7 Jun 2008

Underprovision of Public Goods

Gormk says
I want to point out that "technology" or "technological progress" in a broad sense is a public good. Public goods can never be efficiently supplied by private markets. A similar and related example is education.
Gormk is right in theory (that's why we get PhDs), but he is wrong in reality. The key to understanding the difference is "never be efficiently supplied", so let's dissect that sentence.

In economics, "efficiency" is often defined as the reaching some optimum point, a result that depends on marginal costs and marginal benefits, which tend to be represented as supply and demand curves (respectively). These curves cross at the optimal point beyond which it is not efficient to go any further -- because the benefit is less than the cost. I might, therefore, buy 12.3 years of education at a price of $113,000 but no more -- the next 0.1 years of education may be worth an additional $1,200 to me but may cost $1,205.

What Gormk is getting at is that that society may get more than $5 in benefits from my additional education. Because of this "public good" aspect (everyone in society benefits), society should be willing to subsidize my education so that I take 0.1 years (or more) of additional schooling.*

So -- that's the theory and that makes sense, but it is NOT always true, i.e., the statement education or technology can "never be efficiently supplied" is false. I claim that it's false because I can give a plausible example of when either are efficiently provided without subsidy. And the way to do this is by taking the discrete (non-continuous) nature of these goods into account, i.e., if I am willing to pay for 12 years of education on my own, I am not interested in a 13th year -- and neither is the public, since the cost of an entire 13th year may be less than the sum of private and public benefits.

Now someone may argue that the public can subsidize the first, second, etc. years of education, leaving more money for me to spend on my 13th year, but this accounting is unsound. I am happy to pay for those early years of education myself -- there is NO NEED for public subsidies. I am happy to pay because the private benefit to me exceeds the private cost to me. Why subsidize me for something that I am already going to do?

You can see how this analysis raises lots of tricky problems, i.e., people who are getting subsidies to do what they want to already (e.g., ice cream eating subsidies) are effectively getting free money. That's true when water is sold below cost, since most people are willing to pay more. It's NOT true for ethanol, since farmers would lose money without the subsidies.**

Bottom Line: Public goods may be underprovided, but they often are not. Because of this, subsidizing "public goods" is not always necessary or wise.

* As a recent PhD who had six years of education paid (fees, plus salary), I can attest to the magnitude of this system. What's the public getting for its $150,000 investment? You're reading it!

** That doesn't make ethanol a good idea, but it was supposed to reduce a public bad/negative externality by displacing fossil fuel. That idea sounded good in theory but was false.

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