UD-3

The fundamental characteristic of a private property system is that it assures that if an individual causes a good to be produced, she is the owner. A person may give up her ownership rights in advance. She may sell someone her rights to a good she is planning to produce or help to produce. This is basically what happens when employees accept a production job. They turn over to the employer the rights to the product they expect to help produce.

We can distinguish between a private property system and a communal property system. In a communal property system, a good does not belong to the person who caused it to be produced but to "the community." More completely, a communal property system is one in which all items and actions that are considered goods and resources belong to "the community." To put such a system into effect, a government officials would have to decide precisely what it means for the community to own a good or resource. Consider a forest containing animals that can be hunted and killed for food. Government officials may permit unlimited access by imposing a severe penalty for anyone caught hindering the activities of any hunter. If the population is large, the result will most likely be over-hunting and the extinction of animals that are more desirable as prey. On the other hand, government officials may permit only limited access. One way to achieve this is a licensing system that requires hunters to have a license. The officials can limit access by limiting the number of licenses. Another way is to restrict the number of animals that can be killed during a given time. Each of these methods requires resources to be used for enforcement.

Communal property system: a system in which goods and resources belong to "the community." In practical terms, this means that government officials must decide who will be allowed to use the goods and resources and how they will be used.

A system in which government officials decide on who owns all goods and resources and how they can be used is typically called pure socialism. Most people in the world today seem to agree that the private property system is preferable to pure socialism. The reason is that the private property system is a prerequisite for a market economy, which gives people incentives to produce what they regard as great wealth. However, people do not believe that the market economy is perfect. They believe that "markets can fail." When modern economists try to conceive of a situation of market failure, they are not trying to find a justification for socialism or for government intervention. They are merely showing that the market outcome is not as good as they can conceive of it being.

We have already used Hume's meadow as an example of market failure. Other market failures include public goods and monopoly. The purpose of this chapter is twofold. First, we want to show why the private property system tends to generate what most people seem to regard as great wealth. Second, we want to identify the sources of market failure. Part one describes the system. Part two discusses the public goods problem. Part three mainly deals with a special problem in market failure -- that associated with buying large tracts of contiguous property. Part four identifies other sources of market failure. Part five discusses the special problem of monitoring that arises when agents are hired to decide on the supply of public goods.

A word of caution is perhaps in order. The economic literature contains much debate on the idea of market failure. In theory, it is fairly easy to reason that market failures of particular types have occurred in the past. We know that if people had anticipated these failures and had taken certain actions, they would have been better off, by their own accounting. We cannot be so confident about the future. The problem is that we are dealing with human beings. Human beings are creative. They can discover problems and solutions to them that outsiders cannot even conceive. To decide whether a market will fail in the future, we must use our imagination and judgment. We must try to imagine the ways that individuals can find and take advantage of potential gains from trade. We must then judge whether they will actually discover those ways or other ways that are beyond our ability to conceive at the moment. There is a lot of uncertainty here. So we should not be surprised to learn that intelligent people disagree. At the moment, most professional economists appear to think that market failures are important, that individuals in the market economy cannot find ways to solve them, and that the government in some cases can do a better job. However, this opinion is not universal

and it is quite possible that it will change in the future.

This book is not about the possibly shifting opinions of professional economists. It is about the prospect that democratic government can effectively supply services for which people believe that the benefits are greater than the costs. Since most people believe that such services fall into the category of correcting market failure, we must identify the types of market failure first. If these are, in fact, not really failures -- that is, if we can expect individuals in a free market to discover means of overcoming them -- then our need for government would derive solely from a desire for national defense and the establishment and enforcement of the private property system.

Modern capitalist economies are not a pure private property system. It contains numerous communal rights as well. Part of the reason for this is that different types of private property rights have different costs of establishing and enforcing. If it is too costly to establish and enforce a private property right, citizens would not want to incur the expense. In spite of the reality of modern capitalist economies, the best way to understand a private property system is to begin by building an image of an economy in which there are only private property rights. The image of the so-called pure market economy fits this description. In building this image, we assume a peaceful society with a zero-cost criminal justice system that enforces strict laws against theft and extortion.

A second assumption we make is the absence of goods that have public goods characteristics. We shall discuss these characteristics in part two of the chapter. For the moment, it is not important to describe these.

Economists have studied the imaginary pure market economy quite thoroughly. Modern economics began with the study of such a society. Its most important contribution to human knowledge has been its demonstration that a private property system seems to give people an incentive to produce a greater amount of what ordinary people call wealth. Let us review the work of two of the most important contributors.

Adam Smith (1776) pointed out that in a private property system, if a person wants to earn more money for himself through exchange, he must first produce something or provide a service that someone else wants. Suppose at first that people live in a communal system in which all property is shared. Now suppose that there is a shift to a private property system. People will quickly realize that they cannot share in the goods that others produce and that the goods they produce belong exclusively to them. This realization would give them an incentive to produce goods for their own consumption. More importantly, they will begin to perceive benefits from trade and specialization. Smith observed that self interest leads some people to become butchers, some to become bakers, and so on. Moreover, the larger the market for products, the greater the degree of specialization. If a nation wants to become wealthy, he wrote, it should set up a private property system in which markets will naturally expand and, therefore, lead to greater specialization. In short, he pointed out that the private property system is a situation in which practically everyone tries to earn money and, in the process, develops a specialty that benefits others through exchange. The result, in relation to a communal property system, is a greater amount of what ordinary people call wealth.

The private property system gives people an incentive to cause goods and services to be produced for others.

Twentieth century American economist Frank Knight (1921) went deeper than Smith. He saw that two things are required for people to go into business producing goods for others: (1) saving and (2) betting on one's business judgment. First, for a person to go into the business of producing and selling goods, someone must set aside, or save, goods or money that could otherwise be used for immediate consumption. Either the businessperson herself must save or someone else must save and then lend the savings to her. Second, she must bet on her beliefs about the future. She must bet that the future prices she can get for her goods or services will be higher than her costs of production. The businessperson is not like a gambler at a roulette table. She does not bet on the odds. She bets on her judgments about people. She thinks she knows about future demands for her goods, about the prices that owners of the resources will charge for them, and about her competitors. She thinks that she knows enough to make a profit. Knight pointed out that a private property system gives individuals incentives to save and to bet on their business judgments in order to increase their own wealth.

The private property system gives people an incentive to save and to take risks in business.

Betting can be risky and bettors can surely make errors and be careless. Knight pointed out, however, that the property system forces people to be responsible for their errors and carelessness. It also rewards them for being right. It thereby encourages people to make correct judgments. Thus, the saving and risk-taking are more effective than they would be under a communal system, where the responsibility for errors and benefits from being correct must be shared.

Knight pointed out that the private property system gives people an incentive to make four kinds of choices. (1) People select themselves into occupations on the basis of their best judgment of their skills and of the demand for their skills. (2) People who believe they have greater foresight select themselves into positions where foresight is most important in the satisfaction of wants. (3) People select themselves into either employer or employee positions depending on their judgment of their foresight and capacity to manage others. And (4) people who have confidence in their judgments and the money to back them up select themselves into specializations that entail the greatest risk-taking.

To help us understand Knight's argument, imagine that you develop an idea for a new product. You suspect that if you could borrow the money to hire the resources, you could produce the product at a lower cost than the price consumers will pay you for it. But you are very uncertain. To improve your judgment you would like to produce a few units and present them to consumers in order to learn more about their demand. To do this, you must invest a sum of money.

Suppose that your initial investment leads you to gain greater confidence. Fortified with the new information, you decide to begin full-scale production. But first you must raise more funds. Because you are optimistic about the outcome, you approach some possible lenders. Each one tells you that he will lend you money for a good investment but only if you post collateral. So you agree that if you do not repay the loans, you will forfeit a valuable piece of your property, say a car or house.

Now you would not agree to this unless you had great confidence in your judgment. By making the agreement, you select yourself to be a risk-taker. Also, when the lenders agree to lend you money, they select themselves to be savers. In addition, because there are no completely risk-free loans, they have agreed to bear some amount of risk also. In other words, they are betting partly on their judgment of your judgment.

Suppose that lenders turn you down because you do not have sufficient collateral. Then you can seek out people to be co-investors. You can tell a co-investor that if she takes part of the responsibility for financing full-scale production, you will share whatever profits you earn from the venture.

Naturally, a prospective investor will want to know a great deal about the profit prospects. She may want to inspect the product and receive a detailed description of your production plan as well as a detailed estimate of expected costs and revenues. She may even want to talk with prospective customers. Note that each investor must (1) save and (2) bet on her business judgment. The prospect for profit provides the incentive to do so. If her judgment is correct, she will earn profit. If she is wrong, she will incur a loss.

Knight recognized that the crucial characteristic of the private property system is that it enables people to have confidence that if they earn money by lending or investing in business, they can keep it. And if they use money to buy goods, they can keep the goods. Thus, they have an incentive to bet on their judgments about how their actions can enable them to earn income by producing wealth for others.

Few people have been able to describe the fundamental characteristics of the private property system as skillfully as Knight. Largely as a result of descriptions like his, practically every economist today recognizes that this system leads to a greater amount of what ordinary people call wealth than a centrally planned socialist system. Nevertheless, several objections have been made against the private property system. In this subjection, we discuss several of these.

First, it may objected that the system allows people freedoms that they should not have. A religious conservative, for example, may object to some types of goods or to the legal right to advertise certain products. He may want such goods and advertising banned. Economics has nothing to say about which goods are "good" or "bad" from a moral point of view. It can, however, help us predict the effects of efforts to regulate. Consider for example attempts to regulate the supply and use of recreational drugs. A law that subjects convicted drug producers and sellers to high prison sentences provides incentives for individuals to form criminal enterprises in order to reduce the expected costs of being caught and punished. It also provides incentives for corruption since bribing the police, judges, or punishment administrators are also means of reducing the expected costs. Another effect is that people for whom the expected costs due to punishment are high get replaced by others for whom such costs are low. Since juveniles are treated less unfavorably by the police, courts and corrections than adults; a disproportionate number of juveniles are likely to engage in criminal enterprises. Finally, such a law is likely to increase the number of property crimes committed by drug addicts. The reason is twofold. On the one hand, such a law is likely to increase the price of drugs, thereby raising the gains to such crimes. On the other hand, imprisonment is a means of "kicking the drug habit." Accordingly, drug addicts face a lower cost of punishment for other crimes like burglary and robbery than non-addicts. In short, compared with street killings, untrustworthy police, and the increase in property crime to get drug-buying money; allowing freedom of drug use may be the lesser of two evils, even for those who regard recreational drugs and their use as bad.

A second objection to the private property system is that it exposes people to great risk. People who do not know how to avoid poor investments or how to protect their money from con artists are bound to suffer unexpected setbacks. There are three parts to this argument. The first part is not important, since the risks are due to the uncertainty about which people and methods of production are best for satisfying wants. So long as citizens wanted such people and methods of production to be identified and used, they would have to set up some kind of system to produce this information. It is difficult to imagine how government officials could produce such information more effectively than private investors. The investors have a much greater incentive to avoid wasting resources.

The second part is that those with greater foresight and/or are lucky will succeed and earn profit; those who lack foresight and/or are unlucky will lose money. This is true. However, it is not the end of the story. Those with greater foresight will benefit others by producing goods for them that would otherwise not be produced. They will also discover new and lower-cost methods of production. In the future, these methods will be available to everyone who can understand them. Finally, because they earn profit they will be encouraged to repeat their performance. Those with lesser foresight will not benefit others because they will withdraw resources from places where they are worth more to their losing investments. They will also be discouraged from continuing. But they will not cause old and higher-cost production methods to be employed. Thus, while it is true that less competent investors will lose, their losses will be more than compensated for by the gains to the more competent plus the gains to the users of the products and to other people in the future.

Bill Gates became a billionaire because he started and directed the biggest software producing company in the world. In the process, other upstarts incurred losses. However, if we could add up the money benefits to consumers who used his software and to others who benefitted from the lower costs or higher quality products due to producers' use of the software, we would find that they are many times that earned by Gates. Moreover, the technology has changed forever. Hardly any citizens in a computerized society would want to return to the pre-computer age.

The third part is that people will be swindled. This is true. However, people will be swindled no matter what kind of system is set up. Second, in most systems, swindling can be dealt with by anti-swindling laws or courts that allows a swindled party to sue for compensation due to swindling.

People who object to the private property system because it harms less competent investors would like either to stop private investment entirely or to insure investors against losses. This is possible, of course. However, it could not be accomplished without reducing the profit to shrewd investors and, in the process reducing the amount of in shrewd investment. This would be accompanied by a corresponding decrease in the production of what ordinary people regard as wealth.

A third objection is that people who are naturally limited in their money-making skills will fare badly relative to their more skillful competitors. This, of course, is true. But this fact does not support the claim that a communal property system or centrally-planned socialism is better. Any system in which people are rewarded according to their talent will enable the more skillful to earn higher rewards. In addition, we should keep in mind that, on the whole, people are kind and considerate to some degree. Those who are extremely lacking in talent can usually earn the compassion and charity of others. Also, charity in a wealthy society has a lower cost in terms of what the giver must sacrifice.

Some observers confuse the private property system with gangsterism. Observing countries that have transformed from socialism to capitalism, they see new gangs of extortionists and thieves. They suggest that these are the true characteristics of the private property system. They do not realize that such activities actually violate the system. Gangsterism is not caused by private property. It is due to the fact that private property rights are only partly present. The shift from socialism to capitalism is incomplete. Of course, a complete private property system is not possible. Nor is it desirable, due to the high cost of enforcing all of the necessary private property rights. The issue here is one of degree. Gangsterism is a sign of a system in which gangsters can take for themselves some of the wealth that would otherwise to producers. It is present to some degree even in the more advanced capitalist systems.

Other observers confuse the private property system with imperialism and colonialism. Imperialism and colonialism are consequences of the aims of emperors and government leaders to acquire the rights to use resources that are either owned by others or for which ownership rights are not yet established. First consider efforts to acquire rights that belong to others. When one person takes the rights of another by force or theft, her action is not part of the private property system. It is a violation of the system. Extortion and theft are the antithesis of actions under the system. Kings or politicians who direct the appropriation of property or work from other human beings are thieves or extortionists. Now consider efforts to acquire rights when they are not yet established. Because the rights have not yet been established, such efforts are not part of the private property system either. However, since the consequence is a private property system, the ultimate result is likely to be a greater production of what ordinary people call wealth than there would have been under an alternative system.

So far we have only been concerned with private goods. We now consider "public goods." The incentives for individuals to provide wealth in this form under a private property system are different from those to provide private goods. To understand why, we must first understand the characteristics of public goods.

Jointness: if one person consumes a good, another can consume it simultaneously without greatly increasing its cost of supply or changing the first person's satisfaction.

Public goods have two characteristics that distinguish them from private goods. First, they have the property of jointness in consumption, or non-rivalry. Jointness means that if one person consumes a good, another can consume it simultaneously without greatly increasing its cost of supply or changing the first person's satisfaction. If one person is watching an opera, a second could ordinarily also watch it without greatly interfering with the satisfaction of the first. The second characteristic is nonexclusion. This means that if one person is consuming a good, a second cannot be excluded from consuming it. Opera houses can easily exclude people who do not buy a ticket. However, consider a lighthouse that is used to warn ships of a dangerous coast. If a shipping company builds a lighthouse for its ships, it cannot easily exclude the owners of other ships from enjoying the benefits because it cannot own the sea.

Nonexclusion: if one person is consuming a good, a second cannot be excluded from consuming it.

To understand the effects of jointness and nonexclusion in the extreme, economists imagine a pure public good. This is a hypothetical good that can be produced for everyone in the society to enjoy at the same cost that would be incurred if it was produced for only one person. It is also one for which the cost of exclusion is prohibitive. It is impossible to exclude. There is no such thing as a pure public good. Nevertheless, if we analyze it carefully, we can better understand the special problems due to jointness and nonexclusion.

The private property system does not provide the same incentives for pure public goods as it does for private goods. To see why, we discuss each of the characteristics in greater detail.

The main problem due to jointness is that the consumers have a low incentive to reveal their preferences. To see this, we begin by showing the incentive to reveal preferences for a private good. Put yourself in the shoes of someone who is thinking about buying a private good that has not yet been produced. You believe that you are willing to pay a price that is higher than the costs of production to some producer. However, because you are not a prospective producer, you are uncertain about the production costs. So you approach a producer and ask him if he is interested in making a deal. You probably will not tell him the maximum price you are willing to pay. On the other hand, in order to persuade him to do the research needed to determine his costs, you must convince him that you will probably be willing to pay a price that is higher than his costs. Thus, you must partially reveal your willingness to buy the good. In other words, you must partially reveal your preference. You have an incentive to do this because you expect to gain from exchange.

We could shift the first contact from you to the producer, but this would not effect the results. For example, if the producer was the first to believe that a mutually profitable exchange could be made, he may first approach you and ask how much you are willing to pay. Again you would probably not reveal your maximum price, but you would have an incentive to reveal a high enough price to keep him interested.

Now consider a good with the jointness characteristic. Suppose that you are one prospective consumer of the joint good. You believe that the collective benefits are greater than the production costs. It would not help you very much to approach the producer and tell him this. You would first want to convince other consumers to also reveal their preferences. Your chances of success are not very high. We can see this by taking some other consumer's point of view.

Suppose that you ask another consumer, me, to join with you. You tell me your plan to ask others to join us so that we can reveal a collective preference to a producer. You hope that together we can persuade the producer that it is profitable to supply at a collective price that is acceptable to us. Now if I agree, I will have to make some commitment to pay for the good in the event that it is supplied. I may not need to tell exactly how much I will pay. But I must convince you that I am willing to pay some amount. So I face two alternatives. First, I can make a commitment to buy, in which case I will certainly have to pay if the good is supplied. Second, I can not make a commitment, in which case I will certainly not have to pay whether the good is supplied or not. Looking ahead, I realize that if enough consumers make commitments that are high enough, they will have a good chance of persuading the producer to supply. However, you and the others may be able to persuade the producer without me. If so, I can enjoy the benefits of the good without paying anything. I realize that my commitment may increase the probability of persuading the producer. However, it will only do so by a small amount. Under these circumstances, I may decide not to make a commitment.

Of course, if every consumer decided not to make a commitment to pay, the good would never be provided. So my decision will be based partly on what I predict others will decide. The point we want to make is that for almost every set of decisions that I assume others will make, my best strategy is to not join with you.

Another way to understand this is to think about who receives the benefits and who pays the costs of discovering and revealing one's preferences. If you reveal how much you want a public good by making a commitment, you must pay the producer if he supplies. But others reap most of the benefits. They are "free riders." The incentive to reveal preferences is lower in the case of goods with the jointness characteristic because each person has some incentive to be a free rider.

The jointness problem: the incentive for demanders of a joint good to reveal preferences is lower because each person has some incentive to be a free rider.

If the problem is a lack of knowledge about each others' preferences, why can't the consumers get to know each other better, perhaps by attending a meeting? Sometimes they can. However, there is a free rider problem in organizing such a meeting. Suppose that you organize a meeting to discuss preferences for a public good. You would have to pay the costs of announcing the meeting, finding a meeting place, setting up an agenda, and so on. But most of the benefits of the meeting, if it is successful, would go to others. They would be free riders. Of course it is possible that consumers with especially high demands for the good would be willing to incur such costs. Also the consumers of a particular public good are sometimes members of a club that already exists. A proposal to use club funds to finance a public good may be introduced and voted on at a relatively low cost. But these cases are exceptions. Perhaps a more likely partial solution is that a producer who believes he can earn a profit has an incentive to make it easier for prospective consumers to meet. If he is optimistic enough, he may even agree to finance a meeting. He may provide an advisor to explain the free rider problem to consumers and to suggest ways to circumvent it.

If we adopt the free rider terminology, we could say that the difference between a private good and a joint good is this. Whereas the consumer of a private good has an incentive to find out and reveal his preferences for goods when he thinks that the benefits are greater than the costs, the consumers of a joint good face the free rider problem.

Now consider nonexclusion. We can gain some insight into the problem by supposing that some familiar non-joint good has the nonexclusion characteristic. Take an apple. Suppose that an apple has the nonexclusion characteristic. Then if you produced it, everyone would have the ability and right to eat it. You might think at first that under these circumstances, your incentive to produce would be very low. If you could not stop consumers from eating your apples, how could you profit from producing them? The answer is not as simple as it seems.

One way for you to solve the incentive problem is to decide not to produce any apples unless consumers agree to pay for your action in advance. The effectiveness of this depends on the how many people might want to take apples from you after you produced them. Suppose that only one person, an apple-lover, likes apples. Then if you expected to produce ten apples and also that the apple-lover would take and eat them, you could inform him that you would not begin production until he paid you in advance for them. Following the production, you promise to deliver the apples to him. So long as you are trustworthy and the contract is enforceable, you could make a contract that would give you an incentive to produce.

If there are many apple lovers, the situation is different. In this event, you cannot make a reliable promise to deliver apples because any one of them may take them away from you before you have a chance to deliver. The only way to overcome the problem is for all the prospective takers of apples to agree to allow you to keep the apples you produce until you deliver them to the people who have ordered them. This solution amounts to a collective decision to create private property rights in apples. Accordingly, the scenario we have in mind is one in which the collective solves the incentive problem by creating a system of private property rights in apples. Recognizing this helps us see that if there is an exclusion problem in the case of non-joint goods, the problem is due to the absence of private property rights.

Let us compare this arrangement with the one that would exist when exclusion is possible. If you could exclude everyone, you would be the sole owner of the apples you produce. To obtain apples, a person could either pay you in advance for apples to be delivered later or she could wait until the apples were produced and then offer to buy them. If she waited, she could avoid some of the uncertainty due to a possible change in her wants and possibly also due to some change in production conditions. When there is a nonexclusion problem and private property rights cannot be created by contract to overcome the problem, waiting until you produce is not an option. The only way to give you an incentive to produce is to pay you in advance. In this situation, a consumer cannot avoid bearing uncertainty about her wants, although she can avoid uncertainty about production conditions. She can do this by demanding a contract in which you agree to pay compensation if you do not deliver as you promised. In addition, payment in advance is ordinarily a costlier way to arrange a sale. Because a consumer cannot be certain that you will keep your promise to deliver, she would have to monitor your actions. Beyond this, if you failed to deliver, she would have to seek compensation in court. We conclude that the difference between the exclusion and nonexclusion situations, in the absence of jointness, is that in the latter, buyers would have to bear additional uncertainty and to incur monitoring and court costs.

Nonexclusion problem: the characteristic of nonexclusion, in conjunction with jointness, may lead to inefficiency for three reasons: (1) high collective decision-making costs to consumers of agreeing to pay a producer for his supply, (2) a free rider problem in monitoring, and (3) a free rider problem in the enforcement of advance sales contracts.

Let us turn now to a joint good, like the lighthouse. Similar reasoning would apply. The producer of a lighthouse would be concerned that after the lighthouse was built, shippers would simply "tak e" the lighthouse services without paying. As in the case of the apple, he could try to avoid the problem by deciding not to produce until a sufficient number of shippers made an advance purchase contract with him. However, whereas it is a simple matter for a consumer of apples to agree to an advance contract, it would be a different story for a large number of shippers. They would face rather high costs of making a collective decision. In addition, they would have to bear the uncertainty that after the agreement was made, their wants or the conditions of production would change. They could avoid production uncertainty by making a contract in which the producer agreed to pay compensation if he fails to deliver. However, they would still face a free rider problem in monitoring whether the lighthouse had been built to specifications. And, if it had not, they would face a free rider problem in taking the producer to court.

Thus we say that nonexclusion may lead to inefficiency when jointness is also present for three reasons: (1) high collective decision-making costs to consumers of agreeing to pay a producer for his supply, (2) a free rider problem in monitoring, and (3) a free rider problem in the enforcement of advance sales contracts.

It is important to realize that the public goods characteristics reduce the incentive to discover public goods and the means of producing them. Suppose you are the first to have an inkling that the collective benefits of producing a particular good are greater than the costs. Because you know that the good has the characteristics of jointness and nonexclusion, you may decide not to follow up your belief. Indeed, you are not likely to be alert to possible net benefits from producing public goods in the first place.

Among non-economists, there is a tendency to underestimate the ability of the individuals to invent ways to solve jointness and nonexclusion problems. Take the case of Hume's meadow. Hume assumed implicitly that the meadow is communal property with unlimited access, as described at the beginning of this chapter. He also assumed that shepherds would always be able to use a newly-drained meadow without paying a fee. In a system of private property, these assumptions must be changed. If one person could acquire a clear title to the meadow, he could personally invest in drainage and then charge a fee for allowing others to use the drained meadow. In order to transform such property from communal to private, the government would have to protect a private owner's right to exclude others from using his land. Moreover, the private owner would have to be able to monitor the use of the meadow at a reasonable cost. Monitoring the meadow's use would not be necessary if a collective agreement could be reached to drain it.

Even if the meadow cannot be owned, it may still be possible for a private party to earn a profit from draining it. In a private property system, after the meadow is drained, the property near the meadow would increase in value. A clever businessperson could put together a fund of money and buy up all the land around the meadow before it is drained. Then he could drain the meadow and resell the land. Some bridges, dams and roads have been built by private land developers who acquire title to much of the land that people must use to benefit from such things. After a developer builds, he sells the property to private landowners. When a sufficient amount of property has been sold, he turns over the bridges, dams, and/or roads to a homeowners' association or local government.

If you think that buying up the land would require too much money, consider an alternative. A land speculator could approach each of the landowners and offer them a payment in exchange for a share in the future capital gains in the land. For example, he says: "I will agree to compensate you for any decrease in the value of the land if you agree to pay me a sum of money equal to any increase in land value." Suppose that you are a landowner. Assuming that you have no reason to expect land values to rise or fall, this is a no-lose proposition. It is like free insurance against the possibility that your land would fall in value. If there is an increase in your land value, you will have to pay the speculator. But you can easily do that out of your increased wealth.

It is also true that many goods and services that have general benefits would be supplied because they have great value to particular individuals. A wealthy person may build a park and allow others to use it for recreation either because he enjoys living near a park or because he enjoys making people happy. Another source of funds to support the private supply of public goods is advertising. Newspapers are written and given away or sold at low prices because advertisers wish to communicate with large numbers of potential customers. Publishers collect most or all of their fees from advertisers instead of from subscribers.

In the case of goods with public goods characteristics, the wisdom of government intervention must be determined on a case-by-case basis.

Even if we think that there is only a small incentive for private individuals to supply a public good, we shall see later in this book that governments are not particularly efficient either. The market may be inefficient but the government may be more inefficient. The point we want to make here is that each case must be considered on its own merit. Without a rather complete understanding of the incentive to provide public goods in a private property system, the nature of the good under consideration, and the prospective failure of government; we should not jump to conclusions.

There are many goods that have the characteristic of jointness but for which exclusion is not a serious problem. These include theaters, long-distance highways, bridges, and international airports. Such goods can often be supplied with a tolerable degree of efficiency by private companies. Private owners can charge user fees that generate enough revenue to pay for the production and maintenance of the good. Consider the example of a theater. Because the costs of exclusion are small (one only needs to enclose the stage or screen and limit the entrances), economists do not usually see much advantage in having the government supply theater performances.

A pure case of a joint good that is excludable is one for which the costs of adding another user is zero and the cost of exclusion is zero. There are no pure cases. However, there are cases in which these costs are very low as compared with the cost of supplying units of the good itself. In all such cases, perfect efficiency cannot be achieved. The reason is that perfect efficiency requires the public good producer to charge different consumers different prices (i.e., to price discriminate).

Consider the supplier of swimming pool services. If we neglect the external costs due to the congestion added by a new user, the cost of adding one more swimmer is practically zero. Assume that the swimming services supplier is completely unable to discriminate in price. He must charge the same price to everyone who uses the pool. Assume further that consumers differ in the amounts of money they are willing and able to pay for the services. Now consider a price in the middle range. If he charges this price, some consumers with high demands would be willing to pay a higher price for the service. However, if he raised his price; he would lose too many middle-demand buyers. It would not be profitable. His revenue would be lower than if he charged the lower price.

Now consider the consumers whose demand is lower than the middle range price. He could increase the number of consumers by reducing his price. Because the marginal cost of supplying additional consumers is zero, it might seem like he could increase his revenue in this way. However, he must also reduce his price to the higher demand buyers. As a result his loss in revenue due to the lower price may be greater than the gain in revenue from the greater number of users. So he may decide not to reduce his price and increase the number of consumers even though the marginal cost is lower than the value of the swimming services to the additional consumers. This is inefficient.

If demands for use differ for different times of day, week, or year; there is an additional problem. Suppose that a single price is charged no matter when the good is consumed. Then, during periods of "peak demand," there may be a congestion, or crowding, problem. Efficiency requires that the owner charge an extra price to take account of the congestion cost that each person imposes on others. This means that the price should be higher during peak demand periods than during other periods. On the other hand, during off-peak periods, there is excess capacity in the sense that the cost of supplying additional consumers is near zero. The price should be reduced to the additional consumers in order to gain their contribution to total revenue.

Usually the supplier of a joint good can price discriminate in part. For example, a swimming pool owner can establish special deals for groups. He can set aside times during which the pool can be rented exclusively to a limited number of high-demand groups. Similarly, he can set aside off-peak periods for low-demand groups, which he charges special, relatively low prices. In the case of the theater, the owner can offer discount prices to students and the elderly. However, his discrimination is limited because he cannot easily tell the difference between low and high demanders. We conclude that the supplier of a joint and excludable good may be able to vary his price in some measure. But perfect price discrimination -- and, therefore, perfect efficiency -- is impossible.

Long-distance highways, bridges and airports are somewhat like theaters. It is relatively cheap to exclude users. But they differ in an important way. A movie house can be built practically anywhere and at practically any size. Highways, airports, and bridges often require the purchase of large tracts of neighboring, or contiguous, land from different owners. Suppose that the road requires 100 hectares of land. An investor cannot simply buy any 100 hectares. He must buy land that is contiguous. If parcels of this land are currently owned and used for different purposes by many different individuals, there may be a free rider problem associated with purchasing them.

The contiguous property problem: a producer of a good that requires contiguous property expects that once she buys some of the property needed to produce a good or service, the remaining sellers will engage in hard bargaining, thereby increasing her cost of supply so much that an otherwise profitable project will become unprofitable.

Suppose that you are a private entrepreneur in a pure market economy and that you are thinking about building such a highway. You plan to earn revenue by charging a toll to users. You estimate that the current market price of the land plus the construction costs and other expenses are low enough that the tolls you collect will enable you to make a profit. So you begin to buy the necessary land. As you buy more and more of it, the remaining owners come to realize what you are planning. They calculate that, because you have already bought some land, the remaining land is more valuable to you. So they engage in hard bargaining. Their bargaining may be so tough that you would end up making a loss on your investment. If you anticipate such a reaction, you would decide not to embark on the project in the first place.

As a highway investor, you may attempt to avoid this problem by offering a fixed amount of money for all of the land. This would encourage the landowners to have a meeting in order to try to collectively resolve the bargaining problems. However, there is no obvious reason to believe that they could reach an agreement. And even if they could, the cost of doing so may be extremely high.

One solution is for the landowners to collectively hire a trustworthy agent and to agree to abide by her property appraisal decisions. Imagine a collective of owners of contiguous, potential highway land. A prospective buyer announces that he is willing to pay a substantial price for the land but that he does not want to incur the risk of buying the land one piece at a time. He tells the owners that if they can agree on a single price for all the land, he will consider it. Anticipating a gain, the members of the collective may agree to hire a highly respected and reputable agent. They instruct the agent to appraise the land and, afterwards, to add, say, twenty per cent to each appraisal. They each agree beforehand to sell at the appraised price (plus the twenty per cent).

In practically all countries, government agents have the power to seize land to build highways, bridges, etc. Typically, they pay compensation for land that is taken from private owners. In many cases, like the U.S., the payment of compensation is mandated by the constitution. Given the costs of reaching an agreement, it is possible that such a system is better than waiting for an agreement to be made in the private market. On the other hand, some members of a collective may not wish to give anyone the power to take away their land out of fear that the power will be used against their interests.

The contiguous property problem provides an economic justification only for the purchase of property. It does not justify the government's building of the highway, bridge, airport, etc. or its owning and operating these businesses. The usual justification given for government ownership and operation is the natural monopoly -- or public utilities -- argument. We discuss this in greater detail in the next section.

So far, we have only discussed those instances of market failure that result from non-exclusion and jointness. In this part, we introduce other kinds of market failures and show that many people would benefit if a government policy could overcome the failures.

Collusive monopoly: two or more otherwise competing sellers agree to cooperate to increase their profit by restricting consumers' choices. A collusive monopoly cannot succeed in the long run unless colluders have talents or resources that their potential competitors cannot cheaply obtain.

Suppliers of a particular good may join forces and, as a result, make consumers worse off than they would be if the suppliers competed. Oil producers who conspire to limit supply and raise price are an example. When this occurs, the situation is called a collusive monopoly. Collusive monopoly is mostly a temporary problem. If a country truly has a market economy, everyone is free to compete with the conspirators. Because of this, the collusive monopoly can only be successful in the long run if the colluders have talents or resources that potential competitors cannot cheaply obtain. But talents can be produced and resources can be discovered and invented. For example, if the only two doctors in a small town conspire to raise prices, another resident can decide to study medicine. Assuming that he acquires the talent, he can ultimately force the conspirators either to compete on price or to accept him as a new member with whom they must share their monopoly profit. In the case of collusion to raise oil prices, high oil prices encourage (1) exploration of new fields, (2) the extraction of oil that was previously regarded as too costly to extract, (3) new methods of exploration and extraction, and (4) substitutes.

The monopoly problem: a monopolist has an incentive to charge a monopoly price -- one that is higher than his marginal costs of supplying.

The common sense of the monopoly problem is that a monopolist has an incentive to charge a monopoly price -- one that is higher than his marginal costs of supplying. To best understand how monopoly can be inefficient, let us take the extreme case of a vital resource. Suppose that only two people own parcels of land that contain a particular kind of plant. The plant cannot be produced elsewhere and there is no possibility of duplicating its properties artificially. The plots of land on which the plant is located have negligible value for any other use. One day, quite by accident (i.e., luck), someone discovers that the plant can be used to cure people of a crippling disease. The amount of the plant currently available on the two plots is large enough that everyone who has the disease could be cured. Realizing that competition would cause a low price, however, the two landowners join together in order to maximize their joint profits.

In this circumstance, the more wealthy of the diseased people would be willing to pay high prices. However, poorer people could only afford to pay low prices. Unless the landowners could discriminate among the consumers in price, they could maximize their joint profit only by charging a price that would exclude the low-demand (and, in this case, poor) consumers. If they did this, however, the plant would be used inefficiently. We have assumed that the cost of supplying the plant is very low. Yet the landowners would charge a price that excludes many people who would be willing to pay the low additional supply cost.

A possible solution to this problem would be for the government to buy out the landowners and then offer the plant for a low price. Another solution would be to create a communal right to the plant -- i.e., to take away the owners' private property rights. Alternatively, the government may only take away part of the landowners' rights by demanding that they sell the plant at an "affordable price."

The government policy that is typically recommended to correct for market failure due to the collusive monopoly problem is to force the colluding sellers to cease their action and to pay a fine and/or compensation to consumers who were harmed. If this policy could succeed, all the consumers of the product would benefit from the reduced price and/or compensation. In addition, the incentive to charge a monopoly price would fall.

Under the conditions of the pure market economy, relatively permanent monopolies are always due to the fact that the monopolist possesses some specialized resource or ability to use it that potential competitors do not share. If this was not true, there would be competition. The question we must ask is how the monopolist came to possess this resource or ability. In the pure market economy, there are three possibilities: collusion, luck and initiative. A person may exercise initiative by discovering or producing a superior ability or by discovering a new good or method of production. We have already discussed collusion. We focus here on luck and initiative.

To say that a monopoly is due to initiative, as opposed to collusion, means that the person or persons who possess the monopoly has invested in some activity that has enabled them to gain control over a resource or good that others cannot copy cheaply enough to become competitors. One example is an investment in discovery, like the discovery of new natural deposits of a rare metal. A second example is investment in the invention of a new product or method of production.

If a monopoly is due to luck, a variety of possible policies may be adopted in order to overcome the monopoly problem. However, if the monopoly is due to initiative, the monopoly profit is really a reward for the initiative. To block it would take away the incentive to exercise the initiative. The policy goal should be to preserve the monopoly profits in the face of competition from copiers.

Government anti-monopoly policy often discourages research and investment in new products and methods of production.

It is often not easy to judge whether a monopoly is due to luck or initiative. If government agents were assigned the task of making such a judgment, it is reasonable to expect that they would make at least some mistakes.

As a result, compared with the ideal of a government that always makes correct decisions, real government intervention often discourages at least some future discoverers from making what would otherwise be investments that benefit consumers.

Even if the government allows a person who achieves monopoly through invention to keep the monopoly profit he earns, the incentive to exercise this initiative may be insufficient. This is because a large proportion of what would otherwise be his rewards may go to copiers who sell at lower prices and to consumers who are able to buy at the lower prices. A government policy that may help to raise this incentive is the granting of special monopoly privileges. One way to encourage invention is to grant a patent. A patent right makes it illegal for any other firm to use the invention without the permission of the producer. The right is usually limited to some number of years. (In the U.S., this number is 17.) If effective, a patent may enable all the consumers who are willing and able to buy a product to benefit since, in its absence, no one may have produced the product or sold it at such a low cost.

To provide incentives for individuals to produce a copyable piece of research, educational material, entertainment, or work of art; the government can award a copyright. The copyright is similar to the patent in that it gives the producer a monopoly for some number of years.

A trademark is an exclusive right to attach a distinguishing label to a product. A system that protects trademark rights may provide incentives for a producer to distinguish his product from that of a competitor by, say, maintaining a higher quality standard. Imagine that there are two competitors who produce a product that looks identical to the typical consumer. However, the quality of producer A's product is objectively superior to that of producer B. The problem is that because consumers cannot tell the difference between the two, they are unwilling to pay the higher price for A's product. A could try to distinguish her product by putting a special company mark on it. However, if there was no government-protected trademark system, the low-quality producer could merely copy this by putting the same mark on his product. A trademark law enables a producer to block this by registering her mark with the government. Once the mark is registered, copying is illegal. By means of a trademark law, the government can provide an incentive for firms to distinguish their quality or brand from that of their competitors. The result is that it increases the range of consumer choice. A person who wants high quality or some other characteristics and is willing to pay for it can be more assured that his purchase will indeed result in the higher quality, etc. On the other hand, a person who is willing to accept lower quality at a lower price can also have her demand satisfied.

In some lines of business, competition may not be possible in the long term. Examples that are usually cited are the "public utilities" – water, power, sewers, a city subway system, etc. Such cases are called a natural monopoly because it is assumed that out of some initial competition, only one supplier would survive and thus would have a monopoly. Once the monopoly was achieved, the monopolist would have an incentive to increase profit by restricting consumer choice by, say, raising the price higher than his marginal costs. In this case, no collusion would be necessary for monopoly inefficiency to be present.

Natural monopoly: competition would lead to the survival of only one of the competitors, who would have a monopoly and restrict consumer choice.

It is important to realize that the fundamental problem of monopoly is not that there is a single seller but that the seller charges a price that is higher than his cost of supplying service to low-demand buyers. Consider the case of mass transit by means of a subway system. The owner of an unregulated private company that supplied mass transit could probably discriminate in some measure. For example, she could offer discounts to the elderly and students by checking their ID cards. And she could vary her price according to the time of day, week, and season of the year. But she could not discriminate fully. As a result, she would sometimes exclude some low-demand buyers who are willing to pay more than her cost of supplying them with service.

Thus, the natural monopolist charges a price that is higher than her additional costs of supplying some customers with service. If she could discriminate fully, she would offer services to everyone who values the service more than her marginal cost. But she cannot fully discriminate in price.

The inefficiency of natural monopoly not only applies to natural monopolies that already exist. It also applies to natural monopolies that have yet to be established. For example, it may be efficient in the economist's sense to build a mass transit system. However, because a private company cannot use price discrimination, it may judge that its future revenue will be less than its future costs. Thus, the inability to price discriminate may delay the initial building of the system beyond the most efficient time.

In the case of a natural monopoly that already exists, economists often advise the government to force the monopolist to reduce her price to the point where she could only make an ordinary profit. Another possible solution is a government takeover.

If the real world were like the economic models, these policies might be reasonable. But it typically is not. First, what may appear initially to be a monopoly industry may not be one at all. Examples are various transportation services like trains, busses, ferry services, roads and bridges. Although there may be only one train company, etc., that company may face strong competition in the long run from other forms of transportation. To regulate the profits of one form of transportation may put it at a disadvantage vis. a vis. another form. It would inhibit development of what might otherwise be a more efficient mix of transportation services. If we view a particular transport company as one firm in the transportation industry, we may be inclined to describe the industry as competitive.

Second, some services are monopolies not because they are natural monopolies but because the suppliers have special privileges. The law may permit only one electric company to use the electric lines, one water company the pipelines, one TV company the cable, one telephone company the telephone lines, one waste water treatment company the sewer system, and so on. Such laws may have been useful in the past to encourage the initial investment. But today they may prevent other companies from using the property on which the lines or network are located and/or from building their own networks. If the government takes away the special privileges to use common transport or communication networks, either the monopoly might disappear or regulation might not be necessary.

In some situations, an economic case can be made for the government's building the networks or contracting out their construction. But, after the networks are built, the government can avoid the monopoly price by auctioning off the right to operate a monopoly. To understand how, consider the long-distance highway. Imagine that the government acquires the highway land by paying its current owners the appraised value of their land plus some percentage. Next it asks for competitive bids from contractors to build a highway on the land. It awards the contract to the lowest bidder and proceeds to authorize the highway to be built. It pays for the land and the highway by issuing long-term government bonds. Finally, instead of operating the highway itself, it auctions off, say, a 10-year right to operate it. The buyer of that right would be permitted to exclude any users who did not pay the prices he sets. Assuming that the demand for highway services is high relative to the administration cost, the auction price would be high. The money received from the auction could then be used to pay off the long-term bonds. If any money was left over, it could be used to reduce taxes or to help provide other government services. This would not completely eliminate the monopoly inefficiency. However, when we find out later in this book about government inefficiency, we may feel that it is the best of the alternatives.

The basic principle regarding alleged natural monopoly is relatively simple. Before we accept the argument that X is a natural monopoly, however, we ought to do a careful evaluation, since each case is different. Natural monopoly is discussed further in Chapter Eighteen with particular reference to public utilities.

Externality refers to a harm or benefit that one person confers on others. We are not concerned with the case where only one person is the victim (negative externality) or beneficiary (positive externality). Problems in these cases are best solved by negotiation or by resorting to traditional methods of resolving disputes, like the civil courts. Moreover, we are not concerned with positive collective externalities, since these have characteristics that we associate with public goods. Our interest here is in negative collective externalities.

Negative collective externality problem: the sum of the harm due to an action exceeds the net gain from the action.

The typical examples of negative collective externalities are pollution and congestion. It is important to realize that some amounts of pollution and congestion are economically efficient, since the benefits associated with the actions that cause them are greater than the sum of the individuals' harm. Negative collective externalities are sources of inefficiency when the sum of the individuals' harm exceeds the net gain of the action that causes them. In the case of pollution, this situation may exist because certain scarce resources like clean air and mountain water are communal, unlimited access, property. Congestion of roads, parks, etc. is also due to their communal property characteristics. When there is communal property, market failure arises because of the high costs of working out an effective bargain in which each person would agree to use less of the scarce communal resource.

A change of ownership can sometimes eliminate a negative collective externality problem.

Often the collective negative externality problem can be solved by changing the ownership of the property. A fishing lake that is owned collectively, for example, can be auctioned off to the highest bidder. The bidder would then have an incentive to restrict fishing so that there is an optimum yield. The same kind of solution can be used to avoid excessive deforestation (i.e., the cutting down of young trees to make wood products). It could not completely solve the problem of climate change or a global ozone layer problem due to deforestation, since the communal resource (i.e., the ozone layer) in this case cannot, under current technology, be privately owned.

The economic theory of government in this book is the theory of the demand for and supply of agents to make decisions relating to the supply of public goods and to the correction of other types of market failure. Whenever agents are hired, it is reasonable to expect that members of the collective would be concerned about their competence and honesty. Demanders of private goods are also concerned about competence and honesty when they hire agents to buy or to supply private goods. To help show the difference between private goods and goods with public goods characteristics, this section compares the use of agents in two cases: that of an individual buying a house in the private market and that of a collective buying national defense.

Suppose that you want to buy a house. You can make all the arrangements yourself or you can hire an agent. If you are not very good at finding a seller, determining the quality of a house, or judging a seller's willingness to sell, you may seek help from a real estate agent. You know that you will have to pay a fee. However, you believe that the benefits exceed this cost. (In some places, the market for real estate agents is highly regulated. Since our analogy will be best if we assume a purely private market, we assume here that there is no regulation.)

Because you know little about houses, you must trust your agent to give you accurate and useful information about the possible houses you can buy. Realizing this, you may seek out someone who you already know; or you may ask a friend to refer you to an agent that he trusts. However, even if you choose an agent you do not know, you would still have a reason to trust her. In a market economy, she faces competition. If she performs inadequately or cheats you, she will have to worry about others finding out. If others learn about her bad service, her future profits will fall. To be successful in a free real estate market over time, agents must build their businesses on their reputations.

Of course, there is still some chance that you will be cheated. Some people are particularly skilled at victimizing unwary buyers. Unqualified and dishonest people can become agents temporarily. If you are wise, you will try to select an established seller who has invested heavily in building a good reputation, since such a seller has the most to lose from cheating you. You can also let the agent you hire know that you are keeping an eye on her and that you will tell your friends about her service.

Compare this with the collective purchase of a similar service through the legislature. An example is national defense. Military strategies are extremely complex.

Most people are uncertain about the weapons that enemies might use to attack and about the weapons they might use to repel those attacks. They are similarly uncertain about the likelihood that different countries will attack. Moreover, even if they knew these things, the ability to defend against attacks depends upon secrecy. People cannot require their defense strategists and researchers to reveal their strategies and research without giving potential adversaries an advantage. The ultimate consumers of national defense services are very much like the ordinary house buyer, since they are not very good at measuring the quality of national defense. Also like the house buyer, they cannot know the appropriate price to pay. Thus they have a demand for agents to advise them and to make decisions about supply.

But the use of agents in this task differs from the purchase of agent services in the market economy in an important respect. We can refer to it as the collective monitoring problem.

Although the house buyer cannot be certain whether the real estate agent is providing the service he has contracted for, he has an incentive to select an established agent, to watch over the agent, and to threaten punishment if she violates his trust. In more formal terms, the house buyer has an incentive to expend resources on monitoring up to the point where he believes that his marginal benefit from additional monitoring no longer exceeds his marginal cost. Even with the optimal expenditure of monitoring resources, incompetence and fraud are possible. But this is the best the buyer can do under the circumstances.

People who purchase national defense services collectively also try to do their best; but their best is not so good. National defense services are typically purchased by legislators, who allocate part of the annual budget for this purpose. The benefit from monitoring a legislator is a collective one. In other words, the benefits must be shared with other taxpayers. They are like the benefits of draining Hume's meadow. As a result, we cannot expect efficient collective monitoring. Efficiency in the supply of monitoring requires that effort be expended in monitoring up to the point where the marginal collective benefit equals the marginal cost. Yet a member of the collective has an incentive to monitor only up to the point where the marginal personal benefit equals her marginal cost.

Members of a collective recognize the collective monitoring problem. As a result, they write provisions into the constitution to help deal with it. We shall see in Chapter Five that free speech, freedom of the media, and rights to inspect government documents and to attend government meetings help to overcome the problem. But we do not expect the same kind of efficiency as in the private market.

Thus we expect our agents to be deficient in their hiring of national defense contractors and in the supply of other services. We expect that once the contractors are hired, they will perform inefficiently because they also will be insufficiently monitored. And we expect that when abuses are discovered, suppliers will be inadequately punished.

1. Define jointness, non-exclusion, free-rider problem, natural monopoly, externality.

2. Tell the difference between a system of private property rights and a system of communal property rights.

3. Why can an economist never be certain that a particular situation is a example of a market failure in the future.

4. Tell the difference between the private property system in modern capitalist societies and in the image of the pure market economy.

5. According to Smith, how do the incentives that are present in a pure market economy to earn money give the economy wealth-producing power? (First, identify the incentives; second, tell how they cause the production of what ordinary people regard as wealth.)

6. By comparing a communal property system with a private property system, explain Adam Smith’s view of the consequences of a private property system.

7. By comparing a communal property system with a private property system, explain Frank Knight’s view of the consequences of a private property system.

8. According to Knight, how do the incentives that are present in a pure market economy to earn money give the economy wealth-producing power? (First, identify the incentives; second, tell how they cause the production of what ordinary people regard as wealth.)

9. Religious conservatives object that the market economy and the private property system permit the advertising, production, sale and use of goods to which people should not be exposed. Evaluate this objection according to the text.

10. The market economy and the private property system expose individuals to great risk from which people should be protected. Evaluate this argument according to the text.

11. The market economy and the private property system put individuals who are less skilled in making money at a disadvantage. Evaluate this argument according to the text.

12. Is gangsterism a characteristic of the market economy and the private property system? Explain.

14. Describe the "jointness problem" of a public good by comparing the buyer of a private good with the buyer of a good that has the jointness characteristic.

15. Assume that a good does not have the jointness characteristic. Compare two situations: (1) in which the good has the non-exclusion characteristic and (2) in which the good does have the non-exclusion characteristic. Tell the difference between these by referring to uncertainty about the future.

16. Explain why the nonexclusion characteristic of a good leads to greater inefficiency when the good also has the jointness characteristic than when it does not have this characteristic.

17. It is often costly to exclude users of goods like parks, bridges, roads and dams. Since these goods also have the jointness characteristic, some people believe that producers in the market economy have no incentive to produce them. On the basis of the discussion in the text, describe three ways in which individuals may overcome the public goods problem so that it would be profitable to cause such goods to be produced. [You must assume that it is very costly to exclude users.]

18. Consider a joint good that is excludable, like a theater performance or sports event. Even though producers in the market economy are often willing to supply such goods, the supply is not perfectly efficient. Explain why.

19. Describe the contiguous property problem. Use an example that is different from the one in the text.

20. If you wanted to profit from building a road (or airport), how could you overcome the contiguous property problem?

22. Should agreements among firms that produce the same or similar products always be discouraged by government policy? Explain.

23. Assume that a monopoly is not due to collusion. Then it may be due (1) to luck or (2) to the initiative of the monopolist. Disregarding the government failure that is discussed after Chapter Five, how should the policies toward monopoly be different for the two cases?

24. Under some conditions, a market failure would result if a firm could not possess a monopoly. Describe these conditions.

25. Why do economists use the term natural to describe the monopoly possessed by so-called public utilities like water, power, and sewer system producers.

26. Suppose that a region has only one bus company. Can we conclude that it is a natural monopoly? Explain.

27. Use an example that is different from the text to show the procedure of auctioning off rights to operate a natural monopoly.

29. Give an example of how a collective negative externality problem could be solved by changing the ownership of property. Use an example that is different from that in the text.

30. By comparing an individual's purchase of a house with a collective's purchase of national defense, describe the collective monitoring problem.

Gunning’s Address
J. Patrick Gunning
Professor of Economics/ College of Business
Feng Chia University
100 Wenhwa Rd, Taichung
Taiwan, R.O.C.
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