The Science of Demand (47) - Unofficial Translation of Steven Cheung's 经济解释 - 科学说需求

Chapter VIII.  The Economic Analysis of Public Goods

The analysis of public goods, having a long-lasting history, has always been considered by economists a big conundrum. More than forty years ago, several teachers and friends said that I was the best candidate to crack this open, yet it is far easier said than done. At 4 a.m., April 15, 2010, for some reason I could not get to sleep. Sitting down at my desk, I wrote down the key attributes of public goods that had been hovering in my mind over the years, arbitrarily adding a little more. To my pleasant surprise, that amounted to a comprehensive analysis. On top of clarifying traditional analysis, eleven points of interest were added. As a Chinese proverb says: nowhere was the target found after searching far and wide, yet with no sweat it may come to you.

Section 1.  The Nature of Public Goods

We said in Section 2, Chapter VII that there are two categories of goods: private goods and public goods. The term public goods was invented by Samuelson; it was a misleading term that misled later generations, causing its Chinese translation to carry the meaning of “common goods” which heaped error on error.

Let’s use apple as an example. Apple is a private good. If the price of an apple is $1, and my quantity demanded is two while yours is three, then at the price of $1, the quantity demanded including yours and mine is five. The market demand curve is formed, at every price, by adding up horizontally toward the right individual quantities demanded. This is the market demand for private good.

Suppose the good is a television program that you watch at home, and I watch the same program at home, too. Since you watch yours and I watch mine without any cross-interference, that television program is therefore a public good. The nature of private good is exclusive use, while the nature of public good is concurrent use. There are neither too many nor too few public goods. In addition to television program, other examples include a thought, an invention, Mozart’s music (not referring to a music album but to the music itself), the content of my “Economic Explanation” (not referring to a book but to the content of the book), etc.

More than twenty years ago, an economist published an article in a Hong Kong newspaper, citing public toilet as an example of public good. That was wrong. Public toilet, built by the government and provided free to the public, is undeniably of public use. However, since public toilet cannot be used concurrently, it is thus a private good. The beach can be “publicly used” but not “concurrently used” – while I am lying down for a sunbath, I would not let you lie on top of me. Private goods can be publicly owned, and public goods can be privately owned – these cannot be confused.

The market demand curve of a public good is formed by adding up vertically the individual demand curves of each demander: at every quantity, the marginal use values of each demander are added together. This leads to an interesting question: for a television program, I am willing to pay $2 to watch while you are willing to pay $3. The total of our individual marginal use values is $5. If the television station (cable television) charges $2, its total income is $4; if the charge is $3, you will watch while I will not, total income is only $3. In order to increase total income to the level of total marginal use values for boosting production, the television station has to adopt price discrimination: charging me $2 and $3 for you. However, the cost in adopting price discrimination is exceptionally high: it is not easy for the television station to know the marginal use values of yours and mine. Without price discrimination, the production of television programs will have to be less than optimal. That is, in respect of public good, unless every demander is born equal, or else charging one single price will not attain the Pareto condition. This is an old view of the Pareto condition. A new view includes transaction costs which I will defer till later to discuss. (Free-to-air television charges indirectly: our time value in watching television advertisement is cost, or price in disguise.)

The above analysis has three main points. First, since public good allows concurrent use and exacting payment requires the exclusion of non-payers, public good is more difficult to exact payment. In the case of private good, only exclusive use is allowed. Therefore, with exclusion already in place, exacting payment for private good is certainly easier. Second, when transaction costs or costs in exacting payment are low enough, price discrimination will be adopted in the production and sales of public goods. Third, for the same public good, the marginal use values of different consumers are different.