In
defining public good by the principle of concurrent use and non-interference,
the market demand curve is formed by vertically adding different individual
demand curves together, i.e., at every quantity, the marginal use values of
each demander are added together. However, the concurrent use of a public good
might at times lead to congestion, causing inevitable interference. The key
point here is: irrespective of how congested it is, as long as the quantity of
the public good remains unchanged, it will not because of congestion turn into
private good. Congestion will lead to the demand curves of some consumers
shifting vertically but not horizontally. That is, individual marginal use value
will sometimes shift downward due to interference caused by congestion;
individual marginal use value will sometimes shift upward due to liveliness
caused by more people participating. Regardless, what a producer of public good
considers is market demand instead of individual demand. Since non-payers have
to be excluded, exacting payment in the sale of public good is generally harder
than that of private good – admission by ticket only is one solution.
Remember,
irrespective of how congested it is, whenever consumers of a good increase yet
the quantity of the good does not increase, this is a public good. Its market
demand curve is formed by adding up vertically the marginal use values of
individual consumer. In the belief of visualizing the emperor’s new clothes,
some scholars added together horizontally the demand curves of individual
consumer to handle congestion of public good. This is absolutely ridiculous –
given no change in quantity, adding them together horizontally can never be
right. Whenever an increase in consumers of a good leads to an increase in its
quantity, this is a private good. Its market demand curve is formed by adding
together horizontally individual demand curves, i.e., at every price, the
individual quantities demanded of every demander are added together. The
distinction is clear – vertical addition for public good; horizontal addition
for private good.
Let’s
revert to the pianist example and make it more complicated. The performance of
a pianist can be viewed as a good. An audience large or small is consuming the
same quantity of good, performance is therefore a public good, and admission
arrangements are for excluding non-payers. From the viewpoint of selling this
public good, its market (a concert hall) demand curve is formed by vertically
summing individual demand curves. Assuming the quality of all the seats are
identical, fares will be standardized at such a level that, as envisaged by the
concert organizer, will generate the highest gate receipts. Under this
arrangement with every audience paying the same price, given the marginal use
values of different audiences are not necessarily the same, the concert hall
may not be filled. If transaction costs are low enough, the concert organizer
will adopt price discrimination, making different audiences pay different
prices to increase total income. As long as there are enough patrons, the
concert hall will be filled. Marginal use values of different consumers will
not be the same. This is one difference between public good and private good.
And as said earlier, the Pareto condition has to be interpreted differently. In
order for the marginal use values of different consumers to reach the same
level, the fares for seats of the same quality have to be the same, and there
have to be a number of identical concerts so that different consumers can
choose to attend different number of concerts. On a separate front, if the
qualities of seats are different, different pricing arrangements of the concert
organizer are not counted as price discrimination.
Let’s
raise the complexity level further. The demand for a piano concert can be
considered market demand, yet seats in a concert hall are not public goods:
unless you are a beauty, you cannot sit on my lap when I am occupying a seat.
From the perspective of seats, for a single concert, the demand for seats is
also market demand, yet its demand curve is formed by summing horizontally
individual demand, i.e., at every price, the number of seats are added
together. For seats of identical quality with the same fare, in order to attain
the state that the marginal use values of individual consumer are the same,
unless by coincidence, different consumers have to purchase different quantity
of tickets: some buying three tickets with only one person sitting in the
middle. A bit weird? Certainly. And for seats of different qualities with
different fares, one person buying one ticket for one seat will pull the
marginal use values of different consumers closer.
The main
point here is: attending a piano concert is from one perspective a public good,
but a private good from another. The market demand curve for the former is
constructed by summing individual demands vertically, while summing individual
demands horizontally for the latter. It is the kind of behavior or phenomenon
to be explained that determines which addition is applicable.
The
following is a well-known example. A train was nearly fully-occupied with only
one empty seat left. The marginal cost for carrying one extra passenger was
close to zero. Train tickets had to be bought beforehand, making it difficult
for price discrimination; close-to-zero ticket price will cause the train
operator to suffer huge losses. Yet non-loss-making ticket price would far
exceed the close-to-zero marginal cost, contravening the traditional Pareto
condition. Certain gurus therefore proclaimed: if the government did not
control ticket prices, this industry had to be operated by the government. It
has been said that this was the reason why today the so-called public utilities
(water, electricity, gas, etc.) are typically intervened by governments. Was
that a reason, or an excuse?
Readers
have to note that, turning from the demand for a concert to the demand for
individual seats in a concert hall, or from the demand for a train to the
demand for its individual seats, we are turning from public good to private
good, with market demand curve turning from vertical addition to horizontal
addition. Of interest is, turning from concurrent use to private use, the
marginal supply cost for individual demander drops very sharply – in the train
example marginal cost was close to zero. Continuous decline of marginal cost is
a popular topic in natural monopoly, which I will put aside for the time being.
While still on the concept of public good, I will hereby clarify a few tricks.
As for
public good, I have to remind readers once again what I said earlier in Chapter V about the law of demand: “What
is price? What is quantity? Which price does the demand curve refer to? Which
quantity? Is quantity in substance or by proxy? These questions are
inevitable.” From the discussions on public good and private good, we know that
for the consumption of the same product or service, it can be a public good
from one perspective, a private good from another: different are quantities and
prices for these two kinds of goods, as well as the approaches adopted. Why
does the market use that price and that quantity? To which price and which
quantity does the law of demand refer? Clarifying these issues is essential in
explaining behavior.
Allow me
to add some variation. Strictly speaking, almost all goods bear the nature of
both public good and private good. For instance, appreciating the beauty of a
diamond is concurrent use while wearing a diamond is private use. As such,
transaction of a diamond is a kind of tie-in sale. Generally, the market is
more inclined to determine price and quantity based on the nature of private
use due to its relative ease in excluding non-payers, unlike the case of a
piano concert that requires a gate attendant to check tickets. That is, using
carat as quantity to price a diamond, the value of concurrent appreciation has
already been included in the price. There are also other instances where, due
of the existence of the nature of public good, valuable product or service
becomes difficult to measure, or non-payers cannot be excluded, no market
transaction results. Similarly, an apple can be eaten (private use) or viewed
(public use). The key point here is: other than the two aforementioned
“exclusion” or “tie-in” approaches to assist in exacting payments, the law of
demand in respect of private good implicitly embodies the goods and bads of
public good, and the concurrent-use quality and quantity are assumed constant.
Let’s do a
quick test. Strolling along the street is a pretty woman dressing up like a
fairy. Turning everyone’s head, this is enjoyment of a public good. Without
exacting any payment, why does this beauty spend so much money and time
dressing up? The key point is: the purpose of a lady dressing up dazzlingly is
for tying public good onto herself so as to promote her own identity, similar
to a diamond having a sparkling luster becomes more valuable.
Let’s add
another key point: traditionally, market demand curve is generally formed by
summing individual demand curves horizontally. This treatment of private good,
adopted not due to the scarcity of the nature of public good but rather due to
the existence of “exclusion” costs, explains why the market prefers pricing
according to the quantity of private good. In other words, economists happen to
be right without knowing why!
Volume I, “The Science of Demand”, is coming to an
end. If readers are still following the footsteps of this old timer, then the
better you have become in this game of economic explanation. In Volume II, “The Behavior of Supply”, though the law of demand will be often
applied, it will not be often mentioned. It is time to turn to imperative
concepts like “cost”, “rent”, etc. I will lead readers through a novel
universe.
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