MBA 604
D. Opp

Pure Private versus Pure Public Goods and the Mixed Cases:

Economists categorize goods and services with respect to two basic characteristics:
1) the degree or rivalry or absence of involuntary sharing (the amount of unavoidable joint consumption), and
2) the ability or cost of excluding others from consumption (the ease with which sharing can be prevented).

A complete taxonomy, which covers all goods and services, based upon these rivalry and exclusion characteristics, may be put in the following table:

Rivalry Characteristic

Full Rivalry No Rivalry

Full “Private good” “Monopolies” Exclusion (Efficient (Not enough competition) competition)
Exclusion
Characteristic No “Common “Public good” Exclusion property” (No competition) (Too much competition)

Pure private goods are the case where both rivalry and excludability are high, so that competitive markets are most efficient at provision. Individual consumers have the freedom to choose consumption amount and have complete control over sharing, and rivalry assures that producers can charge a price to each separate consumer. Consequently, an optimal level of output results through the forces of competition in the search for profits, which is an outcome associated with economic efficiency. The economic definition of a pure private good is one where each successive consumer pays an amount sufficient to cover cost, so that marginal benefit equals marginal cost in each instance and overall.

Pure public goods are the opposite case where both rivalry and excludability are low, so that governments provision is the most efficient through the power of taxation to fund production, and letting everyone share equally in consumption, so that no competition is needed. Ideally, sufficient guidance is provided by competition in the electoral process by the preferences of the median voter, and in the political arena between competing interests for different public goods and their level of provision. In these two pure cases, efficiency simply requires achieving a proper division of labor between the private and public sectors based on the principle of comparative advantage, along with some clear rules of law about property rights, which distinguishes the private from the public domain.

The economic definition of a pure public good, once its supply is determined, is one where the marginal cost of adding another consumer is zero, as there is no crowding or rivalry. It should be noted that in the case of pure private goods, each individual chooses the unique quantity she wishes to consume, where everyone pays the same competitive market price, more-or-less, per unit. In the case of the public good, each individual consumes the same amount for a fixed quantity supplied, and each pays a separate tax-price for provision as determined by the particular provisions of the tax code. This bears thinking about in order to understand the difference clearly. On one hand, each individual gets to choose independently how much of the private goods she wants to consume, and everyone pays the same price. On the other hand, each individual consumes the same amount of the public good, the total amount that is supplied and available to everyone, but pays a different tax-price for that joint consumption.

Conflicts over the optimal quantities supplied of public goods, or the relative size of the government sector in the aggregate, arise mainly because of the rivalry-exclusion properties. While each individual consumes the same amount of a public good, their preferences for the optimal amount will differ, which naturally leads to political disagreements about provision with joint consumption. Under an efficient division of labor, public or government-provided goods fall into three basic categories: 1) social welfare programs, which basically redistribute income, 2) human and physical capital enhancement, which tend to be redistributive, but which also increase overall productivity, the benefits of which may be considered a public good, and 3) pure public goods, which are considered “infrastructure” investments that are either physical (e.g., roads), or institutional (e.g., impartial courts). While the first two achieve voter-mandated social and economic objectives, the benefits are largely captured privately, and there are likely to be very different individual preferences regarding their optimal amounts. The third, while non-redistributive, serves as a complement to private goods, but individual preferences will still vary.

Fundamental economic conflicts and public policy problems occur in both the mixed private-public cases of low rivalry-high excludability (the upper right-hand corner of the diagram), and the opposite case of high rivalry-low excludability (the lower left-hand corner of the diagram). In the case of low rivalry-high excludability, there is insufficient competition for efficiency, which is the case of the monopoly and collusive oligopolies with too much market power to exploit consumers by charging consumers a price higher than marginal cost through restricting output. Public policy makers must decide whether to make such firms or industries either more competitive, or “private good-like” through monopoly (or monopsony) and cartel break-ups (through anti-trust), or more “public good-like”, by treating them as “natural monopolies” whose predatory behavior is controlled through greater regulation, or subjecting them to outright public ownership, so that no competition is needed. The economic definition of a nature monopoly is where one firm can supply the entire market at declining average costs.

The opposite problem of high rivalry-low excludability results in too much competition or overutilization of the resource, which is the case of the “common property” resource. This usually takes the form of conflicts about use, or “crowding” or “congestion”, as individuals do not pay the full marginal cost for their use, and some “social costs” inadvertently spillover onto others in the form of public goods (bads). Again, public policy makers must either figure-out how to make such industries more private good-like by creating or extending property rights, so that individuals must pay full marginal cost for the use of such resources through market transactions. Or, they must be made more public good-like as a government owned or regulated monopoly that determines restrictions on who gets to consume how much. The economic definition of a common property resource is one that is zero-priced, so that consumption takes place where the marginal benefit is zero, so that the market price-rationing device to limit consumption is absent. Efficiency requires a positive price set where marginal benefit equals marginal cost.

Public policymakers must decide in both the monopoly and the common property cases what the best rationing device is for such goods and services, which are necessarily characterized by scarcity. In either case, where the private good direction is chosen, so that private ownership of common property ensues on one hand, and anti-monopoly or competitive policies are promulgated on the other, then the competitive market pricing mechanism and consumer choice determines who gets to consume how much. On the other hand, if the public ownership path is taken, then government policy, either through taxes and subsidizes or rules and regulations determines how much and who gets to consume how much.

Political Economy and the Division of Labor between Public and Private:

From a political economy perspective, mature democratic-capitalist states gravitate toward an efficient division of labor between the private and public sectors, and are fairly vigilant about correcting market failures. Consumer sovereignty and freedom of choice is championed in the market, and government concentrates on the provision of public goods as determined by voter preferences. Abusive monopolies tend to be checked and common property problems are resolved in the “public interest” according to broadly interpreted benefit-cost principles. Political debates tend to focus on how market failures should be corrected, either by relying upon competitive market forces or upon government oversight, not on whether they should be corrected.

Of course, the achievement of an efficient division of labor is far from perfect in a dynamic and competitive world. Constantly changes in technology, demographics, social needs, consumer tastes, and globalization impact the delicate balance between public and private, and redefine the problem areas of monopoly and common property. However, democratic-capitalist systems tend to be most responsive in attempting to continually improve the division of labor, as this is the most important prerequisite for improving social welfare.

On the other hand, authoritarian states have a tendency to militate against the efficient division of labor prompted by reliance upon freedom of choice and civic virtue undergirding democratic capitalism. Authoritarians are suspicious, if not threatened, by the workings of the invisible hand and the electoral-legislative-judicial institutional process, and tend to place their faith in the visible, heavy hand of administrative command and control. Consequently, there are plenty of regulations and restrictions on private transactions and political freedom, but no effective rule of law to curb abuses of power or protect private property. The state tends to be overly involved in managing the provision of private goods, which it does poorly by its nature, at the expense of the provision of public goods at which it is naturally more efficient. Moreover, producer sovereignty is favored over consumer sovereignty, so that concentration of monopolistic power in markets and expropriation of common property by the powerful is encouraged rather than discouraged.

In the worse cases, dysfunctional governments create rather than correct market failures. They protect and subsidize private monopolies by restricting competition for the benefit of the elite and well connected. Concomitantly, such governments fail to protect common property, so that it is more easily expropriated as a private good by those who hold economic and political power. The creation of market failures that allow the politically powerful to capture monopoly profits and expropriate common property in exchange for political support is a process known as “rent-seeking” in the political economy literature, where “economic rent” is older synonym for monopoly profit. This is a recipe for rampant corruption, where citizens must pay public officials to receive expropriated public goods. The (shadow) market for corruption consists of the payment of a bribe-price in exchange for a political favor received in the form of a private good. Public goods are converted to private goods and sold to the highest bidder thus sacrificing economic efficiency for the exigency of maintaining political power.

In the very worst cases of “failed states”, there is no division of labor, and everyone is pretty close to self-sufficient, or reduced to working within smaller, narrower, and more primitive groups (e.g., kinship and tribal) in order to provide public goods. The state fails to provide the most basic infrastructure to support market transactions and reduce risks. The private sector is a mix of large powerful state protected or owned monopolies, which collude and cooperate with one another on one hand, and small undercapitalized, and inefficient firms, which are isolated from one another on the other hand. Such state failures are often attended by humanitarian crisis. The absence of public goods, the most basic being public safety and political instability, prevents capitalism from taking root, and a Hobbsian state of nature tends to prevail, where “life is solitary, poor, nasty, brutish, and short”.