a little bit of
housekeeping. I guess this will be
the last reminder that the first homework is
due tomorrow night. A lot of people have
already done it but still 40 people haven't
actually bought the textbook yet so if
that's you I doubt it's people actually here but
if it is you I recommend doing it now otherwise
you won't be able to access the homework.
More importantly our first exam is two
weeks today so I'll start giving you more
information about that I'll try and get some
practice exams to the end of the week I
think the topics I will cover will be up until
the end of the next topic elasticity my
original plan was to have consumer choice on
there but I think the foundations of
rationality and consumer choice is so important
I don't want to rush it just to have it on the
exam so I'll let you know exactly how
things are going like probably after Wednesday's
class but that is my current plan any
questions regarding the homework or the exam
first exam right so once I've written the exam
I'll give you more information about how
many questions etc so we finished up last
class discussing this idea of market failures
where the free market doesn't result in the
efficient equilibria and we started off
by talking about this idea of negative
externalities and the reason why negative
externalities results in inefficiency is that
neither the buyer or the seller take into account
these third-party costs when they decide
their willingness to pay or willingness to
accept for a product. So imagine you're a
buyer and you're buying some steel product. All
you care about is how much I value this
product and how much will I pay. If my willingness
to pay is above the price, I'll pay it.
You're the seller. How much does it cost me
to produce? If I get more than that, I'll
sell it. But as we know this firm could be you
know polluting when they create steel the
more still they create the more pollution
they create which harms everyone's society lower
air quality climate change whatever example
you want to use this isn't internalized by
either the buyer or the seller as a result
we have this inefficiency and overproduction a
student in the previous class brought up i
think a good point it's like hey when i fly
i offset and a lot of people tend to do that
now some people care more than just you
know the the amount of surplus they get from
using a good we all have our own you know values
and preferences in other domains if everyone
did that then the externality would be
internalized but you know offsetting on the
planes 11 or something like that for a local
flight if it was 150 i i doubt that would be
a solution but that is something that is
worth thinking about we spoke about how government
can intervene to solve negative externalities
by either putting in quotas, so a specific
number of pollution permits, or by putting
in an excise tax. Then we looked
at this idea of the Coase
theorem, that if property rights
are well defined, then two parties can
bargain to figure out a solution. So this
is an example I wanted to show. We have a
cattle farmer and a weight farmer, and
there's currently no fence between them.
And the question is, who will build a fence
in what situation? Because if there's
no fence, the cattle will go and just
eat all the wheat. So if we're in
an open range, so if property rights
aren't really defined in the sense
that the wheat farmer owns that land, then
the wheat farmer themselves will build
the fence around the wheat farm so the
cows can't get in. But if there's private
property and the cows go across and
they eat the wheat, the cow farmer is
going to be liable for damages, so they're
going to be the one who builds the fence
to prevent that. And And then we
looked at this example of our
roommate here. So we go here. We can see when
there's some sort of externality, we all
have some willingness to pay or willingness
to accept to move from one
situation to the other. So in this example,
this person was willing to pay up to
$40 to their neighbor to stop them playing
loud music. And if the value is
intertwined in some domain, they'll be
able to put a solution. And this could be in the opposite
situation as well. Let's say you want to throw a party
until 5 a.m. And, you know, your
neighbor's like, hey, I have the
right to say no. That's, you know,
the law, et cetera. You could offer to
pay them the amount of money to let you
throw the party. And if the values
align, you can do that as well. So you've
just got to think about what, like,
the private property situation is or the
law, and if values can align for bargaining
to take place. So I'm going to
ask a little bit of a tangential
question now. I'm going to pick
on someone here. Anyone want to be
picked on before I ask a question?
Anyone want to answer something
a bit weird? Okay, this is a
weird one for you. You're, you know,
deciding policy in the government, and they
ask you a question, what is the optimal number
of deaths from road accidents in the U.S.?
What would you say? The optimal is zero. Optimal is zero. Hands up if you agree that the optimal is zero. Okay, pretty much everyone agrees the
optimal is zero. Hands up if you
disagree. Anyone disagree? We have
one person that disagrees. What's
your name, sorry? Me? Yeah. I don't... Wait, wait, what's your
name first? Ari. Ari? Ari, why do you disagree? Surely the
optimal is zero, right? The optimal
is zero, but I don't know
what people say. It's not a number one. Yeah. It's not
a number one. Yeah, no, that's
a good point. And you're getting
there as well, but going back to here.
Okay, so if we say the optimal is zero,
the answer actually is it's not zero,
but idealistically we want it to be zero.
So why isn't the optimal zero? What
policy are you going to put in place to
ensure zero deaths? Oh, you can't for bad
cars. It's going to be zero deaths from
road accidents, but that's clearly not
an optimal decision. So, this is the
thing. When deciding about how much of a
bad thing we want, the optimal is rarely
zero and this is where economists are a bit
weird we like to trade in in the moral domain
where we say certain number of deaths
are acceptable so a story and the reason
why I ask that is a good friend of mine she's
an economist for the Australian government she
was at some conference and they're talking
about this exact thing road policy they're
speaking about the optimum number of
deaths and a journalist comes up and says surely
the optimal number is zero and they started
laughing which is kind of cruel but this
is the idea the only way to get zero deaths
on the road right now is either van cars
or have everyone go at like one mile an
hour. And if everyone goes at one mile an
hour, it's going to take you a long time to get
from your home town driving down to Fairview.
So there are costs involved in changing
policies. By reducing the speed limit by
five miles an hour in a certain area, we
reduce the probability of deaths, but we also
make it more costly for everyone to travel.
So how do we decide what the optimal number
of a bad thing is. And it's the
same thing with the optimal amount
of pollution. It's not zero. So as
you can see here we have the marginal benefit
of each unit of mitigating pollution and
the marginal cost. And the idea here is for each
extra unit of pollution that we remove from
the atmosphere we get less and less
benefit each time. Still positive but less and
less benefit. And the easiest unit to remove
at first is less costly but this increases over
time. So as per usual, we want to optimize
where our marginal cost equals our marginal
benefit, because reducing any more units
after that is just too costly. And it's the
same thing with deciding on speed limits. At
some point, if you still decrease the speed
limit, even though you may save more lives,
it's going to be more costly on the rest of
the population overall. So due to things like
scarcity and trade -offs, we have some
tough decisions to make in society during you
know COVID we made a bunch of decisions
about closing schools or not and economists
would discuss what is the optimal level
of doing these things now there's a funny
video I have you which I'm not going to show
because it's more of a sound bite but does
anyone watch any UK comedy shows here by any
chance do you know who David Mitchell is does
that name ring a bell yeah Mitchell Webb
so this is actually a Mitchell Webb clip I'm
not going to show it because it's literally
just a sound bite but the idea behind this
is David Mitchell is meant to be like dry
witty slightly on the spectrum as well he calls
up a radio station and they ask him like um
are you happy that you know there were
zero deaths from from drowning in the local
county this year it's like no this is a bad thing
this shows that we're overspending if there
are zero deaths it means we're trying too
hard as a result a lot of people are dying
from other things by not funding those
programs instead so we shouldn't want zero deaths
and And this is kind of an absurd way to
say that the optimal amount of a bad thing
is not zero, but it's a comedy sketch and it
gets to the same point. So positive
externalities are also a market failure
and inefficiency. So a positive externality
is that there's a positive benefit
of a third party from consumption or
production of a good. So some examples here
are tech spillovers when new technology
is invented. You can spill over into
other domains, help create new products,
make us better. Education, the
more people that are educated, the
more benefits they can bring to
others in society. Something as simple
as planting flowers in your yard. When,
you know, third parties walk by,
they get to enjoy the beauty of your
flowers in your yard. If you're a farmer
that plants apple trees, that creates
more nectar. For the bee farmer,
that increases, you know, their
own production. And medicine that
prevents diseases from spreading as well. so all
of these have a private benefit of consumption
a private benefit of production they
also have this social benefit which isn't taken
into account for the exact same reason we
spoke about before so this is my my um i
need to get rid of the the animations so this
is what it looks like so you can see we have
our internal benefit we have our internal
cost and then we have our social benefit as
well. So at QM, at the market equilibrium,
no one individually is taking into account
the social benefit, so we underproduce. And the
amount we underproduce by is at the social
optimum here, so we're underproducing
by QS minus QM. And the deadweight loss here
is how much we're not producing, essentially.
So if we were able to produce here, we'd
get this extra surplus which is here for the
the the producer and here for the consumer
that's how we kind of measure it here so this
triangle in between the two demand curves
lined above the supply curve so like last
time we're going to do this little interactive
quiz on positive externality so if you
want to use your phone qr code play along you're
more than welcome to i'll get back to it
don't worry but you're more than welcome just
to watch the screen as well so i'll give
you a couple of seconds speaker there there
we go okay so use the following table to graph
the demand curve for the mmr vaccine used
to prevent measles mumps and rubella so at
25 there are 200 units demanded sorry what
am i doing at 25 there are 200 units demanded
at $100 there are 125 units demanded and
at $175 there are 50 units demanded so got
it right eventually. Measles, mumps and
rubella are all highly contagious diseases
measles alone infects an estimated 90% of
unvaccinated individuals who have contact with
an infected person so the idea behind this
is that by getting vaccinated if you get the
disease it reduces the likelihood of spreading
it to other people so the way economists
think about this is that this has social
benefit because you reduce the likelihood of
others getting infected if you get the vaccine
so it says graph the social value curve
using the information at the table below so
now at $25 the social demand is 300 at 125
it's 200 and at 175 it is 150 so this is our
social funnel value and the external benefit
in terms of price at each point can be
measured by the vertical distance between the
two curves so what is the private value so
what does each you know individual get in terms
of consumption of the 175th millionth dose
so here it's just 50 saying this is what
producers would be willing to sell it at if it
costs 50 dollars what is the social value of
175th unit so we look where it intersects
with the social value curve and that is 150
dollars is 175 million doses of the vaccine
the socially optimal number of doses no it's
not as we said before the socially optimal
number would be here and then this is
straightforward the quantity is here 175 and the
socially optimal equilibrium and the
quantity is 225 so this is fairly straightforward
and this means the market produces
less than the socially optimal amount at
the social optimal we have 225 units but only
175 under the market okay so this is why
we want to select the deadweight loss so
remember the dead weight loss is in between
the two demand curves above the supply
curve in between the quantity that is not
produced so it's these two triangles here
that's going to be our dead weight loss in
between the two demand curves line above the
supply curve and in between the quantity
demanded difference the difference in
demand finally using the graph what is the per
unit subsidy amount that would move the
market to the socially optimal level so the
government instead of putting taxes they
can subsidize things. So during COVID in a
lot of countries they had these subsidies
for vaccines for this reason and also
it's why in a lot of countries as well
less than the US they subsidize education
heavily as well because of the external benefits.
So in this case we can measure it by
looking at any point in quantity on the
demand curve and seeing where it intersects
with the social value curve 150 and 50 so
a hundred dollars or you could do it here
100 200 a hundred dollars so it doesn't
matter where you do it and that should give
you the answer here right and that is it
so let's go back to so yeah in this case
the government puts in the subsidy or um quotas
aren't actually an option here as well but
yeah um so does anyone have any questions
about negative or positive externalities
before we move on to goods okay great so there's
going to be two types of market failures here
we're going to have something called the
tragedy of the commons which is kind of
relating to the idea of negative externalities
and we'll go through an example there and
the other main market failure is its own domain
public goods before we talk about that
though we need to define types of goods and we
have four categorizations based on two terms
goods can be either rival or non-rival and
either exclusionary or non-exclusionary.
So a good is non-rival if my quality of
consumption of the good is not affected by your
quality of consumption. But if my ability or
quality of consumption is affected by yours,
then it is rival. On the other hand,
a good is non -exclusionary if once
it's provided, no one can be stopped
from using it. and it's exclusionary
when once it's provided you can stop someone
from using it so we have examples here
of our four types of goods private common
club and public and it's essentially a mix and
match of these two terms so a private
good in this case like we've got um university
of texas t-shirts because i stole this
from a professor that i know at ut and i kind
of like these photos and it's excludable and
rival it's excludable because if you
don't pay for it you don't get the shirt and
it's rival because if i buy it there's less
shirts available which means at some point
they're going to run out so this is
excludable and rival then we have a club good
such as a streaming service like netflix
it's excludable because if you don't pay for
the service you can't access it but it's
not rival and i'll say this with a caveat
caveat because in most times my streaming doesn't
affect your streaming however are there
any stranger things fans in here yeah do you
remember what happened at the start of
season five did anyone log on at 8 pm like i
did you couldn't get on netflix it shut
down for two minutes because too many people
were trying to use it in this case it
would be rival and it wouldn't actually fit
the club good definition So as we'll see
in a second, these aren't set in stone context matters a lot. A common good is
not excludable. So an example here
would be, and we'll look at this more in a
second, is like pastures for having your cows
graze. A lot of them are not excludable.
They're public areas, but they're rival in
the sense that when your cow goes in and grazes,
there's less grass than before, and if
too many cows graze, the whole resource
gets depleted. this is going to be the idea
of the tragedy of the commons and finally
a public good is not excludable anyone has
access to it and it's not rival my use of
it doesn't affect your use of it so an example
that we'll talk about as well is in you know
a city lamplight so light posts in the
street are a public good once they're established
you can't exclude anyone from benefiting
from the light and my My ability to view
the light and use it to walk home doesn't
affect your ability. So to kind of drive
this point home, here are some random examples
I came up with and I want us to put
forward reasons, some of them are harder than
others, of what type of good it is. So the
first one is asteroid defence. So remind
me your name, sorry? Michael, what do
you reckon asteroid defence is? And if
you don't remember the terms, you can just
tell me if you think it's rival or not or
excludable or not. Excludable, so that
would make it a public good. Can
you tell me a little bit more about
your reasoning? Like, what got you
to that conclusion? You can't, like,
not protect one specific person.
Yeah, so we're going to put this barrier
around Earth, and it's going to
protect everyone from the asteroid
except Michael. It's not possible to
do that. So, yeah, it's non-excludable, and
why is it non-rival? Yeah, so, like,
my ability to use it doesn't
degrade your ability to use
it. Our, you know, quality of use is
the same for both. So, yeah, no,
this is definitely a public good.
Well done, Michael. Okay, what about
this one? A front row spot
at the beach. Front row spot
at the beach. Yeah? Take club good. Okay, why club
good? Well, assuming that you don't
have to pay for it, that would
be... Or wait. Maybe that's a
common... Wait, non -excludable means you
don't pay for it, right? Yeah, so non
-excludable means you don't pay.
Rival means that my use affects
your use. Yeah. So common good? There's so much space at the
front of the beach, not everyone can take it
so by you taking it you reduce the likelihood
that the next person can be in the front
as well until there's no spots left great
point though about the non-excludable factor
there are a lot of beaches that are free
so you can't exclude anyone from attending
but for example um a few months ago i was on
holiday in albania when the beaches are private
you can't exclude people so this is where
context matters a lot is there a price for
this speech or not and that will determine
whether it's a private good or a common good
the the nature of it being a rival good
remains the same this rival factor because
there's only so much space with the front so by
you taking the spot there's less chance
for the next person to take the front spot
great job tuna in the sea you won't have a crack
at tuna in the sea so this is the canonical
example the tragedy of the commerce over
fishing everyone has access to the ocean,
everyone can fish and everyone's private
incentives actually lead them to fish because
you can go fish and sell it to the market
or use it for food but if everyone's
fishing at the same time there is this nature
of rivalry that you're consuming more fish
than the fish are repopulating with to
the point where we have countless examples
of fish populations disappearing due to
overfishing a less difficult one buying a
sandwich from the cafe Brook, exactly. If you don't
pay you're not getting it, excludable. They
only make a certain number of sandwiches
a day, so it is rival. Okay, anyone watching
Knight of the Seven Kingdoms? Highly
recommend it. Three episodes in and it's
like old style Game of Thrones but in
a more cutesy way. So watching this
on HBO, what do you reckon
this one is? So this is the club good, you
can exclude someone that don't pay the
HBO service, but me streaming this probably
won't affect you streaming it, only in
certain circumstances I might do that,
so that's correct. Okay, these two last
ones are hard, so I don't want to like
point to anyone, but if you want to
take a crack at it, let me know.
Universal healthcare, universal healthcare,
what do you reckon? answer um and probably
the correct answer as well is that when you
put in universal health care in your society
you can't stop any of your citizens from
accessing it but so many people want to see
doctors there's a limited amount of doctors try
getting a specialist appointment in a
country universal health care two months wait a
lot of the time really hard to get but i'm
gonna like make this a little bit more
difficult well not more difficult i guess but
when you think about But this might also be a
private good as well. It depends on the
population of interest. If we only care about
Australia, then for all Australians, it's got
to be a common good. But what if you're
travelling from the US to Australia?
You don't fall under the universal
health care. You can be excluded on
it based on your citizenship status
or visa status. So once again,
demarcating our population of
interest matters. So for example,
my office hours. My office hours for
this class can be a common good. I
can't really exclude anyone from attending
my office hours, but if someone
attends, I only have an hour in my office
hours, so less time to see everyone, you
might not see me. However, if you
think about the whole university, it's a
private good. I'm not going to let some
random person come to my office hours when
my own students want to see me. So this
is why I define the population of interest
matters a lot. What was your
name, sorry? Josh. Josh? Well done, Josh. That's great. Okay, final one. And this one is, I
know, very random, but one of my old
professors put this on the exam of what
type of good is this. And you won't have
to worry about this because our exam is
a multiple choice. But this one stumped a
lot of us back in the day. So what do you
think about the moon? I've already
asked you. I'll come back to you.
Does anyone want to have a crack
at the moon? Yeah. Going to the moon is an interesting one.
Let's first talk about just looking
at the moon. Clearly, you're
public good. We can all look
up at night and enjoy the beauty
of the moon. And me looking up at it, sorry, what
was your name? Schlog? Yeah. And
me looking up, it doesn't affect
your ability to enjoy each
lot, as you said. So it's non-rival and
it's not excludable. Now, going to the
moon is interesting. I don't know how
we want to define it. It's kind of
excludable in a way, because if you don't
have the money, you can't go, in a way. Whether it's rival or not depends on how
many rocket ships there are currently
available. I don't know. You
can probably come up with any type of
delineation for that. Another interesting
one is living on the moon or colonizing the
moon. so in the previous class talked about
guru and despicable me stealing the moon
and then that would be more rival and then
excludable in that sense so this question, as
Schlag said, there are multiple interpretations
of it and depending on what type of aspect
of the moon you're talking about and
what population as we mentioned before,
you're going to have a different answer, so
I'm not going to be able to ask something like
this on the exam but if I, for example,
ever did you could put whatever answer you
think is right as long as you give the reasons
that was given So, yeah, just justify
the reasons for your answer, and a lot of the
time you'll be right. So as we talked about
the tragedy of the commons, it's this idea
we have a common good, so it's non-excludable.
Anyone can put their cow on the 40
acres, but it is rival. It only has 20
cows carrying capacity at 20
plus points. The 20 plus cows is
a tipping point, and the resource is depleted.
And as we'll see in a second, the
incentives for everyone individually is to be
selfish and put their cows in the pasture,
which can lead to the resource being
depleted, which is a market failure based
on the idea of the negative externality,
that is overproduction. so a village has five
residents they have steers and bonds each
cost a hundred dollars this steer is a cow
each villager has a hundred dollars and they
can choose to either invest at a hundred
dollars in a bond that has an annual return
of 13 so you end up with 113 dollars 13
dollars profit or you can buy a steer and send
it to the commons to graze for a year now
the payoffs if you put your steer into the
paddock into the into the commons depends on
how many other steers the less other steers
there are the more green grass your steer
eats the fatter they get the higher you
can sell it at so if there's only if there's
only one steer then they're going to be
fattened up and you can sell it for 126 and
make 26 profit however there are two less
quality grass so you have to have a little
less so it's less fat overall you only make
19 so on and so forth okay so if the
villagers act independently
how many steers will be sent
into the commons and to make this a
little bit easier imagine everyone's making the
decision sequentially so the first you
know a villager makes a decision then the
second and the third so what will the first
villager do what will the first villager do
does anyone want to So the first villager
has a choice between investing in the bond
and getting $13 or investing here and
getting $126 profit. So they'll send. Now our second villager
will come along and they have to
decide do they want to invest in
bonds, get the $13 profit or buy a steer
and now there will be two steers in
the field. and that means they'll get
$119, $19 profit. Then $19 is more than
$13, so they'll send. The third will look
at this and send as well because $16
is more than $13. And the fourth
is going to be indifferent
between the two. For ease, let's
say they do decide to just
buy one and send. Then our fifth person
will come. They'll see that they'll only
get $11 profit if they send, so they'll
invest the bond. So in this situation,
we can say that four people will buy steers
and send them into the field and
interestingly the total income if we sum up
everyone's income after this decision we get
65 so the four people who send their steers
in the field each get 13 and the one who
gets the bond as well also gets 13 so
ironically this is no more income than if
cattle did not exist if everyone just put their
money in the bonds they'd all get the
same result and this is not efficient as
we'll show in the next example the commons
have been degraded because of everyone's
individual incentives. So imagine the
village, yeah? Yes that is true
but like the idea of the commons
probably not really mentioned
in this example is that the field's
usually like overgrays, you can't use it
ever again. That's the main issue
here, which isn't illuminating this
example for sure. It's a good point.
It's a good point. But ignore this example. So imagine now, rather than acting individually, the villagers could act collectively,
make decisions, sum up all their
earnings, and then divide it equally by five.
How would they act? So as we can see
here, what we have is the number of seers
in the field, the amount they sell it
at, the income they get, the total
income for that many steers, and importantly,
the marginal income for adding each
extra steer. And this is going to be really
important here. The answer here is
actually going to be one. Only one is sent if
they act all together. So when you think
about it, if the first person comes and then
decides to put the steer in the field,
because 26, the marginal income is more than
13 of adding to the investing in the bond,
that's what they'll do. But now the
second comes along. And you may see here,
for example, that, hey, $19 per seer,
that's still more than $13 I should invest.
But no, because you're taking away $7 from
the first person's income. So you've
got to take that into account when you're
thinking about the marginal income of everyone.
So the marginal income of the second seer
is you get $19, but you're taking away $7
from the other person, so it's only $12.
$19 minus $7 is $12. and the marginal
income of investing in the bond is 13 so for
every other person after the first they've
got to just invest in the bond so only one
seer is put into the paddock and as you can
see the total income here is 26 plus the
four that put their money into the bond
which is 78 the economic pie is growing from
65 to 78 so when they split it evenly
each person is $15.6. Is this result stable? You're one of the
villagers and you're one of them who
decided to put their money into the bond
instead of purchasing a cow because of
what we talked about. Could you change
your strategy or your decision in any way
to do better in terms of your monetary
payoff yeah you're earning 15.6 after
everyone shares yeah yeah exactly you can
say you know fuck the group I'm gonna
deviate I'm gonna not listen to the plan
instead of buying a bond I'm gonna buy see it
put in the field I'm gonna get 19 it's gonna
screw everyone else over but you've done
better if you're self -interested just care
about your own payoff you can do better and
everyone is thinking that way everyone is
just thinking about their own marginal
benefit so as we see when the villagers
act independently they don't consider that
when they send a steer out in the commons
it negatively impacts others and as we
saw this results in overproduction of the
amount of cows grazing etc when they act together
and they follow the plan they can internalize
this externality But it's not always
practical if everyone's following their own
incentives. There's an incentive for
everyone to cheat here. Up until four people
essentially, it's beneficial to actually
disagree with what the plan is and overgraze
or get a cow and put it into the
fields. And this is the problem with the strategy
of the common. It's like, it's my
individual benefit right now to fish even if
everyone else is fishing. We can't coordinate
in any way and it results in overfishing
if the fish disappear. We're all screwed
in the future. It's really hard to overcome
these incentives. However, I don't want to say it's impossible. So this is
Eleanor Ostrom. She was the first
female to win the Nobel Prize
in economics. The bad news about
Eleanor Ostrom was she was a professor
at IU. So, boo. But she's amazing.
She did incredible work on common goods,
both theoretical, experimental,
and empirical, showing that we don't
necessarily really need government or
private property to solve this so she said people
and communities can develop rules of their
own social rules of self government that
can result in these resources not being
depleted so I'm not going to go into it now but
if you're interested there's some really
cool stuff in here and she has these eight
principles of collective action okay so public
goods is its own type of market failure
what a public good is is it leads the market
to provide inefficient quantities since
everyone gets to consume the public good
once it is available. So you can't exclude
anyone from it, but individuals have little
incentive to purchase the good, they prefer
others to pay for it. So imagine with our
asteroid defense system for example, Michael,
if you can avoid paying for it and it's
still put in place, you still benefit, you
just have money, which is great, that's the
best outcome for you. And when a group of
individuals think this way, they rely
on the efforts or payments of others
to provide a good, we say that there is a
free rider problem. An example you're
probably all familiar with is
group projects in high school
and university. The idea here is
within your group of four people, you get
one grade, everyone gets the same grade
no matter what. So whether you put
in effort or not, it doesn't really
matter. If one person is willing to put
in all the effort, you don't have
to lift a finger and you'll get the
same grade as them. This is literally the
idea of free riding. You're not putting
in any effort and you're riding on
their coattails, etc. So I don't know if
any of you have had negative experiences
in group projects, but this is the
incentive reason why that people have
this opportunity to free ride, which a
lot of people do. So we can show the
public good problem with this example
of streetlights. So imagine in a
society we have three people, person A,
person B, and person C. And this is their
own willingness to pay for a streetlight. So for person A,
for one streetlight, they'd be willing to
pay $30 minus $1, $29. Two streetlights,
the second one they value $28, $27, so
on and so forth. And it's the
same for all of them. So they
all value it. And our societal
demand function is just these three people's
demand functions added together. so 30 plus
30 plus 30 gives us 90 minus q minus
q minus q gives us minus 3q that's just
our demand function for society and the marginal
cost of streetlights so the supply of
streetlights is just going to be a
horizontal line of $54 so what is the equilibrium
to solve that we want to set the
marginal benefit equal to marginal cost the
demand curve against the supply curve that's
all they are they tell us the marginal
benefit and marginal cost so our demand
curve is 90 minus 3q our supply curve is
just 54 p equals 54 they equal each other and
then when we solve this we get a quantity
equal to 12 and in terms of price we
already know the price is 54 because it's flat
but you can just plug in 12 here for quantity
and you'll get 54 as well and the way
this is set up each person pays an even
share, so each person will pay $18 in this case
if the price is $54. So what we have
here is we have our supply curve,
the marginal cost of streetlights
is always $54. We have our individual
demand curves, 30 minus Q, so you can
see that here, and we have our market demand
curve here. Oh, I wasn't meant to do
that. So at the market equilibrium, when the
supply and demand curves intersect we see that
there's going to be 12 of these units
produced at $54 and each person's going to pay
18 so this is going to impact each
individual's consumer surplus at 18 here
that's how much they pay that's how much they
value it this is how much is being produced
so this area here is each individual surplus
length times width divided by 2 so 0 12
12 30 minus 18, 12. 12 times 12, 144 divided
by 2 gives us $72. All seems well and
good. We're going to have 12 lamplights
in our society. However, why does
person A need to reveal their true
demand function? Why do they need
to say, I actually value this first
streetlight at $29? What happens if
they say, hey guys, I don't value
streetlights at all. I'm not going
to pay anything. Free riding essentially
so if they tell person b and c this their
demand function is zero they essentially lie
that means our new societal demand function
is just b and c's put together so for all
intents and purposes person a it just equals
zero they don't have a demand function
anymore so we just add b and c together and we
get 60 minus 2q and we do the same thing here
as before we set this new demand function
equal to the supply function so we get 54
equals 60 minus 2q now we have only three
lights being produced instead of 12 and the
price is still 54 so each person b and c pays
27 and a pays nothing so if you look at the
left here this is person b and c's consumer
surplus So now you can see the intersection
of the new demand function for society is
this, the marginal cost of streetlights is here,
only three are being produced, each pay
$27, so their consumer surplus is going to
be 3 minus 0 times 30 minus 27, so 3 times 3
divided by 2, so 4.5. Meanwhile, A isn't denied
the benefit of the So similar to
B and C, we can calculate their
surplus. So remember, they're
paying nothing. They're paying nothing. So their whole surplus
is going to be how many are produced. So 3
and 0, this whole area under the curve here.
So they get the same 4.5 as B and C, but
because they don't pay anything, they get this
entire rectangle as well. this entire
rectangle which is um if i do my which is what 81
so 81 plus 4.5 is 85 .5 so compare this to
the other example where they get 72 they have
this incentive to lie and say that they don't
value it they have this incentive to free
ride they do better this becomes even more
problematic when you take into account this
just not only applies to player it's all
players they all have an incentive to lie if
each player lies and let someone else produce
because they're not paying a cost they're
going to be better off and this means the
optimal strategy for each player is to lie so
they don't value it and contribute nothing
and what's the result of that how many
lamplights are going to be created bagel zero
lamplights and this is the problem of public goods
public goods benefit everyone but everyone
individually has an incentive not to
contribute at all so if we just have you know a
free flow society a free market public goods
based on incentives will never be created
so one of the key roles of government is to
help solve this free rider problem by using
things such as taxes to get money from people
to you know supply these public goods things
like you know health education army roads
infrastructure parks etc etc on our own
there are arguments this can't be done however
There's some really cool stuff when you go
into the rabbit hole of economics and game
theory. There's a subfield of game theory called
mechanism design. And mechanism design
is all about designing incentives in a
way that allow people, I should say
allow people, it would mean that it's bad
for people to not reveal their true
values for something. So there are
these two called the quadratic
scoring wall, which some of you might
have heard because there's quadratic
voting as well. And then there's this
Vickery-Clarke-Groove mechanism as well, where
they show you should reveal your true
preferences, which is really cool, but way
beyond this course. Another issue is that
governments may over -provide public goods,
since people can still lie about how
much they value it. An example would be,
let's say there's a progressive tax
system. If you lower down the tax bracket,
it's worth you saying that you value the
public goods more, because then the
government will spend more money on it,
probably from other people, you get more
of a benefit even though you only value
it at $27, not $28. So it doesn't solve
the problem. If anything, you may
over-provide public goods compared to
the efficient amount. And all these problems
make it pretty difficult to solve
global public goods. So with public goods
within society, so let's say we're funding
public parks, as we said, the government
can't solve that. But solving
something else, like asteroid defence
for example, who pays for that? Is
it the US? Is it France? How do we actually
organise that? Every country is better off
if they don't have to pay but they still get
the benefit from it. And this is why issues
such as mitigating climate change are so
hard to solve. I don't know if any of you
have looked at the Paris Agreement or Kyoto
Protocol, but one of them has non-binding
decisions so no one follows them, and
the other has binding decisions so no one wants
to join. When we have global public goods,
we don't have a world government to impose
taxes or use a strong hand to fund public
goods. So these problems become so much
harder to solve and rely on really weird and
interesting mechanisms to try and get at them,
which is something that I'm actually
working on. So if you want to talk about
that, I'm always really interested in the
incentives behind global cooperation and,
I guess, more the fracturing of global
cooperation at the moment. finally so the last
slide for today the streetlight example is
known as a linear public good since his funds
increase there's always more benefit that
can be received from extra street lights this
benefit is diminishing but there's always
more however there's another type of public
good known as a threshold public good it either
exists or it doesn't so i don't know if
anyone knows kickstarter but they're like if
we raise x amount of money we can create
this if we get under we don't so in the linear
public goods we have this exact problem of
free writing that i said but actually the
threshold public good is slightly more um
complicated and this is where we start to get
into game theory i'll definitely come back
to this when we when we actually go through
the game theory framework but the idea
is if no one else is funding it then your own
funding is not enough to get it up over the
line you may as well not give anything but
let's say everyone is paying their equal
share your best cost of action is actually not
to free ride but to pay your equal share
because the amount you pay is actually less
than the benefit you get if the game in
kickstarter or if in this case the asteroid defense
example would work gets up and running
so threshold public goods are slightly more
complicated than linear public goods but just
for the purpose of this lecture and this
topic, we're only going to focus on linear
public goods. I just felt it was my duty to
let you know there are ways in which public
goods can be funded just based on incentives
alone but I'll definitely come back to this
in a few weeks time when we get into gang
theory because public goods is an example
of like a multi-person prisoner's dilemma when
you think about it. That's all I
have for today. I guess we're
finishing early. Enjoy and I'll see
you all on Wednesday. Is there a strategy that Yeah, I didn't want
to explain this with a game theory framework
we haven't talked about yet But this is game
theory. That's all this lecture was is game
theory. Yeah You can email and we can
work it out Okay Just limit all
the class it is and I can organise
and make up Is this for
the first exam? It's for the first
exam. I haven't looked at another one yet Look now. Yeah I'll
look at all of them Yeah Because then I
also have an exam We have an exam Monday,
right? Yeah I also have an exam Tuesday so
I can do it Tuesday Like, maybe we
can move it. Well, I was going to hold the make-up on Tuesday. What time's your
exam on Tuesday? I already have,
uh... So you've got three exams that
week, technically. Yeah, two on the same
day. I'll see, maybe I can get the other
one to move, like, a different week.
Yeah, so my plan was to have the make-up
the following day at, like, 2 p.m. or
something like that. Um, give people time.
You had the exam the previous day to study
in the morning, but, yeah, like, you're
in a unique situation where you also have
one in the evening. Imam 8, lay out
the day towels just so I have
them, and then if you can't move
the other one, I'll consider
having you sit a little bit lighter
on the way. Okay, all right.
No worries. That's a rough schedule. Yeah. And then I, like,
I don't know what the policy is.
Yeah, remind me your name, Joseph. Joseph.
Yeah, I'm sorry. You have a,
yeah, yeah, yeah, correct. So,
actually, I want to get you to
the next step. OK. Yeah. OK. Thank you. No worries.