Lecture 7 Public Goods & Externality exclusion of anyone from getting its service is too expensive. i. That means. to confine the benefits of the goods produced to selected persons. . • Nonexclusion: It means that it is impossible or excessively costly. a number of people may simultaneously consume the same good. regardless of whether or not he or she pays for it. A person will benefit from the production of the good. It has two characteristics which are 1) nonrival consumption 2) nonexclusion • Nonrival Consumption: A good is non-rival if consumption by one person need not reduce the quantity consumed by anyone else. In case of national defense. The protection level given by the army in a country does not differ from person to person.Public Goods: A public good refers to a good or service that is usually provided by the government and to we do not have to pay directly to consume the good ( we make an indirect pay through taxation).enational defense. Each person can enjoy the same level of security. public goods are rival in consumption and non-payers can be excluded. whether or not they pay for it. So. But in case of public goods. But in voluntary cooperation. they can extract the payment of the private good or services that they produced. a number of people will automatically get benefit. the main obstacle is free rider problem . they will be able to provide the good. Only if they collect money for supplying the good. For collecting the money voluntary cooperation has to be ensured first.Why it is difficult for private market to serve public goods: Unlike private goods. if each person contributes only $50. he or she receives the same benefit whether he contributes or not.The problem in voluntary cooperation: Free Rider Problem( An example) Assume that there are ten people in a community. Thus each of the ten people has an incentive to withdraw their individual contribution and enjoy the benefit without financing. So. then they will better off (as they get $100 benefit at the cost of $50). The total cost of building the dam is$500. This problem is called “free rider problem”. . If a public good. dam is built for flood protection then it gives a value of $100 to each people. So the total benefit is $1000. if at least one of the ten people thinks that other nine people will finance the good and withdraw itself from its contribution. Now. . The severity of free riding problem will be dependent on the size of the group. This situation will create serious misallocation of resources. • The smaller the group(for example: two people).Free Riding & group size Now if maximum people behave like free rider. the more severe is the potential free rider problem. • The larger the size of group. then the dam will not be built. the less probability of occurring free riding. Everyone is more likely to behave as a free rider. but the benefit per person is $100. Government provision is must needed. it is more likely that public good could not be financed by the voluntary contribution or private market. and use the $500 tax revenue to finance the dam.Public good financing by the government So. Here the government can impose a $50 tax on each person. as the per person cost is $50. Each person would be better off. . consumption or distribution of certain goods. many people who are not directly involved in the market exchange. These side effects of the economics activities are called externalities. get some beneficial or harmful side effects. Externality generally leads to an inefficient allocation of resources.Externality In the process of production. . the side effects are beneficial to others then it is called positive externality When for any activity ( for example: pollution) carried out by an individual.Types of externality 1) Positive Externality 2) Negative Externality When for any activity ( for example: gardening) carried out by an individual. the side effects are harmful for others to others then it is called negative externality . Examples of Positive Externality • Immunization against a contagious disease helps to reduce the chance of contracting disease to other people • Maintenance of Lawn/Garden may improve neighbor’s well-being . • Noise of airplane irritates people who live near airport. .Examples of Negative Externality • Driving an automobile/car creates smoke and pollute air that other people breathe. Difference between public good and externality . All the people simultaneously and intentionally consume public good (like walking on a road). but the externality effected people get the effects (external benefit or cost) less. Another difference is the effects are same on all consumers who consume public good. But they have to bear the cost. the people who directly consumes or produces the good get the effect much. . in case of externality. All the people get same benefit. consumption of public good is an intended process.. People who bears the external cost for water pollution does not want to have it. But. However. Externality is an unintended process.