Common Property

and Public Goods

1
Introduction
• Goods can be classified into different categories based on two different properties.
• A good has the property of rivalry if the consumption by one person precludes consumption by other
people.
• A good has the property of excludability if individuals can be prevented from consuming the good.

Excludable Non-Excludable
Rivalry Private Good: Common Property:
Apple, Computer Park, Fishery
No Rivalry Club Good: Public Good:
Concert, Cable TV Clean Air, National Defense

2
Introduction
• In HE1001, HE2001, we have mainly focused on private goods, which are rivalrous and
excludable.

• In HE3001, externalities of private goods, which we saw last lecture, can often be conceptualized
as working through another non-excludable good.
• E.g. Cigarettes and clean air, Fishing and common sea resources…

• Today, we study further economic issues involving this non-excludability:

1. Common property
2. Public goods

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The Tragedy of
Commons

4
The Tragedy of Commons
• Consider a grazing area owned “in common” by all members of
a village. Villagers each have 1 cow which they can graze on the
common.

• When c cows are grazed, total milk production is , where and

and . Productivity of each cow is the same and is equal to . The
cost of grazing a cow is fixed at . The cost of milk is $1.

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The Tragedy of Commons
• Production via access to the common is non-excludable, but rivalrous.

• Every villager can graze a single cow if they want.

(They own the milk which is produced by their own cow, .)

• Note: the grazing of an additional cow reduces the milk productivity of other cows grazing.
• because given the previous conditions.

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 The Tragedy of Commons

Why is ?

Slope of red line, the tangent at , ()

𝑓 (𝑐 ) is always less than slope of yellow line

This occurs for an increasing, concave

production function which exhibits
diminishing returns and has this specific
shape.
𝑐

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The Tragedy of Commons:
Social Planner’s Problem
How should the village graze their cows so as to maximize their total income?

• The objective is:

• The solution to this problem is where:

• This is the socially optimal solution.

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The Tragedy of Commons:
Individual Problem
How should a villager decide whether to graze a cow to maximise personal income?

• Each villager is assumed to be a small entity compared to the entire village.

He/she considers the current productivity of a cow when choosing to graze.
• Remember is the total number of cows currently being grazed.

• As long as , there will be a villager who will want to graze an additional cow.

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 The Tragedy of Commons:
Individual Problem
• Since nobody owns the common, entry is not restricted, and entry occurs until
• Intuitively, this is where the individual economic profit of grazing another cow is 0.

• More cows are grazed in the individual optimum than the social optimum.
• At the social optimum , the economic profit per cow is
• This is because . Hence .

• The individual economic profit from introducing an additional cow is positive at the social
optimum , which implies that the number of cows grazed in equilbrium when villagers are
individually optimizing is greater.

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The Tragedy of Commons (Graphical
Solution)

• is the social optimum.

• is the equilibrium when villagers

individually optimise.

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The Tragedy of Commons
• What is the intuition behind this?
• When a villager adds one more cow, his personal income rises but every other villager’s income falls. I.e.
the villager imposes a negative externality on others, but doesn’t take that into account.

• Solutions to this problem are similar to that for externalities..

• “Merger” if villagers acted as a single entity, e.g. like a cooperative, then they would have efficient
outcome.
• “Property rights give someone the right to the commons (Coase theorem).
• Taxes charge a fee to use the field.

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Tragedy of Commons, Discussion
• This holds in general: common property leads to a “structure” where externalities are imposed on
others from private use.

• Other modern-day examples:

• Overfishing the high seas.
• Overlogging forests on public lands.
• Over-intensive use of public parks.
• Urban traffic congestion

13
Review Questions 1
Suppose that there is a wi-fi access point with a capacity of 10 people. Because of bandwidth
limitations, after 10 people, wi-fi speed starts to get slower for each unit of usage. Each connected
person decides how much w-ifi to use.

• Suppose there are 5 people who are sharing the a wi-fi access point. Will there be a tragedy of
commons (in wi-fi usage)?
1. Yes
2. No

• Suppose there are now 15 people who are sharing the a wi-fi access point. Will there be a tragedy
of commons (in wi-fi usage)?
1. Yes
2. No

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A simple model of
Public Goods

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Public Goods
• A public good is non-excludable and non-rivalrous in consumption.
• As long as 1 individual chooses to consume (provide) the good, it is not possible to exclude others from
consuming it.
• It is also non-rival in the sense that everyone will consume the same amount.
This causes certain problems for the decentralised market …

• We first start by examining when a public good should be provided.

• To this end, let us consider consumers’ reservation prices of the public good,

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Public Goods
• Suppose we have 2 individuals A and B who have to decide whether to contribute to providing a
public good.

• Assume that the cost of provision is The public good will only be provided if their contributions
exceed the cost of provision.
• (Contributions are assumed not to be refunded in the case of failure.)

• Then it is efficient to provide the public good when .

• Compared to no provision, there exists some sharing of the cost which leads to a pareto improvement.

We will now use game theory to see some problems with privately providing the public good.

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 Scenario 1
• Suppose and . Then A would supply the good even if B made no contribution.
• B then enjoys the good for free. This free riding can lead to inefficient provision.

• Let , , .
Suppose they have to decide whether to individually contribute $50 to providing the public good.
Player B
Contribute Don’t Contribute
Contribute
Player A Don’t
Contribute

• Mixed strategy NE here which implies a positive chance of (Don’t contribute, Don’t contribute) .
• Even though both and , the inefficient outcome of no public good might still result.
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 Scenario 2
• Suppose , but and . Here, they will not individually contribute.
Will sharing the costs help?

• Let , , .
Suppose they have to decide whether to equally share the costs of providing the public good
(The public good is only provided if both of them contribute their share.)
Player B
Contribute half Don’t Contribute
Contribute
Player A half
Don’t
Contribute

• Two pure strategy NE here: (Don’t contribute, Don’t contribute) & (Contribute, Contribute)
• The need for both to contribute may hinder provision of the public good even when it is efficient: .
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An extended model of

Public Goods

20
 Variable Public Good Quantities
• Now, let us consider a case where we can have variable amounts of the public good.
The cost of providing amount of a public good is .

• The cost of the private good is 1.

• Each individuals has wealth given by and preferences which are a function of private
consumption and public goods consumption .

What is the optimal amount of the public good?

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 Social Optimal Outcome
• Any pareto efficient allocation can be shown to satisfy the following condition:

Where is the marginal rate of substitution between the private and public good for .
• tells us how much one marginal unit of the public good is worth in terms of the private good

• Since the price of the private good is 1,

can be interpreted as the total private spending (across individuals) which gives the same utility
as one marginal unit of the public good .

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Social Optimal Outcome
Why is this condition optimal?

1. If ,
• Reducing the public good by 1 unit.
• The decline in utility is worth of the private good.
• The cost savings is .
• Use the cost savings to compensate each individual with of the private good.
• Will have left over!

• Can redistribute left over money to everyone and have a possible pareto improvement!
Too much of the public good here..

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Social Optimal Outcome
Why is this condition optimal?

2. If ,
• Reduce each individual’s private consumption by .
• Increase the public good by 1 unit which costs . Utility will be exactly the same as before.
• But will have left over!

• Can redistribute left over money to everyone or buy more public goods and have a possible pareto
improvement! Too little of the public good here..

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 Social Optimal Outcome (Quasi-
linear)
• Suppose that preferences are quasi-linear .

• Then the condition gives us: which is independent of .

There is a unique level of the public good which is pareto efficient!

• This is just the utilitarian solution:

s.t.

Why? From HE2001, we know that quasi-linearity implies that the pareto efficient allocation with money
transfers is the one which is utilitarian.

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 Private outcomes
• Suppose that each individual decides on how much public good to purchase
• The total public good is just the sum which each purchases:
• For simplicity, assume fixed marginal costs of contributions:

s.t.

• Solving, we get the condition: for all .

• This implies that and there is too little of the public good.
• This is because investing in public goods generates positive externalities on others which individuals do
not account for. Positive externalities also means that individuals want to free-ride on others!

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Review Questions 2
Consider a public good with cost function . There are 2 individuals with general preferences . They
each contribute amount of the public good and privately consume the left over .

1. Suppose the level of contributions are such that and . Is this pareto efficient?
1. Yes
2. No

2. Is there overconsumption or underconsumption of the public good?

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Mechanisms for Public
Goods Provision

28
Alternative Mechanisms
• To the extent that public goods remain non-excludable, given the externalities and free riding
incentives involved, private market mechanisms are often inefficient.

• Hence public goods provision tends to rely on more centralised mechanisms.

• Voting is one example, but has its weaknesses (see HE2001 notes, textbook).
• Alternatively, perhaps we can design a specific procedure which determines whether to provide a
public good and how much each person should pay?

How may such a mechanism decide on how much/ whether to supply a public good?

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Demand Revelation
• The previous discussions imply that we need to know their marginal valuations to efficiently
supply a public good!
• How do we do so? If we naively just ask them, people might have incentives to inflate their
valuations of the good to get more of it.

• A scheme that makes it rational for individuals to reveal truthfully their private valuations of a
public good is a revelation mechanism.

• An example of this is the Vickrey-Clarke-Groves (VCG) taxation scheme.

We will now study how it works.

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The Setup
• N individuals; . All have quasilinear preferences.
For simplicity, we consider the case of a discrete public good:
(don’t provide) vs (provide).

• is individual i’s true (private) valuation of the public good.

• The cost of providing the public good is

• It is hence efficient to supply the public good if

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The VCG mechanism
When is the good provided?
• Everyone is asked to report their true value . Individual report is called .
• If , then the public good is provided.

Who pays what?

• If the public good is provided, each individual i must pay the average cost,
• No matter whether the public good is provided or not, they will need to pay a tax which
depends on everybody’s reports.
• The aim of this tax is to make them want to tell the truth.

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The VCG mechanism: Taxes
• We call an individual pivotal if
and or

• I.e. with his inclusion, the supply decision changes from what the others would want to do (on
average) based on their reports.

• Why the focus on pivotality?

• Losses are only inflicted on others when an individual is pivotal.

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The VCG mechanism: Taxes
• Suppose
Then, if was like others on average, then public good would not be provided.
• If including causes the public good to be provided.
This goes against what the others want and generates an aggregate loss on them.

• Suppose
Then, if was like others on average, then public good would be provided.
• If including causes the public good not to be provided.
Again this, goes against what others want and generates a loss on them.

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The VCG mechanism: Taxes
• Everyone is taxed an amount equal to the loss they inflict on others this happens when
a person is pivotal.

• If the public good is provided :

• if non-pivotal.
• if pivotal.
(If was pivotal in providing the public good, others must have not wanted to provide it.)

• If the public good is not provided :

• if non-pivotal.
• if pivotal.
(If was pivotal in not providing the public good, others must have wanted to provide it.)

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The VCG mechanism: Payoffs
• Suppose other agents favour the public good:

• Then agent payoff is

Loss in utility from tax if good is not provided

, which is whether the public

good is provided, is influenced
by the agent’s choice of report.
It is as if agent is choosing .

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The VCG mechanism: Payoffs
• Suppose other agents do not favour the public good:

• Then agent s payoff is:

Loss in utility from tax if good is provided

, which is whether the public

good is provided, is influenced
by the agent’s choice of report.
It is as if agent is choosing .

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The VCG mechanism
• The blue terms are the portion of utility for which agents have control over (through their
report).

• From the conditions of when the good is provided, when

Given the messages from other agents , agent ’s message potentially determines the value
of .

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The VCG mechanism
• Expanding the blue term gives:

• Notice that in order to maximise utility, it would be best to report the truth:
• If, a report would result in provision of the public good resulting in this positive utility.
• If, a report would result in non-provision of the public good resulting in the avoidance of
this negative utility.

• Other non-truthful reports will result in weakly less utility.

• Intuitively, this is because the tax forces them internalize the externality which his
report causes for others.

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The VCG mechanism
• Reporting is thus a (weakly) dominant strategy.

• Everyone reporting is thus a Nash Equilibrium of this game.

• In this Nash Equilibrium, since the public good is provided when , and everyone is
telling the truth, the mechanism will indeed provide the public good if it is efficient to
do so.

• Notice that the VCG mechanism like an auction: messages are like bids and these result
in allocations of the public good.
• Truthfulness arises from a mechanism similar to that of the second price auction.

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Remarks on the VCG mechanism
• The VCG implicitly requires quasi linear preferences as we can’t have payments influencing
demand for the public good.

• While it guarantees the efficient provision of the public good, there is still resource inefficiency
due to taxes removing wealth from pivotal individuals
• These taxes cannot be fed back into the system so as to maintain incentive compatibility.
• There is thus a drop in private consumption.

• This result is more general: there are no processes which are simultaneously dominant
strategy incentive compatible and have no resource inefficiency over a reasonable range of
possible environments. (even under quasi-linear utility.)
• See the textbook for more discussions of weaknesses: collusion and equity.

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Review Questions 3

The government is considering providing a public good for 3 users, I, J and K using the VCG
mechanism. The cost of the public good is 9.

1. Will the public good be provided?

a) Yes
b) No

2. Suppose they all report their true values. Select all agents who are pivotal.
a) I
b) J
c) K
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References
• Varian Chapter 35
• Varian Chapter 37

• Related articles: changing the structure of public goods

• Digital media and the public goods problem
• The lighthouse myth

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