Public Goods and
the Tragedy of the Commons
Chen Zhao
University of Hong
Kong
1
CO2 concentration in the atmosphere has risen
about 43% since the beginning of the industrial
revolution in the mid-eighteenth century—half of
that since 1980.
The increase in CO2 concentration has serious impact
on the environment.
Who will reduce its CO2 emission if there’s no
profit in it?
[Link] 2
Wikipedia is available to all, free of charge.
Who will pay for it?
[Link] 3
Khan Academy is available to all, free of charge.
Who will pay for it?
[Link] 4
Excludability
o Goods can be classified as:
o Non-excludable: When people who don’t pay cannot be easily prevented from
using a good
o Example:
o National defense
o RTHK’s Radio signal
o O2 and CO2 concentration in the open air
o Excludable: When people who don’t pay can be easily prevented from using a
good
o Example:
o Jeans
o Apples
5
Excludability: Is it easy to prevent people who don’t
pay from using a good?
National defense
Jeans
Excludable Cheeseburger Non-excludable
Jeans Lighthouse
Paper books
Cheeseburger E-books National defense
Bluefin tuna in fish market Digital music Air in open space
personal electronics gasoline
Timber in public land Timber in public land
Paper books
Bluefin tuna Lighthouse
Air in a tiny room personal electronics
cinemas
private parks air E-books
gasoline cinemas Digital music
satellite television private parks
free-to-air television
E-books satellite television
Digital music Bluefin tuna in ocean
free-to-air television
6
Rivalry
o Goods can be classified as:
o Non-rival: When one person’s use of a good does not reduce the ability of another
person to use the same good
o Example:
o Digital music
o Wi-fi
o O2 and CO2 concentration in the open air
o Rival: When one person’s use of a good reduces the ability of another person to
use the same good
o Example:
o Cheeseburger
o Coffee
o O2 and CO2 concentration in a tiny room
7
Rivalry: Does my use of a good reduce your ability of using the same good?
National defense
Jeans
Rival Cheeseburger Non-rival
Jeans Lighthouse
Paper books
Cheeseburger E-books National defense
Digital music air
personal electronics oil
Timber in public land
Paper books Lighthouse
Bluefin tuna
personal electronics
Bluefin tuna
air E-books
oil
cinemas
Timber in public land Digital music
private parks
free-to-air television
satellite television
satellite television
free-to-air television
8
Four Types of Goods
Four Types of Goods
Excludable Non-excludable
Rival Private Goods Common Resources
Jeans Tuna in the Ocean
Hamburgers Wildlife
Contact Lenses Public Roads
Non-rival Non-rival Private Public Goods
Goods / Club good Environmental
Cable TV Protection
Wi-Fi National Defense
Digital Music Mosquito Control
9
Private Goods and Public Goods
1. Private Goods are excludable and rival.
o Most goods are private goods.
o Private goods can be efficiently provided in competitive markets.
o Because they are excludable, there is a strong incentive to pay
for and produce them.
o Because they are rival, excludability may not lead to inefficiency.
o Excluding non-payers does not create inefficiencies.
10
Private Goods and Public Goods
2. Public Goods are non-excludable and non-rival.
o Because they are non-excludable, it is difficult to get people to
pay for them voluntarily.
o Because they are non-rival, production costs do not significantly
change with additional users.
o Goods that have high degrees of both of these properties are
often called public goods, like the radio and defense examples
given.
11
Example
o Jones, Smith and Patrick are the only three residents of their village.
There is a security device that will alert them to the presence of
trespassers on their respective properties, which are contiguous.
o The cost of the device is $100.
o Its value to Jones, who is poor, is $20.
o Its value to Smith, who is rich, is $50.
o Its value to Patrick, who is rich, is $60.
o Would either person be willing to purchase the device individually?
No. Its cost is higher than the value to either
individual. 12
Example
o Is it efficient for the three together to purchase it?
o Yes because its total value ($130) exceeds its cost ($100).
o How much should Jones pay?
o How much should Smith pay?
o How much should Patrick pay?
13
Collective action
• It is often impractical for private citizens to negotiate for the joint purchase of
goods or services.
This is especially likely
when large numbers of
people are involved.
14
Collective action
• Communications costs
• The free-rider problem: each individual’s contribution is an insignificant
part of the total required.
– Each thus has an incentive to hold back in the hope that others will
contribute.
• Bargaining problems: even when only few people are involved, it may be
difficult to reach agreement on what constitutes a fair sharing of the total
expense.
The role of Government:
When these problems arise, governments may use tax revenues
to buy public goods on the public’s behalf.
Even when government acts as the public's purchasing agent,
political agreement must be reached on how public purchases
are to be financed.
15
Private Goods and Public Goods
o A Free Rider enjoys the benefits of a public good without paying a
share of the costs.
o Free riders can disrupt market efficiency.
o With enough of free riders, public goods will be underprovided by
the market.
Is he working on your group project?
Or is he on Facebook, free-riding on 16
Private Goods and Public Goods
o Failure to provide public goods at the optimal level can create
substantial costs.
o The benefits of public goods provide a strong argument for taxation
and government provision.
o By taxing everyone and producing the public good, government
can make people better off.
Without the government-
provided Chek Lap Kok
airport, how would you
travel to Japan?
17
Private Goods and Public Goods
o Just because everyone can be made better off with taxation and
government provision does not mean that everyone will be made
better off.
o Some people may want more of the public good while some may
want less. Some people may want none.
18
Private Goods and Public Goods
o A Forced Rider is someone who pays a share of the costs of a public
good (through taxation) but who does not enjoy the benefits.
19
Private Goods and Public Goods
o If the government provides the public good, how much should it
produce?
o Ideally, the amount that maximizes total surplus
o In practice? This could be difficult.
o The total benefit of a public good is the sum of the benefits to
each individual.
o How will the government know how much each person values
the good?
o Vickery-Clark-Groves mechanism
o Voting and other democratic processes can help to some extent.
20
Vickrey-Clark-Groves mechanism – a solution to the
free-rider problem
• VCG ensures truth-telling.
• With truth-telling by all participants, we will obtain the total
valuation of the public goods.
• With the truth valuation of the public goods, we will be able to
decide on the optimal amount of public good.
How does VCG ensure truth-telling?
21
Example
o The cost of the security device is $100.
o Its value to Jones, who is poor, is $20.
o Its value to Smith, who is rich, is $50.
o Its value to Patrick, who is rich, is $60.
o Consider the following policy:
1. Each report a valuation.
2. If the sum of the reported valuations are more than $100,
security device is installed.
3. Each pays $100 – the sum of others’ reported valuation.
22
Truthful reporting
o If Own valuation < $100 – sum of others’ reports, I do not want the
security device installed.
o If Own valuation > $100 – sum of others’ reports, I want the
security device installed.
o In both cases, truthfully reporting will lead to my desired outcome.
o Moreover, my contribution does not depend on my own report, it is
$100 – sum of others’ reports.
o Hence, there is no reason to lie.
23
Example
o The cost of the security device is $100.
o Its value to Jones, who is poor, is $20.
o Its value to Smith, who is rich, is $50.
o Its value to Patrick, who is rich, is $60.
o Yes!
o Jones receives $10.
o Smith pays $20.
o Patrick pays $30.
o What about the rest of the cost?
Financed by other tax revenue (unrelated to the report).
They are enjoying the same economic surplus($30) for example.
24
Why VCG works?
• Individual incentives align with the society!
• Everybody will truthfully report own value, and
The payoff of each person
= Own valuation – (Total cost – sum of other’s valuation)
= Total valuation – Total cost.
25
An alternative solution to public good
o How did our ancestor (or ourselves nowadays) solve public good
provision problem?
o Donations
o People feel good about contributing to the public good provision
especially when their contribution are recognized.
26
Donations
o To encourage contribution, we
will give donors lifelong
honors.
Fujian Tulou
27
Donations
Putting the honor poles next to each other encourages competition
for large donations.
28
Private Goods and Public Goods
3. Non-rival Private Goods are goods that are excludable but non-
rival.
o Markets can provide these goods but do so at an inefficient level.
o Entrepreneurs sometimes find clever ways to profit from non-
rival private goods, even without exclusion.
E.g. advertising on “free” T.V. stations
29
Wi-fi: excludable and essentially non-
Common Resources and the
Tragedy of the Commons
4. Common Resources are goods that are non-excludable but rival.
o Consumers cannot be excluded from consuming these goods
o but when anyone consumes it, there is one less for everyone
else.
o There is a strong incentive to consume these resources before
others.
30
Common Resources and the
Tragedy of the Commons
o The Tragedy of the Commons is the tendency for any good which is
un-owned and non-excludable to be overused and
undermaintained.
o Example: Fish
o Since fish in public waters are not owned, it is difficult to prevent
anyone from fishing.
o When one person catches a fish, there are fewer fish available to
everyone else.
o Each person has the incentive to fish before others.
31
The Tragedy of the Commons
32
Example: Raising cattle
o A village has five residents, each of whom has accumulated
savings of $100.
o Each villager has two investment opportunities:
1. Buy government bond for $100 that pays 11% interest per year.
2. Buy a year-old steer for $100, send it onto the commons to
graze, then sell it after one year.
33
Example: Raising cattle
o The Relationship Between Herd Size, Selling Price, and Gain (or
Profit) per Steer
Number of steers Price per 2-year- old Gain per steer ($)
on the commons steer ($)
1 120 20
2 116 16
3 114 14
4 112 12
5 110 10
If each person decides individually how to invest,
how many steers will be sent onto the
commons? 34
Example: Raising cattle
If each person decides individually how to invest, how many steers
will be sent onto the commons?
Number of steers on Price per 2-year- old Gain per
the commons steer ($) steer ($)
1 120 20
2 116 16
3 114 14
4 112 12
5 110 10
o Opportunity cost of investing in steer = 11
o Send steer if and only if price of 2-year-old steer is larger than 111
o Four of the villagers send 1 steer, and hence a total of 4 steers.
o Total village income = 11 + 4(12) = 59
35
Example: Raising cattle
Continue from the example, what is the socially optimal number
of steers?
Number of steers Price per 2-year- Profit from Marginal profit
on the commons old steer ($) steers ($) ($)
1 120 20 20
2 116 32 12
3 114 42 10
4 112 48 6
5 110 50 2
o Decision rule for socially optimal investment:
Send another steer only if the value of the herd increases more
than 11.
o Thus, we should send a second steer but not a third.
Total income = $32 + $33 = $65
36
Tragedy of commons
o The problem with private decisions is that no individual has any
incentive to take into account that an extra steer will eat grass that
otherwise would have been available to the steers already on the
commons.
o The tragedy of the commons can be interpreted as a type of
externality.
37
Example: Sharing milkshakes
o Sam and Stan are identical twins with a craving for chocolate
malted milkshakes, and have agreed to share one.
If each has a straw and each knows that the other is self-
interested, will the rate at which they consume the
milkshake be optimal?
38
Example: Sharing milkshakes
o Each knows that any part of the milkshake he doesn't drink will be
drunk by the other.
o So each consumes at a faster rate than he would if he had half the
shake all to himself.
39
Examples of Tragedies of the Commons
Harvesting timber on public land.
Each tree cutter knows that a tree not harvested this year will be
bigger, and hence more valuable, next year.
But he also knows that if he doesn't cut the tree down this year,
someone else will.
40
Examples of Tragedies of the Commons
Picking blackberries in a public park
Each individual knows that
the blackberries would taste
better if allowed to ripen for
another week.
But each also knows that
blackberries not eaten today
may not be there next week.
41
Examples of Tragedies of the Commons
Harvesting whales in international waters
Each individual whaler knows
that harvesting an extra
whale reduces the breeding
population of whales and
hence the size of future whale
populations.
But he also knows that any
whale he fails to harvest
today will just be taken by
some other whaler.
42
Examples of Tragedies of the Commons
Southern Bluefin Tuna catch
Source: Commission for the Conservation of
Southern Bluefin Tuna
43
Examples of Tragedies of the Commons
Pollution
Each individual polluter
has no incentive to take
into account the cost his
pollution imposes on
others.
44
Common Resources and the
Tragedy of the Commons
The Difference is Ownership
Chickens “Chicken of the Sea”
Owned, not unowned, endangered.
endangered.
45
Tragedies of the Commons
o Clearly defined property rights are one way to solve the tragedy of
the commons
46
Example: Sharing softdrinks
o Once a week, Smith purchases a six-pack of cola and puts it in his
refrigerator for his two children. He invariably discovers that all six
cans are gone on the first day.
o Jones also purchases a six-pack of cola once a week for his two
children, but unlike Smith, he tells them that each may drink no
more than three cans.
o Explain why the cola lasts much longer at Jone’s house than at
Smith’s.
47
Example: Sharing softdrinks
o At Smith’s house, each child knows that the cost of not drinking a
can of cola now is that it is likely to end up being drunk by his
sibling. Each thus has an incentive to consume rapidly to prevent
the other from encroaching on his share.
o Jones, by contrast, has eliminated that incentive by making sure
that neither child can drink more than half the cans. This step
permits his children to consume at a slower, more enjoyable pace.
48
Defined property rights as a solution to tragedy of
the commons
Weyerhauser doesn't cut trees down too quickly on its own land.
Weyerhaeuser is an international forest products company with annual sales of
$22.6 billion. It was founded in 1900 and currently employs about 54,000
people in 18 countries.
49
Defined property rights as a solution to tragedy of
the commons
People don't harvest
blackberries too
soon from their
backyard garden.
50
Defined property rights as a solution to tragedy of
the commons
People don't dump
toxic wastes into
their own
swimming pools.
51
Regulation as a solution to tragedy of the commons
Fishing licenses limit the amount of fish that can be taken.
52
Happy Solutions to the
Tragedy of the Commons
(ITQs) are like Tradable Pollution
Permits-
but for catching fish
Why are these fish thriving? New Zealand issues
Individual Transferable Quotas (ITQs) for fish 53
Regulation as a solution to tragedy of the commons
Laws regulate air and water pollutants.
54
Regulation as a solution to tragedy of the commons
Zoning laws limit the size and other features of buildings,
signs, land-use patterns, etc.
55
Regulation as a solution to tragedy of the commons
Mandatory recycling
56
Example: Taxation as a solution to the tragedy
o In the cattle-grazing economy considered earlier, suppose there is
now a 25% tax on income earned from cattle.
o If people decide individually between bonds and cattle, how many
steers will be sent onto the commons?
57
Example: Taxing the income from cattle
With a 25% tax on income from cattle, only 2 steers
will be sent onto the commons, and this is the
socially optimal number.
Number of steers Price per 2-year- old After-Tax Profit per
on the commons steer ($) steer ($), with
25% tax on cattle
income
1 120 15
2 116 12
3 114 10.50
4 112 9
5 110 7.50
Total income = 3(11) + 2(12) + 8 = 65
(bonds) (cattle) (tax) 58
Tragedy of the commons
o One of the continuing sources of inefficiency in modern economies
involves the allocation of resources that no single nation's property
laws and regulations can govern.
o Several species of whales have been hunted to near extinction
because international laws of property are insufficient to restrain
individual incentives to kill whales.
59
Tragedy of the commons at the Mediterranean Sea
The Mediterranean Sea has long had serious problems with pollution, because none
of the many nations that border it has an economic incentive to consider the effects
of its discharges on other countries.
[Link] 60
