Public good (economics)

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Lighthouses are often used as an example of a public good, as they benefit all maritime users, but no one can be excluded from using them as a navigational aid. PhareDeLaVieille DSC08079 PtrQs.jpg
Lighthouses are often used as an example of a public good, as they benefit all maritime users, but no one can be excluded from using them as a navigational aid.

In economics, a public good (also referred to as a social good or collective good) is a good that is both non-excludable and non-rivalrous. For such utilities, users cannot be barred from accessing and/or using them for failing to pay for them. also, use by one person neither prevents access of other people nor does it reduce availability to others. Therefore, the good can be used simultaneously by more than one person. [1] This is in contrast to a common good such as wild fish stocks in the ocean, which is non-excludable but is rivalrous to a certain degree. If too many fish are harvested, the stocks will be depleted thus limiting the access by other people.

Contents

Public goods include knowledge, official statistics, national security, and common language(s). Additionally, flood control systems, lighthouses, and street lighting also for part of the common social goods. Collective goods that are spread all over the face of the earth may be referred to as global public goods. [2] For instance knowledge is well shared globally. Information about men, women and youth health awareness, environmental issues, and maintaining biodiversity is common knowledge that every individual in the society can get without necessarily getting preventing others access. Also, sharing and interpreting contemporary history with a cultural lexicon, particularly about protected cultural heritage sites and monuments are other sources of knowledge that the people can freely access. Popular and entertaining tourist attractions, libraries and universities are some of other collective goods that are accessed.

Many public goods may at times be subject to excessive use resulting in negative externalities affecting all users; for example air pollution and traffic congestion. The closeness of the people while interacting with other people in the public utilities also has appeared to cause negative impact to people. The result of this is a faster and increased spread of infectious diseases such as SARS and COVID-19 [3] . Public goods problems are often closely related to the "free-rider" problem, in which people not paying for the good may continue to access it. Thus, the good may be under-produced, overused or degraded. [4] Public goods may also become subject to restrictions on access and may then be considered to be club goods; exclusion mechanisms include toll roads, congestion pricing, and pay television with an encoded signal that can be decrypted only by paid subscribers.

There is a good deal of debate and literature on how to measure the significance of public goods problems in an economy, and to identify the best remedies.

Terminology, and types of goods

Paul A. Samuelson is usually credited as the economist who articulated the modern theory of public goods in a mathematical formalism, building on earlier work of Wicksell and Lindahl. In his classic 1954 paper The Pure Theory of Public Expenditure, [5] he defined a public good, or as he called it in the paper a "collective consumption good", as follows:

[goods] which all enjoy in common in the sense that each individual's consumption of such a good leads to no subtractions from any other individual's consumption of that good...

Non-rivalry: as explained above, one person using the product does not prevent others use.

Non-excludability: that is, it is impossible to exclude any individuals from consuming the good.

Pure public: when a good exhibits the two traits, non-rivalry and non-excudability, it is referred to as the pure public good.

Impure public goods: the goods that satisfy the two public good conditions ( non-rivalry and non-excludability ) only to a certain extent or only some of the time.

Private good: The opposite of a public good which does not possess these properties. A loaf of bread, for example, is a private good; its owner can exclude others from using it, and once it has been consumed, it cannot be used by others.

Common-pool resource : A good that is rivalrous but non-excludable. Such goods raise similar issues to public goods: the mirror to the public goods problem for this case is the 'tragedy of the commons'. For example, it is so difficult to enforce restrictions on deep-sea fishing that the world's fish stocks can be seen as a non-excludable resource, but one which is finite and diminishing.

Club goods : are the goods that excudable but are non-rivalrous such as private parks.

Definition matrix

Excludable Non-excludable
Rivalrous Private goods

food, clothing, cars, parking spaces

Common-pool resources

fish stocks, timber, coal

Non-rivalrous Club goods

cinemas, private parks, satellite television

Public goods

free-to-air television, air, national defense

Elinor Ostrom proposed additional modifications to the classification of goods to identify fundamental differences that affect the incentives facing individuals [6]

  1. Replacing the term "rivalry of consumption" with "subtractability of use".
  2. Conceptualizing subtractability of use and excludability to vary from low to high rather than characterizing them as either present or absent.
  3. Overtly adding a very important fourth type of good—common-pool resources—that shares the attribute of subtractability with private goods and difficulty of exclusion with public goods. Forests, water systems, fisheries, and the global atmosphere are all common-pool resources of immense importance for the survival of humans on this earth.
  4. Changing the name of a "club" good to a "toll" good since many goods that share these characteristics are provided by small scale public as well as private associations.

Challenges in identifying public goods

The definition of non-excludability states that it is impossible to exclude individuals from consumption. Technology now allows radio or TV broadcasts to be encrypted such that persons without a special decoder are excluded from the broadcast. Many forms of information goods have characteristics of public goods. For example, a poem can be read by many people without reducing the consumption of that good by others; in this sense, it is non-rivalrous. Similarly, the information in most patents can be used by any party without reducing consumption of that good by others. Official statistics provide a clear example of information goods that are public goods, since they are created to be non-excludable. Creative works may be excludable in some circumstances, however: the individual who wrote the poem may decline to share it with others by not publishing it. Copyrights and patents both encourage the creation of such non-rival goods by providing temporary monopolies, or, in the terminology of public goods, providing a legal mechanism to enforce excludability for a limited period of time. For public goods, the "lost revenue" of the producer of the good is not part of the definition: a public good is a good whose consumption does not reduce any other's consumption of that good. [7]

Debate has been generated among economists whether such a category of "public goods" exists. Steven Shavell has suggested the following:

when professional economists talk about public goods they do not mean that there are a general category of goods that share the same economic characteristics, manifest the same dysfunctions, and that may thus benefit from pretty similar corrective solutions...there is merely an infinite series of particular problems (some of overproduction, some of underproduction, and so on), each with a particular solution that cannot be deduced from the theory, but that instead would depend on local empirical factors. [8]

There is a common misconception that public goods are goods provided by the public sector. Although it is often the case that government is involved in producing public goods, this is not always true. Public goods may be naturally available, or they may be produced by private individuals, by firms, or by non-state groups, called collective action. [9]

The theoretical concept of public goods does not distinguish geographic region in regards to how a good may be produced or consumed. However, some theorists, such as Inge Kaul, use the term "global public good" for a public good which is non-rivalrous and non-excludable throughout the whole world, as opposed to a public good which exists in just one national area. Knowledge has been argued as an example of a global public good, [10] but also as a commons, the knowledge commons. [11]

Aggregate demand (SMB) is the sum of individual demands (MBi) Samuelson condition.png
Aggregate demand (ΣMB) is the sum of individual demands (MBi)

Graphically, non-rivalry means that if each of several individuals has a demand curve for a public good, then the individual demand curves are summed vertically to get the aggregate demand curve for the public good. This is in contrast to the procedure for deriving the aggregate demand for a private good, where individual demands are summed horizontally.

Some writers have used the term "public good" to refer only to non-excludable "pure public goods" and refer to excludable public goods as "club goods". [12]

Examples

Yosemite National Park, an example of an environmental good. Half Dome with Eastern Yosemite Valley.jpg
Yosemite National Park, an example of an environmental good.
Common examples of public goods include:
shading light on some mis-classified public goods

"'national defense' is surely not an absolute good with only one unit of supply. It consists of specific resources committed in certain definite and concrete ways—and these resources are necessarily scarce. A ring of defense bases around New York, for example, cuts down the amount possibly available around San Francisco." [15]

Jeffrey Rogers Hummel and Don Lavoie note,

"Americans in Alaska and Hawaii could very easily be excluded from the U.S. government's defense perimeter, and doing so might enhance the military value of at least conventional U.S. forces to Americans in the other forty-eight states. But, in general, an additional ICBM in the U.S. arsenal can simultaneously protect everyone within the country without diminishing its services". [16]

Public goods are not restricted to human beings. [17] It is one aspect of the study of cooperation in biology. [18]

Free rider problem

Free rider problem, is a form of market failure, in which market-like behavior of individual gain-seeking does not produce economically efficient results. The production of public goods results in positive externalities which are not remunerated. If private organizations do not reap all the benefits of a public good which they have produced, their incentives to produce it voluntarily might be insufficient. Consumers can take advantage of public goods without contributing sufficiently to their creation. This is called the free rider problem, or occasionally, the "easy rider problem". If too many consumers decide to "free-ride", private costs exceed private benefits and the incentive to provide the good or service through the market disappears. The market thus fails to provide a good or service for which there is a need. [19]

The free rider problem depends on a conception of the human being as homo economicus : purely rational and also purely selfish—extremely individualistic, considering only those benefits and costs that directly affect him or her. Public goods give such a person an incentive to be a free rider.

For example, consider national defense, a standard example of a pure public good. Suppose homo economicus thinks about exerting some extra effort to defend the nation. The benefits to the individual of this effort would be very low, since the benefits would be distributed among all of the millions of other people in the country. There is also a very high possibility that he or she could get injured or killed during the course of his or her military service. On the other hand, the free rider knows that he or she cannot be excluded from the benefits of national defense, regardless of whether he or she contributes to it. There is also no way that these benefits can be split up and distributed as individual parcels to people. The free rider would not voluntarily exert any extra effort, unless there is some inherent pleasure or material reward for doing so (for example, money paid by the government, as with an all-volunteer army or mercenaries).

The free-riding problem is even more complicated than it was thought to be until recently. Any time non-excludability results in failure to pay the true marginal value (often called the "demand revelation problem"), it will also result in failure to generate proper income levels, since households will not give up valuable leisure if they cannot individually increment a good. [20] This implies that, for public goods without strong special interest support, under-provision is likely since cost-benefit analysis is being conducted at the wrong income levels, and all of the un-generated income would have been spent on the public good, apart from general equilibrium considerations.

In the case of information goods, an inventor of a new product may benefit all of society, but hardly anyone is willing to pay for the invention if they can benefit from it for free. In the case of an information good, however, because of its characteristics of non-excludability and also because of almost zero reproduction costs, commoditization is difficult and not always efficient even from a neoclassical economic point of view. [21]

Efficient production levels of public goods

The Pareto optimal provision of a public good in a society occurs when the sum of the marginal valuations of the public good (taken across all individuals) is equal to the marginal cost of providing that public good. These marginal valuations are, formally, marginal rates of substitution relative to some reference private good, and the marginal cost is a marginal rate of transformation that describes how much of that private good it costs to produce an incremental unit of the public good.) This contrasts to the Pareto optimality condition of private goods, which equates each consumer's valuation of the private good to its marginal cost of production. [5] [22]

For an example, consider a community of just two consumers and the government is considering whether or not to build a public park. One person is prepared to pay up to $200 for its use, while the other is willing to pay up to $100. The total value to the two individuals of having the park is $300. If it can be produced for $225, there is a $75 surplus to maintaining the park, since it provides services that the community values at $300 at a cost of only $225.

The classical theory of public goods defines efficiency under idealized conditions of complete information, a situation already acknowledged in Wicksell (1896). [23] Samuelson emphasized that this poses problems for the efficient provision of public goods in practice and the assessment of an efficient Lindahl tax to finance public goods, because individuals have incentives to underreport how much they value public goods. [5] Subsequent work, especially in mechanism design and the theory of public finance developed how valuations and costs could actually be elicited in practical conditions of incomplete information, using devices such as the Vickrey–Clarke–Groves mechanism. Thus, deeper analysis of problems of public goods motivated much work that is at the heart of modern economic theory. [24]

Other problems associated with public goods

According to Mahatma Gandhi, several developmental aspects to grand the people with the public goods has for many years gone astray. As recorded by Thakker, Gandhi had a different perspective of the public goods;

"...need to protect the environment and to guard against the abuse of natural resources. Our mindless destruction of natural wealth is alarming. Mighty projects, big dams, giant industries and other massive ventures raise questions about the quality of life affected by them. The quest for the mirage of material development often leads to the destruction of forests, ecological imbalances, scarcity of water, soil erosion, silting of rivers and desertification pose grave dangers to environment." [25]

With the aim to achieve provision of public services several other challenges arise which include;

Local public goods

The basic theory of public goods as discussed above begins with situations where the level of a public good (e.g., quality of the air) is equally experienced by everyone. However, in many important situations of interest, the incidence of benefits and costs is not so simple. For example, when people keep an office clean or monitor a neighborhood for signs of trouble, the benefits of that effort accrue to some people (those in their neighborhoods) more than to others. The overlapping structure of these neighborhoods is often modeled as a network. [27] (When neighborhoods are totally separate, i.e., non-overlapping, the standard model is the Tiebout model.)

Recently, economists have developed the theory of local public goods with overlapping neighborhoods, or public goods in networks: both their efficient provision, and how much can be provided voluntarily in a non-cooperative equilibrium. When it comes to efficient provision, networks that are more dense or close-knit in terms of how much people can benefit each other have more scope for improving on an inefficient status quo. [28] However, voluntary provision is typically below the efficient level, and equilibrium outcomes tend to involve strong specialization, with a few individuals contributing heavily and their neighbors free-riding on those contributions. [27] [29]

Ownership

It would be rather simple to assume that the public goods are owned by public sector. However, the management of the utilities in the hands of the public, clearly indicate less benefit to the users due to free-riders. Thus, a question regarding public goods being owned by the public or the private sector rises.

Economic theorists such as Oliver Hart (1995) argue that ownership matters for investment incentives when contracts are incomplete. [30] The incomplete contracting paradigm has been applied to public goods by Besley and Ghatak (2001). [31] They consider the government and a non-governmental organization (NGO) who can both make investments to provide a public good. Besley and Ghatak show that the party who has a larger valuation for the public good should be the owner, regardless of whether the government or the NGO has a better investment technology. This result contrasts with the case of private goods studied by Hart (1995), where the party with the better investment technology should be the owner. However, more recently it has been shown that the investment technology matters also in the public-good case when a party is indispensable or when there are bargaining frictions between the government and the NGO. [32] [33]

See also

Related Research Articles

Environmental economics is a sub-field of economics concerned with environmental issues. It has become a widely studied subject due to growing environmental concerns in the twenty-first century. Environmental Economics "...undertakes theoretical or empirical studies of the economic effects of national or local environmental policies around the world .... Particular issues include the costs and benefits of alternative environmental policies to deal with air pollution, water quality, toxic substances, solid waste, and global warming."

In the social sciences, the free-rider problem is a type of market failure that occurs when those who benefit from resources, public goods, or services of a communal nature do not pay for them or under-pay. Free riders are a problem because while not paying for the good, they may continue to access or use it. Thus, the good may be under-produced, overused or degraded.

Externality

In economics, an externality is the cost or benefit that affects a third party who did not choose to incur that cost or benefit. Externalities often occur when the production or consumption of a product or service's private price equilibrium cannot reflect the true costs or benefits of that product or service for society as a whole. This causes the externality competitive equilibrium to not be a Pareto optimality.

Market failure

In neoclassical economics, market failure is a situation in which the allocation of goods and services by a free market is not Pareto efficient, often leading to a net loss of economic value. Market failures can be viewed as scenarios where individuals' pursuit of pure self-interest leads to results that are not efficient– that can be improved upon from the societal point of view. The first known use of the term by economists was in 1958, but the concept has been traced back to the Victorian philosopher Henry Sidgwick. Market failures are often associated with public goods, time-inconsistent preferences, information asymmetries, non-competitive markets, principal–agent problems, or externalities.

A Pigovian tax is a tax on any market activity that generates negative externalities. The tax is intended to correct an undesirable or inefficient market outcome, and does so by being set equal to the external marginal cost of the negative externalities. Social cost include private cost and external cost. However, in the presence of negative externalities, the social cost of a market activity is not covered by the private cost of the activity. In such a case, the market outcome is not efficient and may lead to over-consumption of the product. Often-cited examples of such externalities are environmental pollution, and increased public healthcare costs associated with tobacco and sugary drink consumption.

Rivalry (economics) the property of goods whose consumption by one consumer prevents, makes it harder to, or lessens the benefits of simultaneous consumption by other consumers

In economics, a good is said to be rivalrous or a rival if its consumption by one consumer prevents simultaneous consumption by other consumers, or if consumption by one party reduces the ability of another party to consume it. A good is considered non-rivalrous or non-rival if, for any level of production, the cost of providing it to a marginal (additional) individual is zero. A good can be placed along a continuum ranging from rivalrous to non-rivalrous. The same characteristic is sometimes referred to as jointness of supply or subtractable or non-subtractable.

Erik Lindahl

Erik Lindahl was a Swedish economist. He was professor of economics at Uppsala University 1942–58 and in 1956–59 he was the President of the International Economic Association. He was an also an advisor to the Swedish government and the central bank, and in 1943 was elected as a member of the Royal Swedish Academy of Sciences. Lindahl posed the question of financing public goods in accordance with individual benefits. The quantity of the public good satisfies the requirement that the aggregate marginal benefit equals the marginal cost of providing the good.

Private good

A private good is defined in economics as "an item that yields positive benefits to people" that is excludable, i.e. its owners can exercise private property rights, preventing those who have not paid for it from using the good or consuming its benefits; and rivalrous, i.e. consumption by one necessarily prevents that of another. A private good, as an economic resource is scarce, which can cause competition for it. The market demand curve for a private good is a horizontal summation of individual demand curves.

Club good

Club goods are a type of good in economics, sometimes classified as a subtype of public goods that are excludable but non-rivalrous, at least until reaching a point where congestion occurs. Often these goods exhibit high excludability, but at the same time low rivalry in consumption. Thus, club goods have essentially zero marginal costs and are generally provided by what is commonly known as natural monopolies. Furthermore, Club goods have artificial scarcity. Club theory is the area of economics that studies these goods. One of the most famous provisions was published by Buchanan in 1965 "An Economic Theory of Clubs," in which he addresses the question of how the size of the group influences the voluntary provision of a public good and more fundamentally provides a theoretical structure of communal or collective ownership-consumption arrangements.

In traditional usage, a global public good is a public good available on a more-or-less worldwide basis. There are many challenges to the traditional definition, which have far-reaching implications in the age of globalization.

Public goods game

The public goods game is a standard of experimental economics. In the basic game, subjects secretly choose how many of their private tokens to put into a public pot. The tokens in this pot are multiplied by a factor and this "public good" payoff is evenly divided among players. Each subject also keeps the tokens they do not contribute.

Positional goods are goods valued only by how they are distributed among the population, not by how many of them there are available in total as would be the case with other consumer goods. The source of greater worth of positional goods is their desirability as a status symbol, which usually results in them greatly exceeding the value of comparable goods.

In economics, a good or service is called excludable if it is possible to prevent people (consumers) who have not paid for it from having access to it. By comparison, a good or service is non-excludable if non-paying consumers cannot be prevented from accessing it.

"The Lighthouse in Economics" is a 1974 academic paper written by British economist Ronald H. Coase, the 1991 winner of the Nobel Prize in Economic Sciences.

A Lindahl tax is a form of taxation conceived by Erik Lindahl in which individuals pay for public goods according to their marginal benefits. In other words, they pay according to the amount of satisfaction or utility they derive from the consumption of an additional unit of the public good.

The Logic of Collective Action: Public Goods and the Theory of Groups is a book by Mancur Olson, Jr. published in 1965. It develops a theory of political science and economics of concentrated benefits versus diffuse costs. Its central argument is that concentrated minor interests will be overrepresented and diffuse majority interests trumped, due to a free-rider problem that is stronger when a group becomes larger.

A collective action problem or social dilemma is a situation in which all individuals would be better off cooperating but fail to do so because of conflicting interests between individuals that discourage joint action. The collective action problem has been addressed in political philosophy for centuries, but was most clearly established in 1965 in Mancur Olson's The Logic of Collective Action.

The economics of science aims to understand the impact of science on the advance of technology, to explain the behavior of scientists, and to understand the efficiency or inefficiency of scientific institutions and markets.

In public choice theory, preference revelation is an area of study concerned with ascertaining the public's demand for public goods. According to some economists, if government planners do not have "full knowledge of individual preference functions", then it's likely that public goods will be under or over supplied.

The benefit principle is a concept in the theory of taxation from public finance. It bases taxes to pay for public-goods expenditures on a politically-revealed willingness to pay for benefits received. The principle is sometimes likened to the function of prices in allocating private goods. In its use for assessing the efficiency of taxes and appraising fiscal policy, the benefit approach was initially developed by Knut Wicksell (1896) and Erik Lindahl (1919), two economists of the Stockholm School. Wicksell's near-unanimity formulation of the principle was premised on a just income distribution. The approach was extended in the work of Paul Samuelson, Richard Musgrave, and others. It has also been applied to such subjects as tax progressivity, corporation taxes, and taxes on property or wealth. The unanimity-rule aspect of Wicksell's approach in linking taxes and expenditures is cited as a point of departure for the study of constitutional economics in the work of James Buchanan.

References

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  3. "SARS | Home | Severe Acute Respiratory Syndrome | SARS-CoV Disease | CDC". www.cdc.gov. Retrieved 25 October 2020.
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  19. Ray Powell (June 2008). "10: Private goods, public goods and externalities". AQA AS Economics (paperback ed.). Philip Allan. p. 352. ISBN   978-0-340-94750-0.
  20. Graves, P. E., "A Note on the Valuation of Collective Goods: Overlooked Input Market Free Riding for Non-Individually Incrementable Goods Archived 30 June 2013 at the Wayback Machine ", The B.E. Journal of Economic Analysis & Policy 9.1 (2009).
  21. Babe, Robert (1995). "Chapter 3". Essay in Information, Public Policy and Political Economy. University of Ottawa: Westview Press.
  22. Brown, C. V.; Jackson, P. M. (1986), "The Economic Analysis of Public Goods", Public Sector Economics, 3rd Edition, Chapter 3, pp. 48–79.
  23. Wicksell, Knut (1958). "A New Principle of Just Taxation". In Musgrave and Peackock (ed.). Classics in the Theory of Public Finance. London: Macmillan.
  24. Maskin, Eric (8 December 2007). "Mechanism Design: How to Implement Social Goals" (PDF). Nobel Prize Lecture.
  25. "Gandhian Perspective of Development | Relevance of Gandhi | Articles on and by Mahatma Gandhi". www.mkgandhi.org. Retrieved 25 October 2020.
  26. Wilkinson, Allie (3 June 2015). "Overfishing could push European fish species to extinction". Science | AAAS. Retrieved 25 October 2020.
  27. 1 2 Bramoullé, Yann; Kranton, Rachel (July 2007). "Public goods in networks". Journal of Economic Theory. 135 (1): 478–494. doi:10.1016/j.jet.2006.06.006.
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Bibliography

Further reading