q = 21 - 6P

Q = 6 - 3P

Social Marginal Benefit of Bread Consumption: Q = 27 - 9P

Answer 3 [4 Marks]

Bread if becomes a Public Good, we do a vertical summation, that is we sum the Prices.

Q = 21 - 6P

=> 6P = 21 - Q

=> P = 21/6 - Q/6

And,

Q = 6 - 3P

=> 3P = 6 - Q

=> P = 6/3 - Q/3

Adding the above 2 Equations,

Social Marginal Benefit = 5.5 - 0.5Q

P = 5.5 - 0.5Q

Answer 4 [6 Marks]

This situation is an example of the Free Rider Problem that arises on the use of Public Goods. Everyone thinks that others will pay and I need not pay. This is what happens with regard to the beautification program as well. Every household owner feels he may not pay as someone else who enjoys the benefit will pay. Some household owners are reluctant to pay as they feel that they are bearing the burden of all the house owners who enjoy the benefit but do not pay.

As a result of this problem, no one would eventually pay for the program, and the overall beautification of the neighbourhood would go down.

Answer 5 [5 Marks]

A Radio Broadcast is a public good as it cannot be excluded from someone using it, neither does it cause rivalry if anyone additionally uses/does not use it.

On the other hand, a highway is also a public good. Anyone with a vehicle could use it. We are assuming here that there are no toll charges for using this highway. If an additional car comes in it does not reduce the benefit of others, means it is non-rival. It is non-excludable because anyone with a vehicle is free to use the highway.

Rahul Sunny answered 1 year ago

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