1ECON1010 
Introductory Microeconomics 
LECTURE 11 
Public Goods 
1 
Q1. The market equilibrium price and output will be too  
low, compared to the socially optimal price and output, for  
an economic activity if it creates: 
2 
(a) a negative externality. 
(b) no externality. 
(c) any type of externality 
(e) need more information to reach a conclusion. 
(d) a positive externality. 
Last lecture feedback  
Plan of Lecture 11. 
Lecture 11 ECON1010 3 
1. Last week, we discussed how competitive  
markets can produce inefficient outcomes in the  
presence of externalities. 
2. This lecture, another example of how competitive  
markets can produce inefficient outcomes in  
providing public goods. 
Lecture 11 ECON1010 4 
Non-rivalrous Rivalrous 
Non-excludable Public Common  
Excludable Collective Private  
Four Different Types of Goods 
Rivalry 
E 
x 
cl 
u 
d 
a 
b 
il 
it 
y 
5 
The extent to which consumption of a good (or  
service) by one person lessens its availability for  
others. eg: driving a car 
Rivalry 
Lecture 11 ECON1010 
The extent to which the consumption of a good  
(or service) by one person does NOT lessen its  
availability for others.  
eg: watching 7pm TV news. 
Non-rivalrous 
6 
The extent to which non-payers can be excluded  
from consuming a good or service (most of the  
time!) eg: buying a new car. If can’t pay for it,  
excluded from getting the car. 
Excludability 
Non-payers are able to consume the good or  
service. eg: gaining benefits of national defense  
even if not paying taxes. 
Non-Excludability 
27 
Goods and services that have characteristics of  
being both non-rivalrous and non-excludable. 
Examples: 
Public Goods (the focus of this lecture) 
Lecture 11 ECON1010 
1. Fire works displays 
2. Free to air TV 
3. Street lights 
8 
Goods and services that have characteristics of  
being both rivalrous and excludable. 
Examples: 
Private Goods 
Lecture 11 ECON1010 
1. hamburger 
2. massage 
3. plane flight 
9 
Goods and services that have characteristics of  
being both rivalrous and non-excludable. 
Examples: 
Common Goods 
Lecture 11 ECON1010 
1. fish in the ocean 
2. atmosphere 
3. firewood from a forest 
The “tragedy  
of commons” 
Goods and services that have characteristics of  
being both non-rivalrous and excludable. 
Examples: 
Collective Goods 
1. Pay TV 
2. Uncrowded toll road 
Note: in the tutorials, discuss examples that can  
be found on campus at UQ. 
10 
All goods do not necessarily fit neatly into one of  
the four boxes relating to excludability and rivalry. 
Example: Public road 
A comment! 
a. During peak hour, the road is non-excludable  
and rivalrous = common good 
b. During off-peak hour, the road is non- 
excludable and non-rivalrous = public good 
Non-rivalrous Rivalrous 
Non-excludable Public Common 
Excludable Collective Private 
Rivalry 
E 
x 
c 
lu 
d 
a 
b 
il 
it 
y 
Lecture context – who should provide the  
goods and services we consume? 
12 
1. The role of the government is to make laws that:  
• aim to control negative externalities 
2. The role of the private firms (aim to profit maximise) 
Getting the balance right is the key as it affects people’s  
well being.  
• enable markets to operate 
• promote competition and restrain market power  
3A Focus on Providing of Public Goods. 
Q1. Is there any incentive for an individual (or firm) 
to provide public goods? 
13Lecture 11 ECON1010 
Q3. If governments are to fund public goods, how 
can the revenue be best raised to pay for them? 
Q2. Can providing public goods be socially efficient? 
Individuals & incentives in providing public goods. 
Bob and Ed live on two properties in the outback. 
Water is scarce. However, drilling a well can provide a  
reliable water source.  
A pumping station can be installed to access the 
underground water at a total cost of $12 000. 
Sufficient water will be available to make it non- 
rivalrous. The pump stations will be located on a boundary 
corner of both properties. Neither Bob nor Ed would be 
excluded from using the water. Both desire the pumping 
station to be built. 
Bob earns twice as much as Ed. Bob would be willing to  
pay $9 000 while Ed would be willing to pay $4 500. 
14 
Q1: Would Bob or Ed be willing to pay the full  
cost of constructing the pumping station? 
Cost Benefit Principle: 
Do it when the MB ≥ MC 
Individually, neither Bob nor Ed would pay  
for the pumping station.  
For Bob, MB = , MC =  
Decision: MB < MC, so Bob won’t pay for it. 
$9 000 $12 000 
For Ed, MB = , MC =  
Decision: MB < MC, so Ed won’t pay for it.  
$4 500 $12 000 
15 Lecture 11 ECON1010 16 
Q2: Is it socially efficient for Bob and Ed to share 
the funding to construct the pumping station? 
Cost Benefit Principle: 
Do it when the MB ≥ MC 
what is the MB for a public good?  
(non-rivalrous and non-excludible) 
but 
0 
0.5 
1 
1.5 
2 
2.5 
3 
3.5 
4 
4.5 
0 5 10 15 20 25 30 35 40 
P 
ri 
ce 
( 
$ 
/k 
g 
) 
Quantity Demanded (kg) 
Sue Tim 
Market Demand 
= Marginal Benefit 
= horizontal summation of  
quantities 
Market Demand for Private Goods (lecture 3) 
(rivalry and excludability applies) 
But what is the MB for a Public Good? 
(non-rivalrous and non-excludable) 
Consider: Is it worth preserving one  
hectare more of National Park? 
Everyone is different. Some would pay a  
lot of money, others something, and some  
don’t care and would pay nothing! 
The sum of the prices, each individual would  
be willing to pay, is the MB of preserving one  
more hectare of National Park. 
419 
The Marginal Benefit for a Public Good. 
A conceptual difference exists with a public  
good (compared to a private good) in that  
public goods are non-excludable and non- 
rivalrous.  
A public good demand is obtained by vertically  
adding each consumer’s willingness to pay. 
(ie: my willingness to pay PLUS your  
willingness to pay). 
Constructing Demand for a Public Good 
A public good demand curve  
is the vertical summation of  
the individual demand curves 
Q (pump stations) 
Price 
($/pump station) 
1 
D1 
$9 000 
Bob 
D2  
Ed 
$4 500 
Price 
($/pump station) 
Q (pump stations) 
1 
+ 
20 
Lecture 11 ECON1010 21 
A public good demand curve is the vertical  
summation of the individual demand curves. 
$13 500 Demand = DBOB + DED 
Price 
($/pump station) 
1 
Q (pump stations) 
(Connect to previous slide) 
= Marginal benefit 
Constructing Demand for a Public Good 
(continued) 
Cost Benefit Principle: 
Do it when the MB ≥ MC 
Yes, it is socially efficient to share the  
funding costs of building the pump station. 
For society, MB = , MC =  
Decision: MB > MC, so build it! 
$13 500 $12 000 
Q2: Is it socially efficient for Bob and Ed to share 
the funding to construct the pumping station? 
22 
23 
Finding the Optimal Quantity of a Public Good. 
Will be at the intersection of the MB (demand)  
and MC (supply) curve, as with private goods. 
Question:  
How do economists find the MB curve for a  
particular good in society? eg: Great Barrier Reef. 
Answer:  
This provides a challenge for economists working  
in the public sector and is the theoretical basis for  
contingent evaluation studies. 
Is there any incentive for firms (or individuals)  
to provide public goods?  
24 
Note: It might be socially efficient for public 
goods to be provided, but individuals rarely have 
the incentive to provide them. Governments step 
in to fund public goods in many instances. 
Can providing a public good be socially  
efficient?  
The central funding problem for public goods. 
NO. 
YES. 
5Government Provision of Public Goods 
Cost benefit rule still applies: 
Which public goods should be considered and  
then provided? 
25 
Government should only consider providing those 
goods or services where the benefits (= sum of 
how much all individuals are willing to pay for the 
good or service) exceed the costs (= sum of all 
explicit and implicit costs). 
Government Provision of Public Goods 
The non-excludable and non-rival nature of  
public goods means they are vulnerable to the  
free-rider problem. 
26 
Free-rider problem 
The incentive that arises to not contribute to the 
provision of a good or service in situations in  
which individuals (or companies, or countries) 
are able to enjoy the benefits of a good or  
service without contributing to its cost. 
Free-rider problem 
▪ provides the theoretical justification for their  
possible provision of public goods by the  
government. 
▪ is why competitive markets will tend to under- 
provide public goods (as they are not able to  
cover the costs of production). 
27Lecture 11 ECON1010 
Royal New Zealand Air Force (RNZAF) 
In 1945, the Royal New Zealand Air Force  
(RNZAF) consisted of more than 1000 aircraft,  
including numerous combat aircraft. Sixty  
years later, it only had 53 aircraft, none of  
which were combat aircraft. 
Lecture 11 ECON1010 28 
How can New Zealand’s decision to abolish its  
air combat capacity be explained, in part, by  
using the free-rider problem? 
Union Membership and free-riding. 
Throughout Australia, there is a union that  
represents university lecturers called the  
National Tertiary Education Union (NTEU). 
29 
Lectures can join by paying a yearly membership  
fee. This entitles them to vote on such things as  
proposed pay increases and pay scales for various  
staff positions. 
How is it possible for staff members to be free- 
riders? 
Paying for Public Goods 
Not everyone benefits equally from the provision  
of a given public good or service. 
It would seem equitable if people were taxed in  
accordance with their willingness to pay (it turns out  
this is efficient as well).  
The design of a tax system can aim to provide a  
solution to this problem, at least in part. 
Practically though, the government lacks precise  
information on people’s willingness to pay.  
6Paying for Public Goods 
Head Tax = a tax that collects the same amount from  
every taxpayer no matter what your income is (an equal  
tax rule). 
e.g. car registration. Everyone pays the same car  
registration for the same model car. 
Outcome: 
This is a form of regressive tax: As income rises, and  
the tax remains constant, the proportion of tax paid  
from the income decreases. 
A head tax system rules out the provision of many  
worthwhile public goods.  
31 
Any incentive for individuals to provide public goods? 
Example:  
Bob and Ed live on two properties in the outback. 
Water is scarce. However, drilling a well can provide a  
reliable water source.  
A pumping station can be installed to access the 
underground water at a total cost of $12 000. 
Sufficient water will be available to make it non- 
rivalrous. The pumping station will be located on a 
boundary corner of both properties. Neither Bob nor Ed 
would be excluded from using the water. Both desire the 
pumping station to be built. 
Bob earns twice as much as Ed. Bob would be willing to  
pay $9 000 while Ed would be willing to pay $4 500. 
Paying for Public Goods using a Head Tax 
The cost of the pumping station is $12 000. 
To fund the project, Bob and Ed must pay equal  
amounts ($6 000). 
Bob willing to pay $9 000, so votes for the project. 
In general: a democratic government imposing a head  
tax is very often unable to raise sufficient funds for  
various projects.  
Ed willing to pay $4 500, so he votes against the project. 
Result: the $12 000 would NOT be raised and the  
pumping station would NOT be built. 
33 
Paying for Public Goods – Proportional tax 
Proportional tax: a specified proportion of income  
is paid as tax. Rising income means a larger tax is  
paid to the government. 
Examples:  
1. Goods and Services Tax (GST) = 10% in Australia 
(rising income corresponds to rising consumption) 
2. Medicare levy = 2% of taxable income. 
34Lecture 11 ECON1010 
Paying for Public Goods - Proportional Tax 
The cost of the pump station is $12 000. 
Bob earns twice as much as Ed and so will end up  
paying twice as much tax. If the total cost is $12 000: 
Result: the $12 000 would be raised and the pump  
station would be built. Bob would have a surplus of  
$1 000 and Ed $500. 
Bob pays 2/3 *12 000 = $8 000 (willing to pay $9 000) 
Ed pays 1/3 *12 000 = $4 000 (willing to pay $4 500) 
35Lecture 11 ECON1010 
Paying for Public Goods – Progressive Tax 
Progressive tax: as income increases, the proportion of  
tax paid also increases. 
In Australia, tax brackets ensure the government  
captures more tax as an individual’s income increases. 
Most industrialised countries have some form a  
progressive tax system.  
Taxable income Tax on this income* 
0 – $18,200 Nil 
$18,201 – $37,000 19c for each $1 over $18,200 
$37,001 – $80,000 
$3,572 plus 32.5c for each $1 over  
$37,000 
$80,001 – $180,000 $17,547 plus 37c for each $1 over $80,000 
**$180,001 and over 
$54,547 plus 47c ** for each $1 over  
$180,000 
7Paying for Public Goods – Progressive Tax 
Wealthy people tend to assign greater value to  
public goods than low-income people (because they  
have more money). 
Higher income earners being asked to pay more for  
public goods increases the economic surplus and  
provides better outcomes for rich and poor. 
Progressive tax system produces an economically  
efficient (and effective) outcome. 
37 
Head tax results in smaller amounts of public goods  
being available that the wealthy would want and value. 
Conclusions. 
1. As with a private good, the optimal level of provision of a  
public good is determined by the intersection of the supply and  
demand curves.  
Lecture 11 ECON1010 38 
3. Competitive markets will tend to under-provide public goods 
because they are vulnerable to the free-rider problem. 
2. The demand curve for a public good represents the vertical  
summation of consumers’ willingness to pay. 
4. The free-rider problem means that public funding is often 
necessary to provide certain goods and services.  
5. A case can be made progressive tax systems are both more  
equitable and more efficient in the provision of public goods. 
Next Lecture 
▪ Lecture 12. 
Economics of Information. 
Lecture 11 ECON1010 39 
Another context where economists know competitive  
markets can produce an inefficient outcome in the  
presence of costly and / or imperfect information.