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Study the introduction above. What do you expect to learn from this lesson? Enter your answers on the right.
Study the vocabulary words and look for them in the lesson. You will be tested on them.
What if the government decided to leave the business of road-building up to private citizens? If you wanted a road in front of your house, you’d have to pay a contractor to build it. Or more likely, you and your neighbors could chip in and hire someone to build you a small network of streets.

What problems might arise in this scenario? For one thing, if groups of individuals pooled their money to build a road or a freeway, who would they allow to use it? Would drivers have to constantly stop and pay the owners of each road they drove on? How would individuals living in sparsely populated areas come up with enough money to build the roads they needed?
Public Goods
Roads are one of many examples in which the government provides a
public good, a shared good or service for which it would be inefficient or impractical (1) to make consumers pay individually and (2) to exclude non payers. Dams are another example of public goods.

Let’s look at the first feature, making consumers pay individually: How would you like to receive a bill in your mailbox for your share of launching a space shuttle or cleaning Mount Rushmore? To simplify the funding of government projects in the public interest, the government collects taxes. What about the second feature of a public good, excluding non payers? As a society, we believe that certain facilities or services should be available to all. Besides, excluding non payers from highways would be a nightmare.

Most goods are public simply because a private provider could not charge those who benefit or exclude non payers from benefiting. For example, in 1872, Congress created the nation’s first national park, Yellowstone. The national park system ensured that the natural resources Americans value would be protected.

If a park were privately owned, the owner could charge an admission fee. Yet some benefits generated by the park, such as the preservation of wildlife, would be enjoyed by non payers as well as payers. The owner could neither charge people for that public benefit nor exclude them from it.

Public goods have other characteristics:
Any number of consumers can use them
without reducing the benefits to any single
consumer. For the most part, increasing the
number of consumers does not increase the
cost of providing the public good. So if you’re driving on a highway and eight other drivers come along, they do not significantly reduce the road’s benefits to you or increase the government’s cost of providing it. 



What is the author suggesting in the introduction at the top of the page?
Individuals really do not need government to provide for the needs of society, such as roads.
People should build their own roads instead of relying on the government.
Individuals can’t provide all of the needs of society without the help of government.
The government should not allow individual people to build their own roads.


Which of the following is an example of a public good?
a city park
a movie theater
a grocery store
cable television


Which of the following is a critical rule for determining whether something is a public good?
The benefit to each individual who uses the facility is greater than the cost.
The benefits of the facility are greater for the society than for the individuals using it.
The total benefits to society are greater than the total cost.
The total cost is small for each individual taxpayer.


Which of the following is NOT an example of a public good?
shopping malls
national parks
municipal libraries
Costs and Benefits

As you read in Section 1, the federal
government steps in to act in the public
interest whenever it determines that the
benefits of a policy outweigh the drawbacks.
In road construction, the advantages
are obvious. The drawback is the
economic freedom we give up, since none
of us individually gets to decide what
roads will be built, and where. Still, in this
example the advantages of public road
construction outweigh the drawback. In
other cases, weighing benefits against costs
is more complicated and open to debate.
Cost is critical in determining whether
something gets produced as a public good.

When a good or service is public,

the benefit to each individual is less than
the cost that each would have to pay if it
were provided privately, and
2. the total benefits to society are greater
than the total cost.

In such circumstances, the market would
not provide the good; the government
would have to, or else it wouldn’t get done.
Study carefully Figure 3.4 on the next page.
Does the dam-building project meet the
two criteria for a public good?
Public goods are financed by the public
the part of the economy that
involves the transactions of the government.
The private sector, the part of the
economy that involves transactions of individuals and businesses, would have little
incentive to produce public goods. 


The owner of the Chargers is asking the city of San Diego to build a new stadium. He tells the city council that it would cost him more to build the stadium than he could ever earn back in revenue. Further, he says, the city would get back more in tourist dollars and other fees than it would cost the city to build the stadium. The owner of the Chargers is describing the stadium as
social experiment
a private good or service
a public good or service
scientific experiment


What is the likely outcome if the city of San Diego does not build a new stadium for the Chargers?
some outside financial group will likely come in with private money and build the stadium
the stadium will not get built
the cost of building the stadium will fall until the Chargers can afford to build the stadium
the Chargers will build the stadium themselves


You do not always have to agree with your textbooks. Look at this diagram. It shows the process that determines whether a public good will be generated. If you are using public money to benefit a small group of farmers, are you then using public money to provide a private good? People in the cities provided some of the tax dollars for the project. How does the damn benefit them?

What do you think? Explain your ideas in a short essay on the right.

Opportunity Costs
If the farmers also wanted irrigation ditches built to carry the lake water to their fields, would the ditches be built as a public good? Explain.
Free-Rider Problem

A phenomenon associated with public
goods is called the “free-rider problem.” A free rider is someone who would not choose to pay for a certain good or service, but would get the benefits of it anyway if it were provided as a public good.

Would you voluntarily contribute, say,
$3,500 to buy army helmets? —your portion
of America’s military cost this year?
Perhaps not. Yet when the government
provides a system of national defense, you
benefit, whether you pay or not.

Try another example: Everyone on your
street wants fire protection except one
penny-pinching neighbor, who says it’s not
worth the money. Do you want him to
have fire protection anyway? Yes. If his
house catches fire, yours could ignite as
well. So local taxes pay for firefighting
services for all property in a given area,
because all residents are better off if the
government provides this service.

Returning to the example of roads, you
might not be willing to pay for a new
freeway in your area. But if it is built, you
would use it. You would be a free rider.

Free riders consume what they do not
pay for. The free-rider problem suggests
that if the government stopped collecting
taxes and relied on voluntary contributions,
many public services would have to
be eliminated.  


A person who receives a public good even though he does not pay for it is called a
tax payer
free rider


If you are in the bottom 50% of wage earners in the United States you pay no federal income taxes. What are you likely to be called by the people who do pay the taxes?
a middle class earner
tax supporter
an entitlement
free rider


The top 10% of tax payers in the United States pay 70% or all taxes. Why is this true?
Rich people are greedy and need to be punished
The graduated income tax structure tends to punish the rich and favor the poor
No body else has any money
The graduated income tax structure tend to punish the poor and favor the rich


If the government no longer had the ability to force people to pay taxes but instead had to rely in voluntary taxes from the people, what would happen to public services in the United States?
There would be fewer public services and the people as a whole would suffer
They would stay about the same because most people don’t mind paying taxes and would continue to support public services
Nothing, people would only provide services that were really needed.
People would have more money to spend on public services and would be willing to do so
Market Failures
Free riders are examples of market failure, a
situation in which the market, on its own,
does not distribute resources efficiently. To
understand market failure, recall how a
successful free market operates: Choices
made by individuals determine what goods
get made, how they get made, and who
consumes the goods. Profit incentives
attract producers, who, because of competition, provide goods and services that
consumers need at a price they can afford.

In the road-building scenario, are these
features of a free market present? No. If a
company did build a road, it could charge a
high price for tolls because it would have no
competition. Also, companies would not
choose to build roads in sparsely populated
areas because profit incentives in those areas
might be non-existing. This way of getting
roads built would be highly impractical.

In this scenario, the criteria for a
properly functioning market system do not
exist. That’s why economists consider this
situation a market failure.

Note that public ownership can sometimes
produce negative externalities, however.
Some public lands, for example, might be
more usefully managed if owned privately.



Car manufacturers in the United States decide to produce automobiles without all of the environmental devices such as smog devices and catalectic converters. The cars cost $1000 less than the same cars with environmental safeguards. As a result most people choose to save the $1000 and the environment suffers. This is an example of
social justice
market failure
everyone benefits
free riders


SDG&E, through negligence, caused brush fires, that resulted in the loss of many homes. The people sued SDG&E but the company said that their stock holders should not have to pay for the losses. Instead they got the California Public Utilities Commission to raise the gas and electric rates for the SDG&E customers. This is an example of
market free choice
free enterprise
market failure
All of the previous examples involve side effects of some sort. They illustrate what economists call externalities. An externality is an economic side effect of a good or service that generates benefits or costs to someone other than the person deciding how much to produce or consume. Externalities can be positive or negative, as follows.
Positive Externalities
We’ve said that public goods generate
benefits to many people, not just those who
pay for the goods. Such beneficial side
effects are called positive externalities.

The private sector can create positive
externalities, too. In fact, many experts
believe that the private sector generates
positive externalities more efficiently than
the public sector can, and at less cost to
taxpayers. For instance:

• Dynamo Computers hires underprivileged
teenagers and trains them to be computer
programmers. Those workers are then
available to be hired by other companies,
who benefit from the workers’ skills
without having paid for them.

• Mrs. Garland buys an old house that is
an eyesore in the neighborhood. She
paints the house, cuts the grass, and
plants flowers. Her neighbors were not
involved in her economic decision. But
they receive benefits from it, such as
higher property values and a better view.

Whether private or public, positive
externalities cause part of the benefit of a
good to be gained by someone who did not purchase it. In the 1990s, several endangered species, including the bald eagle and the peregrine falcon, were saved from extinction. Protection of species critical to our ecosystem benefits us all.
Negative Externalities
Of course, some decisions to produce goods
and services generate unintended costs,
called negative externalities. Negative
externalities cause part of the cost of
producing a good or service to be paid
for by someone other than the producer.
For example:

• The Enchanted Forest Paper Mill dumps
chemical wastes into a nearby river,
making it unsafe for swimming. The
downstream city of Tidyville is forced to
install special equipment at its water treatment
plant to clean up the mess. If the treatment cost is $20 per ton of paper produced, and the mill’s production cost is $100 (the cost of all the materials, labor, and machinery required to produce it), the full, or social, cost of a ton of paper is $120. The community, not the polluter, winds up paying that $20.

• Your next-door neighbor, Mr. Fogler, takes up the accordion and holds Friday night polka parties in his backyard. Unfortunately, you hate polka music.



Companies depend on a well educated labor force to do its work. People are educated by the public school system operated by the government. Remember, the company does pay taxes like everyone else to support the school system. Can we claim that the company is benefiting from a positive externality in this situation?
Yes, this is a positive externality for the companies
It is hard to tell because the company is part of the community and shares in the costs of education
No, this is a negative externality for the companies
Education cannot be an externality because it operates from inside the government


Cox cable provides cable TV service to the community. We have hundreds of channels on many topics to satisfy our entertainment and educational needs. At the same time much of the content on cable TV is inappropriate for young children. Some programming can be classified as pornographic. What does this show about cable TV?
Cable TV produces only positive externalities
Cable TV has both positive and negative externalities associated with its service
Cable TV has no externalities associated with it because people know that they are getting when they subscribe to the service
Cable TV produces only negative externalities


How would a outdoor sportsman see the externalities created by the creation of the lake or dam?


How would an environmentalist see the externalities created by the creation of a lake by a dam?
Government’s Goals

In a pure market economy, the buyer gets the benefits of a good or service through their purchases. You buy something, you get the benefit. Also, your purchases determine what and how much will be produced.

When externalities are present, we have a
market failure, because the costs or benefits
of a good or service are not assigned
properly. Understanding externalities helps
us see how the government functions in the
American economy.

First, the government encourages the
creation of positive externalities. Education,
for example, benefits students, yet society
as a whole also benefits from an educated
population. This is because educated
workers are generally more productive.

Next, the government aims to limit
negative externalities, such as acid rain.
Pollutants from coal-burning power plants
and auto emissions can drift high into the
atmosphere and come down in the form of
acid rain, which causes ecological damage.
Why is acid rain a negative externality? It is
part of the cost of producing power and
driving cars, but for decades that cost was
being imposed upon people other than the
producers of this pollution. The cost was
damaged trees, lakes, and wildlife.

To help address this negative externality,
the federal government now requires all
new cars to have an expensive antipollution
device called a catalytic converter. In
addition, the Environmental Protection
Agency offers incentives to power-plant
operators to put “scrubbers? ” on their
smokestacks to cut emissions. These
actions transfer the costs of pollution back
to its producers.



Why is there a market failure when externalities are present?
Only the government has positive externalities
Only the government has negative externalities
private purchases have no externalities
The buyer may not receive the benefits or costs of what they purchase


What is the governments attitude toward positive externalities?
The government encourage policies that produce them
The government ignores positive externalities
The government discourages policies that produce them
The government operates only through free markets


When the government encounters a negative externality it
ignores it
discourages it
encourages it
A Libertarian Point of View
John Stossel
In "Myths, Lies and Downright Stupidity," I bet my readers $1,000 that they couldn't name one thing that government does better than the private sector.

I am yet to pay.

Free enterprise does everything better.

Why? Because if private companies don't do things efficiently, they lose money and die. Unlike government, they cannot compel payment through the power to tax.

Even when a private company operates a public facility under contract to government, it must perform. If it doesn't, it will be "fired" — its contract won't be renewed. Government is never fired.

Contracting out to private enterprise isn't the same thing as letting fully competitive free markets operate, but it still works better than government.

Roads are one example. Politicians call road management a "public good" that "government must control." Nonsense.

In 1995, a private road company added two lanes in the middle of California Highway 91, right where the median strip used to be. It then used "congestion pricing" to let some drivers pay to speed past rush-hour traffic. Using the principles of supply and demand, road operators charge higher tolls at times of day when demand is high. That encourages those who are most in a hurry to pay for what they need. It was the first time anywhere in the world that congestion pricing was used. Bureaucrats were skeptical. Now congestion pricing is a hot idea for both private and public road management systems.

Likewise, for years there was a gap in the ring road surrounding Paris that created huge traffic problems. Then private developers made an unsolicited proposal to build a $2 billion toll tunnel in exchange for a 70-year lease to run it. They built a double-decker tunnel that fits six lanes of traffic in the space usually required for just two. The tunnel's profit-seeking owners have an incentive to keep traffic moving. They collect tolls based on congestion pricing, and tolls are collected electronically, so cars don't have to stop. The tunnel operators clear accidents quickly. Most are detected within 10 seconds — thanks to 350 cameras inside the tunnel. The private road has cut a 45-minute trip to 10 minutes.

Indiana used to lose money on its toll road. Then Gov. Mitch Daniels leased it to private developers. Now it makes a profit. The new owners spent $40 million on electronic tolling. That's saved them 55 percent on toll collection. They saved $20 per mile by switching to a better de-icing fluid. They bought a new fleet of computerized snowplows that clear roads using less salt. Drivers win, and taxpayers win.

It also turns out that government roads often run more smoothly when drivers have more, not less, freedom.

Public housing vs private housing
Public schools vs private schools
Public parks vs private parks
The old public phone company vs the new private phone companies.
Public highways such as 805 and 5 vs the private highway, 215

Once again, freedom and responsibility triumph.


Libertarians believe that
the government always does things better than private enterprise
there is little or no difference between the performance of government and private enterprise
private enterprise always does things better than government
if private enterprise did things better there would no need for government


Libertarians believe
private schools are better than public schools
private parks are better than public parks
privately owned homes are better than public housing
all of these items are true


Which group would most favor the free market approach to economics?


Libertarians are likely to believe
government should increase taxes to provide needed public services
government needs to create more laws to safeguard the public
government should lower taxes so individuals have the resources to solve their own problems
government knows best
public sector
public good
market failure
free rider
private sector


the part of the economy that involves the transactions of individuals and businesses


an economic side effect of a good or service that generates benefits or costs to someone other than the person deciding how much to produce or consume


a shared good or service for which it would be impractical to make consumers pay individually and to exclude non payers


a situation in which the market does not distribute resources efficiently


the part of the economy that involves the transactions of the government


someone ho would not choose to pay for a certain good or service, but who would get the benefits of it anyway if it were provided as a public good

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