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A note on the valuation of collective goods: overlooked input market free riding for non-individually incrementable goods

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  • Graves, Philip E.

Abstract

For at least fifty years economists have argued that vertically-aggregated marginal willingness to pay, when set equal to marginal provision cost, will result in optimal public good provision levels. This methodological approach would be expected to yield an exact analog, in terms of optimal levels of public good provision, to efficient provision of private goods in a perfect market setting. There is, however, a potentially serious flaw in the approach as actually practiced, since initial incomes are implicitly–and wrongly–taken to be optimal. From a given income, the output demand revelation problem has long been recognized–that there will be difficulty inferring true demands for public goods at that income (the traditional ‘free rider’ problem). But what has failed to receive widespread recognition among theoreticians, and especially among practitioners, is that there will also be a concomitant ‘input demand revelation’ problem. In any situation where workers cannot individually increment a class of goods by increasing their income (e.g. public goods), they will have no incentive to generate the income that would have been devoted to that class of goods. They will only generate income that is optimal to pay the higher taxes or prices associated with whatever initial public goods levels are provided. As a consequence, the benefit-cost practitioner will, even if somehow able to accurately guess marginal willingness-to-pay out of current income, observe only one apparent optima. There are an infinite number of such optima, one for each level of free riding in input markets, where aggregated marginal willingness-to-pay will appear to equal marginal provision cost. The one true Samuelson ‘optimum optimorum’ occurs when there is free riding in neither output nor input markets (that is, when the ‘full’ demand revelation problem is solved). As a consequence, pure public goods, as well as other ‘non-incrementable’ goods and goods for which non-use values are of importance will be undervalued, hence under-provided. Evidence is presented that the problem raised here might be of importance, undermining the practical significance of the Coase theorem vis-a-vis Pigouvian taxation.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 19928.

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Date of creation: 2009
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Handle: RePEc:pra:mprapa:19928

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Keywords: environmental economics; willingness-to-pay; willingness-to-accept; benefit-cost analysis; public goods; publicly-provided goods; efficiency;

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  1. Theodore Groves & John Ledyard, 1976. "Optimal Allocation of Public Goods: A Solution to the 'Free Rider Problem'," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 144, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  2. Horowitz, John K. & McConnell, Kenneth E., 2002. "A Review of WTA/WTP Studies," Journal of Environmental Economics and Management, Elsevier, Elsevier, vol. 44(3), pages 426-447, November.
  3. Nicholas E. Flores & Philip E. Graves, 2008. "Optimal Public Goods Provision: Implications of Endogenizing the Labor/Leisure Choice," Land Economics, University of Wisconsin Press, University of Wisconsin Press, vol. 84(4), pages 701-707.
  4. Kahneman, Daniel & Knetsch, Jack L & Thaler, Richard H, 1990. "Experimental Tests of the Endowment Effect and the Coase Theorem," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 98(6), pages 1325-48, December.
  5. A. Myrick Freeman III, 2002. "Environmental Policy Since Earth Day I: What Have We Gained?," Journal of Economic Perspectives, American Economic Association, American Economic Association, vol. 16(1), pages 125-146, Winter.
  6. Charles R. Plott & Kathryn Zeiler, 2007. "Exchange Asymmetries Incorrectly Interpreted as Evidence of Endowment Effect Theory and Prospect Theory?," American Economic Review, American Economic Association, American Economic Association, vol. 97(4), pages 1449-1466, September.
  7. Hanemann, W Michael, 1991. "Willingness to Pay and Willingness to Accept: How Much Can They Differ?," American Economic Review, American Economic Association, American Economic Association, vol. 81(3), pages 635-47, June.
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Cited by:
  1. Philip E. Graves, 2010. "Appropriate Fiscal Policy over the Business Cycle: Proper Stimulus Policies Can Work," CESifo Working Paper Series, CESifo Group Munich 3160, CESifo Group Munich.
  2. Philip E. Graves, 2010. "A Note on the Design of Experiments Involving Public Goods," CESifo Working Paper Series, CESifo Group Munich 3187, CESifo Group Munich.
  3. Philip E. Graves, 2010. "Benefit-Cost Analysis of Environmental Projects: A Plethora of Systematic Biases," CESifo Working Paper Series, CESifo Group Munich 3144, CESifo Group Munich.

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