Public+goods,+rent+seeking

=**Public Goods & Rent Seeking**=

The government is involved in the marketplace because free markets do not always result in socially efficient quantities of goods at socially efficient prices. It is necessary to correct these market failures, in most cases through taxes, in order to push the market into a “calmer” state of equilibrium. Some of the causes of market failure are market power, externalities, public goods, incomplete information, and rent seeking. This space will focus only on public goods and rent seeking.

__Public Goods__
The easiest way to determine what a public good is, is to determine what it is not…a private good. Private goods can be consumed by one person and not shared with anyone else. For example, when you buy a soft drink from a vending machine you own that beverage and no one else can have it once it is consumed. Public goods do not work that way. They are nonrival and nonexclusionary in nature and therefore benefit persons other than those who buy the goods.

//**Nonrival goods**// include public health and welfare programs, education, roads, research and development, national and domestic security, and a clean environment. Other consumers are not prevented from using these goods if you also use them.

//**Nonexclusionary goods**// cannot be allocated to a single person. Radio waves are nonexclusionary because everyone can enjoy listening to it. No one is //excluded// from using it.

Market failure occurs with public goods because very few people are willing to pay for them. There is little incentive to purchase public goods because people prefer to let other consumers pay for them. It is easier to take a //free ride// on the efforts of others who provide the good.

It can be seen that public goods tend to be intangible items, that is, things which are difficult to grasp with the hands, and that many of them fall into the category of information or knowledge. Private goods are invariably tangible items, that is, items that can be touched, moved and/or seen by humans. Very often both types of goods work in tandem or are symbiotic; for example, a piano, which is a private good, can be used to play a melody, which is a public good. The methods for creating both a piano and a melody are public goods, and a specific performance of the melody on the piano is a private good, but a radio or television broadcast of that performance is a public good.

Another example of a public good is a lighthouse, and we can use this to see why public goods are not provided in the socially efficient quantity. Suppose 3 commercial ships continually travel to and from a port on the coast of Maine. All three ships have identical inverse demand functions for the lighthouse: S1 = 300,000 – Q, S2 300,000 – Q, S3 300,000 – Q. The inverse demand curves reveal how much each ship values another lighthouse where it is needed. Below we can see the individual and total demand curves.



Notice that the total demand curve is the sum of the individual demand curves. If the marginal cost of providing lighthouses is $860,000 per lighthouse, the socially efficient quantity of lighthouses on the coast of Maine is 2.

860,000 = 900,000 – 3Q

The marginal cost of each lighthouse is above each ship’s demand curve so none of them will be willing to pay for even one lighthouse on its own. The only way the ships can achieve the socially efficient quantity is to pool their resources.

__Rent Seeking__
Rent seeking typically consists of pursuing government intervention that will provide a comparative advantage to a particular industry. By restricting entry or reducing output, regulations often reduce competition, create cartels, and increase returns. Thus, tariffs and licensing restrictions are regulatory measures commonly sought by rentseekers.

//**Example:**//

You are the manager of a business that faces an inverse demand curve of P = 10 – Q and has a cost function of C(Q) 2Q. The government is considering legislation that would regulate your price at the competitive level. What is the maximum amount you would be willing to spend on lobbying activities designed to stop the regulation?

If the regulation passes, your firm’s price will be regulated at marginal cost ($2) and the firm will earn zero profits. If not, the firm can continue to produce output on charge the firm’s price. The output is determined by the point where MR = MC:


 * 10 – 2Q = 2**

The firm’s price is obtained by inserting this quantity into the demand function.


 * P = 10 – (4) 6**

Your firm stands to lose profits of PQ – C(Q) = $16 if the regulation is imposed. The most you would be willing to spend on lobbying activities is $16.

//Multiple Choice//
1) The two defining characteristics of a public good are a. Rival and nonexclusionary b. Nonrival and nonexclusionary c. Rival and exclusionary d. Nonrival and exclusionary

2) One of the problems of public goods is free riding. This concept is best characterized by a. Individuals who consume more than their fair share of a resource, or shoulder less than a fair share of the costs of its production. b. Claiming that you do not want a resource in order to evade payment, but enjoying the benefits of that resource once it has been established. c. Misrepresenting your personal valuation of a public good. d. All of the above

3) A solution to the problem of free riding and public goods is a. To let the free market rule b. To institute taxes c. To charge association dues d. Both b & c

4) In economics, **_** occurs when an individual, organization, or firm seeks to make money by manipulating the economic and/or legal environment rather than by making a profit through trade and production of wealth. a. Social welfare b. Rent seeking c. Market power d. Incomplete information

5) If you are the manager of a monopoly and the government is considering implementing regulations on your industry, how much would you be willing to spend in order to avoid the legislation? a. The amount equal to your marginal cost b. Whatever it takes to prevent the legislation c. Total profits that it stands to lose if the legislation is passed

1) B 2) D 3) D 4) B 5) C
 * //Answers://**

//**References:**// __Baye, Michael R. 2006.__ Managerial Economics and Business Strategy. McGraw-Hill/Irwin: New York, NY. Public Goods Theory. Retrieved on 11/24/2007 from http://libertariannation.org/b/pubth.htm Cowen, Tyler 2007. The Concise Encyclopedia of Economics. Retrieved on 11/24/2007 from http://www.econlib.org/library/Enc/PublicGoodsandExternalities.html Wikipedia, Public Goods, 2007, Retrieved 11/24/07 from http://en.wikipedia.org/wiki/Public_good Wikipedia, Rent Seeking, 2007, Retrieved 11/24/07 from http://en.wikipedia.org/wiki/Rent_seeking