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The Demand and Supply of Public Goods; Buchanan, James M.
44 paragraphs found.

It is, however, important to note that the public choice tradition has never denied the logic of the market failure argument as such. Indeed, Buchanan himself made extremely significant contributions to the market failure-public goods literature. For example, what are almost certainly Buchanan's two most famous articles—"Externality," with W. C. Stubblebine, and "An Economic Theory of Clubs"—fall precisely into this area of inquiry. In fact, public goods theory constituted a major (perhaps the predominant) element in Buchanan's research agenda throughout the 1960s. The Demand and Supply of Public Goods is to be seen as an important part of that body of work and should be read alongside the articles in volume 15 in the Collected Works, Externalities and Public Expenditure Theory, as Buchanan's attempt to synthesize and focus his views on those "public goods" issues. The Demand and Supply of Public Goods should perhaps also be read alongside the earlier contributions of Samuelson and Richard A. Musgrave. John G. Head provides a survey of this literature contemporaneous with The Demand and Supply of Public Goods that includes an article-length review of Buchanan's book. *2


It is interesting specifically to contrast Buchanan's approach with the earlier Samuelson exposition. Two features are notable. First, whereas Samuelson's central purpose is to establish "optimal conditions" for the supply of public goods, and to show thereby that the Pareto optimum could never be a market equilibrium, Buchanan seeks to derive that market equilibrium directly. Such derivation is necessary to Buchanan's broad purpose of explicitly comparing market performance with political performance: Buchanan has much less interest in conceptually possible but institutionally infeasible ideals. Second, and related, much of Buchanan's treatment reads like a purely positive account of institutional choice. The quest for mutual advantage through exchange—whether a two-person exchange as for ordinary private goods or a many-person exchange as in the public goods case—serves in The Demand and Supply of Public Goods as a motivator of action as well as a relevant normative test. Accordingly, The Demand and Supply of Public Goods is an important piece of Buchanan's contractarian theory of the "productive state" with the ambiguity between the positive and normative use of the contractarian approach deliberately allowed full rein. *3 The contrast with Samuelson's much more overt (if incomplete) normative treatment, with the independently derived "social welfare function" as an express articulation of the "ethical observer's optimum," is worth noting. In this respect, Buchanan is much more faithful to the Wicksellian approach than is Samuelson, although both Samuelson's and Buchanan's treatments of the public goods question derive ultimately from Wicksellian sources. (In Samuelson's case, the derivation is through Musgrave's paper on Erik Lindahl's version of Knut Wicksell's analysis.) *4


The particular occasion for writing the first draft of The Demand and Supply of Public Goods was a series of lectures given at Cambridge University in 1961-62. The audience originally conceived for the book was therefore a group of relatively able undergraduate and graduate students. But little of the flavor of a textbook is detectable here—there is no dry pedagogy and surely no concession to the undergraduate concentration span. What Buchanan provides here is a clear statement of the contractarian approach to public goods problems, very much in the "voluntary exchange" tradition of Wicksell and Lindahl.

Geoffrey Brennan
Australian National University

The title, "The Demand and Supply of Public Goods," has been selected to emphasize those features that set the book apart from orthodox public finance and at the same time tie it to neoclassical economics. Public finance, traditionally, has neither contained a theory of demand nor one of supply. Public goods and services have not been central to this subdiscipline. Public finance has been rather straightforward applied price theory, and its scientific content has been limited to predictions about the reactions of individuals and firms to fiscal institutions. The scholar from outer space, coming to earth in the post-Marshallian era, might have concluded on perusing the English-language literature that governments exist wholly apart from their citizens, that these units impose taxes on individuals and firms primarily to nourish the state; and he might have thought that positive public finance consists in predicting the effects of these taxes. Normative public finance, observed alongside the positive elements, consists in pronouncements about how taxes should be imposed.


Marshallian economics is essentially a theory of the demand for and the supply of private goods, and of the institutions (markets) through which exchange takes place. Traditional public finance has been applied Marshallian economics with a liberal side dosage of utilitarian nonsense. The linguistic provincialism of English-language scholars precluded familiarity with early continental attempts to extend economic theory to public as well as to private goods. The words of Sax, Pantaleoni, de Viti de Marco, Mazzola, Erik Lindahl, and, most importantly, Knut Wicksell remained almost wholly ignored in English and American writings before World War II.


Through the work of R. A. Musgrave, Howard Bowen, Paul Samuelson, J. G. Head and others, this deficiency has been overcome to an extent during the last quarter-century. A theory of the demand for and the supply of public goods and services has emerged, built on the foundations of the late-nineteenth-century continental efforts, and this theory is now beginning to find its place in the elementary public-finance textbooks, especially those that have been written since the mid-1950s. No independent and systematic exposition of the theory has appeared; this provides the motivation for the present book.

James M. Buchanan and W. C. Stubblebine, "Externality," Economica 29 (November 1962): 371-84; James M. Buchanan, "An Economic Theory of Clubs," Economica 32 (February 1965): 1-14. Both papers are included in volume 15 in the series, Externalities and Public Expenditure Theory. James M. Buchanan, The Demand and Supply of Public Goods (Chicago: Rand-McNally, 1968), volume 5 in the series. Samuelson, "The Pure Theory," 387-89; "Diagrammatic Exposition," 350-56; and "Expenditure Theories," 332-38; Richard A. Musgrave, The Theory of Public Finance (New York: McGraw-Hill, 1959). John G. Head, Public Goods and Public Welfare (Durham: Duke University Press, 1974).
Ch. 1, A Methodological Introduction
Chapter 1A Methodological Introduction

People are observed to demand and to supply certain goods and services through market institutions. They are observed to demand and to supply other goods and services through political institutions. The first are called private goods; the second are called public goods.


Neoclassical economics provides a theory of the demand for and the supply of private goods. But what does "theory" mean in this context? This question can best be answered by examining the things that theory allows us to do. Explanation is the primary function of theory, here as everywhere else. For the private-goods world, economic theory enables us to take up the familiar questions: What goods and services shall be produced? How shall resources be organized to produce them? How shall final goods and services be distributed? Note, however, that theory here does not provide the basis for specific forecasts. Instead, it allows us to develop an explanation of the structure of the system, the inherent logical structure of the decision processes. With its help we understand and explain how such decisions get made, not what particular pattern of outcome is specifically chosen.


The extended methodological digression on the function of orthodox economic theory in application to the private economy is designed to provide some assistance in discussing the analogous role of theory as extended to the public economy, to the demand for and the supply of public as opposed to private goods. At base, the economist must begin from the same set of conditional hypotheses. He deals with the same individuals as decision-making units in both public and private choice, and, initially at least, he should proceed on the assumption that their fundamental laws of behavior are the same under the two sets of institutions. If he predicts that the average or representative person will purchase a greater quantity of private good A when the relative price of A is reduced, he should also predict that the same person will "purchase" a greater quantity of public good B when the relative "price" of B is lowered. This step in itself represents a significant departure from orthodoxy in public finance. Individual behavior patterns in demanding public goods, in participating in political decision processes, in voting, have not been examined in detail by economists (or by anyone else). A body of theory devoted to individual participation in voting processes is only now emerging. And even here, the individual's behavior in demanding public goods, as some functional relationship between quantity demanded and the "tax-price" that he pays, has not been studied either analytically or empirically. Even more dramatic departures from public-finance orthodoxy are required, however, when inferences as to results are drawn. There is nothing analogous here to the competitive model, the use of which so greatly facilitates our elementary textbook predictions concerning the outcomes produced under voluntary exchange processes in the private-goods sector.


As suggested above, many economists have more or less jumped over the step of institutional theorizing in their analysis of markets, perhaps without fully realizing that they have done so. They are able to do this because the competitive-model assumptions yield predictions about outcomes that are not dramatically at variance with observation, tending thereby to corroborate both the assumptions and the conditional hypotheses. Despite all of the discussion about the unrealism of these assumptions, they remain paradigmatic for economists. Decisions on the demand-supply of public goods are made through political, not market, institutions, and there is no analogue to competitive order that eases the analytical task.


The same barrier between positive and normative theory is much more difficult to maintain when the demand-supply of public goods is introduced. Here the role of theory seems much more limited, and the analysis much less relevant to the observed world. The theoretical idealization analogous to the competitive order, that represented by Wicksell's unanimity rule for making group choices, is sufficiently removed from real-world experience so that it rarely serves even as a norm for policy action. Presumably, by contrast with the private-goods sector, the costs of attempting to approximate the ideal here are considered to be so great that wholly different norms must be introduced.


The reason is not difficult to find. A community of individuals decides to demand goods and services publicly through governmental-political processes, rather than privately, precisely because the bilateral exchanges facilitated by market arrangements are insufficiently inclusive. External effects are exerted on parties other than those directly entering into the market exchange, and these effects are considered to be relevant and important. "Exchanges," trades, agreements among all members of the community are deemed more efficient by these members. Multilateral agreements are, however, far more costly to negotiate than bilateral ones. In addition, the incentive for initiating negotiation leading toward agreement in such cases may be absent. These facts are evident to such an extent that it often appears as folly to make any attempt to examine the outcomes that genuinely voluntary exchange processes would produce in the theoretical idealization described by the unanimity rule. The limits of the voluntary exchange theory of the demand for and the supply of public goods are indeed narrow, especially when compared with its analogue, the theory of perfectly competitive markets.


Initially, the costs of negotiating n-person agreements are largely ignored. In a broader framework, and at a later stage, these costs must be introduced since they are essential to an understanding of the public economy. Analysis at this second stage must incorporate the costs of reaching agreements, or making collective decisions, and an economic theory of political constitutions developed. The individual's own recognition that, in the public-goods world, he is likely to be caught in an n-person analogue to the prisoners' dilemma will prompt him to agree to "workable unanimity" rules. He will trade off some efficiency (as measured by the standard criteria) in exchange for more efficient decision-making. The whole theory of political order becomes directly relevant to the demand and the supply of public goods, inclusively considered.


The analysis is developed progressively from the simplest models to complex ones. Chapter 2 examines the demand-supply of a single pure public good in the highly restricted two-good, two-person, world-of-equals model. Only the world-of-equals assumption is dropped in Chapter 3. The purity of the public good is abandoned in Chapter 4, and the analysis is extended to a many-person group in Chapter 5. The novel world where all goods are public is treated in Chapter 6. The problems presented by the publicness of any political decision are introduced in Chapter 7, and the specific institutions of fiscal choice are considered in Chapter 8. The interesting and important question that has been assumed to be central in much of the modern theory, Which goods should be public? is examined in Chapter 9. Suggestions for a positive theory of public finance are advanced in the concluding chapter.


One additional and final point should be made in this introductory chapter. The demand for and the supply of public goods are discussed throughout the book under the assumption that the community contains a specific number of persons. I shall neglect in this book the important set of issues that is introduced when attempts are made to determine efficient or optimal sizes of membership in sharing groups. I hope to develop some of the analysis of these issues in a later work.

Ch. 2, Simple Exchange in a World of Equals
Chapter 2Simple Exchange in a World of Equals

In this chapter we shall examine the demand and the supply of public goods in the simplest of models, one in which there are only two persons and two goods, one public and one private. To make simplicity absolute, we assume initially that the two persons are identical, both as to productive capacity and as to tastes. For convenience, we shall name these two persons Tizio and Caio, adding a touch of Italian flavor to the analysis. We may think of these two persons as being the only inhabitants of an island in the tropics. This allows us to use coconuts as the purely private good. Coconuts are available to each person upon a specific outlay of time spent in gathering them, and this outlay per coconut gathered remains constant over relevant quantities. Mosquito repelling is the other good (service), and this is purely public or purely collective. That is to say, the death of one mosquito benefits each man simultaneously, and is thus equally available to each man. The service of mosquito repelling is also continuously variable, and specific quantities can be secured by certain outlays of time on the part of either person. The cost per unit of output remains constant over relevant quantities.


Our purpose is to examine the process through which equilibrium in the demand and the supply of both the private and the public good is attained, and to define the characteristics of this outcome which will tend to emerge from the simplified two-person exchange process.


Figure 2.3. Click to open in new window.
Figure 2.3

The tools that are most familiar to traditional micro-economists are the geometrical constructions of Marshallian demand and supply, and these can be employed here in analyzing trade or exchange in the mixed world that contains both private and public goods. For expositional simplicity, it is necessary to neglect income-effect feedbacks on individual marginal evaluations of the public good. We assume continuous variation in the quantities of the two goods. Under these conditions, it becomes possible to derive a single marginal evaluation schedule or curve for the public good, measured in units of the private good, a schedule or curve that will not shift as a result of changes in the distributions of the net gains-from-trade in the public good. Such a curve is plotted as E in Figure 2.3. Because of our assumption that Tizio and Caio are identical with respect to both tastes and productive capacities, the construction is simplified greatly. This allows us to utilize the same marginal evaluation curve for each person. We can also draw in a curve that measures the marginal cost of producing the public good. For simplicity, we assume this to be uniform over varying quantities; this is drawn as MC in Figure 2.3.


How much will Tizio be willing to pay Caio for the latter's offer to undertake additional public-goods production? This is shown by Tizio's own marginal evaluation of the quantities beyond the amount 0 X1. Trading equilibrium is attained when demand equals supply, or at position B, where the output 0 X is produced, in this illustration wholly by Caio, and is consumed by both persons. At this trading equilibrium, the amount that Tizio is willing to pay Caio for the marginal extension of production is just equal to the minimal amount that Caio is willing to accept. There remain no unexploited gains-from-trade at the margin of adjustment. By our neglect of income effects, the distribution of the inframarginal gains-from-trade does not modify the position of trading equilibrium. Over the range of production between 0 X1 and 0 X, such gains may be shared in any one of many ways, depending on the relative bargaining strengths and skills of the two traders.

Ch. 3, Simple Exchange in a World of Unequals

His classic example involved the joint supply of meat and leather, to which he added wool and mutton, wheat and straw. (The relevant discussion here is found in Alfred Marshall, Principles of Economics, 8th Edition, pp. 388-390, and Mathematical Note XVIII, p. 854.) The producer or supplier of bullocks simultaneously meets two separate demands, that for meat and that for leather or hides. These final products, desired by different demanders, are jointly supplied in the process of breeding and growing steers, necessarily so, under Marshall's initial assumption that the relative proportions of the final products in each unit of supply are fixed. Meat and leather are, of course, demonstrably different products at the stage of final demand, different in a superficially descriptive sense. The single unit of supply embodies two separate units of consumption. And no observing economist would predict that the equilibrium price for the meat contained in one bullock (the unit of supply) need be equal to the equilibrium price for the hides contained in the same bullock.


We can review Marshall's analysis by converting it into our own, Tizio-Caio model of two-person, two-good exchange. Assume, as before, that both persons produce and consume coconuts privately. For our second good, however, let us now substitute bullocks for mosquito repellent. Tizio, we shall say, uses hides for clothing; Caio has no use for hides at all. On the other hand, Caio eats meat; Tizio does not. Under these assumptions, the jointly supplied unit is, in effect, a purely public good because of the technology of production. Strictly speaking, we should also require the additional restriction that withholding of unused product is somehow impossible. Note that the problem in this converted Marshallian supply situation has become in almost all respects identical to that discussed in the earlier mosquito repellent illustration. The fact that, at the final or ultimate stage of consumption, the consumption units appear descriptively different in one model and similar in the other is irrelevant. In equilibrium, Tizio's demand price for leather or hides plus Caio's demand price for meat, both defined in terms of the quantities contained in the unit of supply, must just be equal to the marginal supply price of the jointly-produced unit.


Marshall used his theory of joint supply to make predictions. He predicted that, under the restrictions of his model, a decrease in the demand for meat would tend to increase the equilibrium price for hides. We can do precisely the same thing with our public-goods model. In the two-person case, let us suppose that Caio becomes partially immune to mosquito bites; his demand for the commonly shared good falls. As a result, in any new equilibrium position, Tizio must contribute a larger cost of producing the good at the margin of adjustment. Or, conversely, suppose that Caio's demand should increase. Here, equilibrium output of the public good will increase and Tizio will find himself paying a somewhat lower marginal price.


Both in this chapter and in the one preceding we have introduced individual demand and/or marginal evaluation curves for a public good without careful definition. This gap must now be filled. The derivation of an individual demand curve or schedule for a private good is straightforward. The potential buyer is confronted, conceptually, with a set of all possible prices, and the maximum quantity that he stands ready to purchase at each price becomes a point in the schedule. In such a derivation, we assume that each offer embodies an equality between average and marginal price. That is to say, the individual demander is assumed to be faced with a series of supply schedules or curves, each of which allows him to vary quantity purchased without modifying average price. Without this critical assumption, no demand schedule for the individual could be derived, even for a purely private good. If, instead of uniform average-marginal prices, the buyer should be confronted with a set of separate "price offers" that contain varying relations between average and marginal price, no single-valued demand relationship between quantity demanded and either average or marginal price would exist. There would be no individual demand curve. Here the individual buyer would be in a position analogous to the monopolistic seller. In the latter case, there is no supply curve that may be derived. The monopolist faces, not a set of demand prices that are uniform over quantity (such as confront the competitive seller) but, instead, a set of demand schedules in the relevant market.


What has all of this to do with the derivation of an individual demand schedule for a purely public good? Can we not, at least conceptually, derive such a schedule in the same way that we derive the demand schedule for a private good? Can we not imagine that we confront the individual with a series of prices, uniform over the quantity range, and ask him what quantity he would prefer at each of these prices? Clearly such a procedure is possible, and we shall employ it in the following section. With public goods, however, this procedure is much more arbitrary than in the comparable private-goods model, and its usage may suggest apparent determinacy where none exists. In the world of private goods, most buyers of final products do face horizontal supply curves. The market economy operates to prevent the emergence of monopolistic quantity discounts or quantity premiums save in rare instances. For this reason an individual demand curve derived in the orthodox manner becomes a relevant tool of analysis. With public goods, by contrast, there are no institutions that prevent price discrimination over quantities, and such quantity differentials may well emerge from an open trading process. To analyze the demand for public goods, therefore, we need something akin to the orthodox demand curve but which possesses more general applicability.


Note that the marginal evaluation curve, ME1, does not tell us anything at all about how much the person would purchase at any other supply price or price offer. It is not, therefore, analogous to the demand curve in this general sense. The construction does enable us, with facsimiles of the Marshallian tools, to depict the characteristics of the final equilibrium position for the individual. Only in this sense does the marginal evaluation construction resemble that of the orthodox demand curve in the absence of further qualifying assumptions.


Figure 3.3. Click to open in new window.
Figure 3.3

This conclusion need not imply that we dispense with the simple Marshallian geometry. It does suggest that we handle the tools properly and with due caution. Does there exist a methodologically legitimate means of utilizing the familiar constructions to find equilibrium in the supply of public goods, given individuals' utility functions and the costs of the good to the community of persons? As is indicated above, in the general case where marginal-price uniformity cannot be assumed present and where income effects cannot be neglected, there is no such means. If used with proper caution, however, the arbitrary convention regarding marginal-price uniformity revitalizes the geometrical construction. Refer now to Figure 3.3. As before, assume that the public good is available to the community at constant marginal cost, indicated by the curve MC. We adopt the convention that tax-prices per unit of the good are to be uniform over various quantities for each person, although, of course, these need not be uniform as among separate persons. This step allows us to derive demand curves for the public good in the orthodox fashion. Conceptually, we simply confront each individual with the opportunity to "purchase" or to "vote for" a most preferred quantity at each price (marginal = average). These curves for Tizio and Caio are labeled D t and D c in Figure 3.3. (Note specifically that these are not marginal evaluation curves.) The information contained in these demand curves and the cost curve allows us to determine uniquely the efficient supply of the public good and the equilibrium set of marginal tax-prices that each person must confront. 0 X1 represents this quantity, and BX and CX the equilibrium marginal-average tax-prices. The determinacy here is introduced through our assumption as to the uniformity in tax-price over quantity. This assumption or convention, which is admittedly an arbitrary even if a reasonable one, allows income effects to be included in the model, but it does so only by guaranteeing one particular division of the gains-from-trade that are secured in producing the public good.

Ch. 4, Pure and Impure Public Goods

For simple illustrative purposes, think of such a good as bread. Under normal circumstances, a unit of this good, defined in physical units produced or consumed per unit time, can be transformed into only one consumption unit. That is to say, only one person can enjoy directly the benefits of a loaf of bread in a single time period. It is physically impossible for you and me to eat the same loaf of bread. Even here, however, we can analyze the attainment of trading equilibrium with the tools provided by the theory of pure public goods. The critical step is to define the good properly. Generically, "bread" is privately divisible among separate consumers, and we cannot apply the theory of indivisible goods to the demand and the supply of "bread" as so defined. We may, however, define the "good" that we propose to analyze in such a manner that it does embody the necessary indivisibility characteristics. To do so, all that is required is that we define our commodity in terms of identifiable units. In this example, define the good to be analyzed as "my bread." There will then be as many separate "my breads" as there are persons, all within the single generically defined commodity group "bread." But with this relatively simple definitional step, we can proceed to apply the theory without qualification.


Once again, it is useful to recall the theory of joint supply. This will allow us to introduce a simplification. The necessary condition for equilibrium is that the summed marginal evaluations of the consumption components must be equal to the marginal cost of the production unit. Apply this condition to the purely public good. The production unit, or unit of joint supply, provides or embodies n-consumption units, when n is the number of persons in the group. Since there is only one production unit, however, the analysis can be limited to this single unit dimension on the cost side. The same analysis may be extended readily to purely private goods, however, provided only that we make the same summation over persons on the cost side as we do on the demand side. The general condition necessary for optimality in all cases is that summed marginal evaluation equals summed marginal cost, with the units appropriately defined.


Again the theory of joint supply is helpful. To the extent that a good or service, as produced, satisfies more than one demand, we can measure quantity, not in homogeneous-quality consumption units, but in production units. And there is nothing inherent in the jointness of supply, per se, which suggests that different demanders need enjoy or have available to them homogeneous-quality units for final consumption. This point is, of course, made evident in Marshallian joint supply, where final consumption components may be demonstrably different in some physically descriptive sense (meat and hides). The point is less apparent, but equally valid, with reference to publicly supplied goods and services. In our fire protection example, suppose that a fire station is physically located nearer to Mr. A's residence than to Mr. B's. In terms of homogeneous-quality final consumption, these two persons do not enjoy the same quantity of fire protection. However, the services of the fire station, given its physical location, are equally available to both A and B, and, as joint consumers, they may be said to enjoy the same quantity of the public good, fire protection, so long as the latter is defined strictly in production or supply units.

Ch. 5, Many Private Goods, Many Persons

One stage of this remaining generalization is simple. No difficulties arise in shifting our attention from a world where one private good and one public good exist to a world where there are n private goods and one public good. This is the model within which much of the theoretical discussion of public goods demand-supply has taken place. The results are equivalent to those reached in the simplified two-good model. All that is required here is the selection of one from among the n private goods as a numeraire, that is, as a money commodity. Once this is done the model reduces to the two-good case as before, with the numeraire becoming a common denominator for all private goods. Actual and potential exchanges can be treated as transfers in the numeraire. In this respect, the "market" for the single public good is not different from that for any single selected nonnumeraire private good. All trades reduce to two-good dimensions. This acknowledged function of the money commodity has been emphasized for its efficiency-promoting results. The costs of exchange in a money economy are drastically lower than those in any comparable barter system. The dimensional aspect here has not, however, been so fully appreciated for its facilitation of elementary theorizing about the market processes. The use of money allows the economist, who has normally been concerned almost exclusively with private-goods exchange, to possess a "magic number," two, despite all of his sophisticated models covering many commodities.


Figure 5.1. Click to open in new window.
Figure 5.1

This distinction is illustrated in Figure 5.1, which is again the familiar Edgeworth-box diagram. Under two-person trade in isolation, the contract locus, jk, represents the set of all possible final equilibrium positions, given A as the initial point. At each position on this locus, the necessary marginal equalities hold; all gains-from-trade are exhausted. In shifting from A toward the contract locus, each trader is motivated to bargain, to behave strategically, in order to secure more favorable distribution of the available spoils. In an n-person situation the same two traders would tend to move swiftly along the single ray, r, to a unique point, g, on the contract locus, the slope of this ray being the price ratio between the two goods. This price is set externally, and, once set, it determines uniquely the solution to the "bargaining game" in which these two players would engage if they were isolated. The price ratio exerts this stabilizing and efficiency-generating influence because it represents the terms upon which each trader may exchange with outsiders, that is with alternative sellers-buyers. Clearly, neither trader will ordinarily give his direct opposite number much better terms than he can secure from others. Most of the structure of neoclassical price theory consists of inferential predictions about characteristics of rays along which exchanges take place; that is, with predictions about prices that will come to be established through the interplay of all the demand-supply elements in n-person, n-commodity markets.


Knut Wicksell produced an escape from the free-rider dilemma inherent in the large-number, public-goods interdependence. If the rule of unanimity should be applied, even in a relative or qualified sense, public goods will tend to be supplied efficiently. Analytically, this Wicksellian contribution provides a major step toward the development of a theory of the demand and the supply of public goods and services. In terms of the institutions through which choices are made in the real world, however, more relevant theory is yet required. To some extent, the Wicksellian contribution serves much the same function here as the economist's assumption of perfect competition in the theory of private-goods demand and supply. There is a major difference between the two devices, however, and this must be recognized. Again to an extent, something approaching the descriptive meaning of perfect competition can be shown to emerge from the interaction of individuals engaged in private market processes. Rarely will Wicksellian choice-making institutions emerge naturally from the rational decisions of individuals, even when we consider the appropriate stages of constitutional choice. Real-world observations suggest that considerations other than simple efficiency must loom large in dictating the rules for collective decision-making. The Wicksellian device is helpful, however, in establishing a benchmark from which possible sacrifices of first-order economic efficiency can be measured, at least conceptually. Subsequent chapters will explore some of the issues involved in developing a theory of public goods that seems better for explaining real-world events.

Ch. 7, The Publicness of Political Decisions

Individuals demand certain goods and services that they supply publicly through political rather than market organization. These goods enter as arguments in individual utility functions, and a theory of demand can be derived. The modern theory of public goods has been largely devoted to such derivation. If interpreted properly, this theory provides predictive hypotheses concerning the outcomes of collective decision processes under certain highly restrictive assumptions. At the same time and in a more familiar context, the theory provides allocative or efficiency norms for the provision of these goods and services. In either usage, the theory applies to any goods and services that are, for any reason, organized publicly. The technical characteristics of goods may and should influence the decisions on the appropriate organization of supply. This will be discussed more fully in Chapter 9. But the theory, as such, is appropriate to public organization for any good or service.


This "publicness" in the organization of supply requires further discussion. To the extent that decisions are made politically, regardless of their specific content, there are "public-goods" elements present. It is in this context that the theoretical exercises of Chapter 6 provide a useful bridge between the analysis of private demand and that of "public supply." In a world without a private-good numeraire, all decisions are necessarily public, whether these be concerned with the supply of particular goods or with rules that govern behavior. For this reason, in Chapter 6, quantities of public goods, issues and even candidates for elective office were often used interchangeably as the objects of collective choice; deliberate ambiguity was employed as a means of stressing the identity of the analysis in each case.


Within an income-wealth classification and given some specific rate structure, an individual's tax-share will finally be determined, not by his own particular demand for or evaluation of the public good (or public-goods bundles) but by his position in the private economy after he has made his tax-base adjustments. He is never in a position where he can react to the "offers" of others in any direct sense. He cannot express his public-goods preferences explicitly. He can, however, express these indirectly through the political process. He can, directly or through his participation (or nonparticipation) in electing representatives, approve or disapprove various tax-share vectors and various proposals for public-spending programs. Preferring high levels of public-goods supply, he will vote for larger spending projects and, perhaps, for tax-sharing arrangements that place higher shares on his own income-wealth class. As the analysis below will indicate, however, there is much less likelihood that individuals will positively approve increases in their own tax-shares.

Ch. 8, The Institutions of Fiscal Choice

The analytical models introduced in earlier chapters of this book are skeletons, as all useful analytical models must be. They are designed to isolate important relationships in any theory of the demand and supply of public goods. Such a theory must be supplemented with the data of experience before any genuine understanding of fiscal process can be achieved. This filling in, this discussion of the historical-institutional record, is a task for scholars whose competence differs from my own. Although this book is limited to the models of analysis, one aspect of the theory itself remains to be discussed. In keeping with the metaphor above, the ossification of the skeletons must be examined. Are there logical derivations or analytical reasons for the built-in rigidities in the institutions of fiscal choice? The theory of the demand and supply of public goods must be supplemented by a theory of fiscal institutions before our task is finished. Public goods are demanded and supplied through processes that are themselves selected at some stage and apparently for reason. We need to understand something of the logic of institutional choice even if we cannot discuss this in great detail.


The distinction between the theory of institutions, to be examined, and the theory of demand and supply, previously examined, is one that may not seem automatically relevant to economists. Familiar analogies drawn from everyday experience in private life may prove helpful, although, as with all analogies, they will also be misleading in parts. Consider a man whose apartment is located one block from a corner newsstand. His early morning time schedule is such that on some mornings, unpredictable as to dates, he has adequate time to read the morning newspaper with his breakfast. On other mornings he must rush to work without time for even so much as a headline glance. He may, on mornings when his time is not so scarce, walk down to the newsstand and purchase the paper. Or, alternatively, he may choose to have a paper delivered to his apartment every morning, even though he recognizes that on many mornings this paper will go unread. The standard theory of the demand for morning newspapers helps us to understand the behavior of this man generally as he decides whether or not to purchase newspapers. This theory needs to be supplemented, however, by a "theory of institutions" in order to help us understand his behavior in deliberately institutionalizing his choice, even though he recognizes that, in specific instances, the results will be inefficient.


In a large-number political setting, the only one relevant for considerations of public-goods demand and supply, the first set of institutions or rules to be examined are those that define the manner of arriving at group or collective outcomes. These institutions and/or rules, as a set, make up the political constitution. The approach suggested here allows us to examine existing and potentially alternative constitutional rules in terms of efficiency criteria that are similar to those used in orthodox economic analysis. This institutional choice approach makes it conceptually possible to derive an explanation for a political constitution from the choices of individuals as they participate in the basic decision process on the rules that determine the procedures of group choice itself.


One primary consideration must be the nature of the goods and services that the community is expected to supply collectively. As a preliminary to more detailed analysis, the hypothesis suggested is that general rules on tax-sharing are more acceptable when the goods and services to be publicly supplied provide general benefits rather than special benefits. This begs several questions concerning definitions, questions that have already been discussed in some detail earlier. Ignoring real-world relevance for the moment, assume initially that the community is expected to supply publicly only goods and services that yield equal flows of homogeneous-quality consumption services to each citizen. In this extreme model, individual demands for public goods and services will differ, but they will do so only because (1) income-wealth positions differ, and (2) utility functions differ. To ignore for the moment income-generated differences in demand, assume that all members of the community earn equal incomes and have the same wealth.


The analysis of existing and alternative tax-sharing and expenditure arrangements or rules in a long-period constitutional setting will not be carried out here. The discussion of this chapter has been limited to pointing out the relevance of this institutional analysis to any comprehensive theory of demand and supply of public goods and services. The fact that an analysis of the institutions of fiscal choice must be appended to the more restricted pure theory of public-goods allocation does not, of course, make the latter analysis irrelevant or unnecessary. The pure theory, which has been the subject matter of earlier chapters, must be essentially completed before institutional analysis can even begin. Even with the pure theory of public goods, much remains to be done, and the theory of fiscal institutions has only been developed in bits and pieces. For this reason, I have not, in this chapter, tried to analyze tax-sharing and budgetary rules in terms of specifically defined alternatives. I have not, for example, tried to examine the possible derivation of a rule for proportional income taxation as opposed to one for progressive income taxation. One of the important and largely incomplete tasks of fiscal research and scholarship is precisely this of applying the institutional-choice methodology to the whole range of potentially important fiscal alternatives.

Ch. 9, Which Goods Should Be Public

X = x1 + x2 + ... , + x n.

At the end of our scale, we include those goods and services that are "purely public," those that are perfectly indivisible as to benefits among the separate persons in the group. Here, if X is the total quantity available to the group, this same quantity is also available to each and every individual in the group,


X = x1 = x2 = ... , = x n.

All other goods and services are then arrayed between these two extremes in accordance with the relative importance of "divisible" and "indivisible" elements. For goods and services along the spectrum between the two extremes, no simple algebraic definition comparable to the familiar ones above is possible. As earlier discussion showed, the problem of defining units becomes important here. For current purposes, it is sufficient to think of all in-between goods as including both divisible and indivisible elements in varying ratios.

The Range of the Publicness Interaction


One major flaw in the scalar ranking of goods and services solely by the divisibility-indivisibility characteristic should be apparent. Goods and services will not hold the same rank in the scale as the size of the group changes. It is necessary to supplement the ranking by a second one that describes the range or limit over which the indivisibility characteristic, if it exists, holds. An example will clarify. It is probable that the benefits from mosquito spraying are almost wholly indivisible over the set of families living in one small suburb. It is equally clear that the benefits from mosquito spraying become fully divisible as among residents of suburbs in different outlying areas of the city. As in the case with the degree of divisibility, we may think of a whole scale or spectrum that defines the limits of the interaction. At the one extreme, again, we have the purely private, fully divisible good or service, where this interaction is defined as being limited to the single consuming unit, the person or the family. At the other extreme, we have the good or service that is fully indivisible as to benefits over a group that is, conceptually, of infinite membership.

A Summary Classification


Figure 9.1. Click to open in new window.
Figure 9.1

The two independent characteristics, degree of indivisibility and extent or range of indivisibility, may be represented in a single box diagram, Figure 9.1. Along the abscissa we measure the size of the interacting group. Along the ordinate we measure the degree of indivisibility, from zero at the origin to perfect indivisibility at the top. It now becomes possible for us to place any good or service somewhere in the box as it embodies these two characteristics.


The theory of public goods, as it was initially developed, tended to force all goods into the two sets represented at the origin on the one hand and at 0' on the other. Purely private or fully divisible goods and services that may be classified as falling at or near the origin may be put in category (1) for purposes of later analysis. Goods and services classified as falling at or near 0' may be put in category (5).


Three additional categories are noted in Figure 9.1, although no attempt is made to delineate precisely the areas of the figure to which these might refer. Category (2) includes those goods and services that are partially divisible, but which involve indivisibility or "publicness" elements only over a limited number of persons. Category (3) likewise includes goods and services that are only partially divisible. But here the publicness elements extend over a large number of persons. Category (4) covers those goods and services that are fully indivisible, or nearly so, but for which the range of indivisibility extends only over groups of limited size. Whole areas may be empty; few goods and services are likely to be found near the southeast corner of the diagram. It will be helpful to discuss the relevant categories falling between (1) and (5) in more detail.


(2) Partially divisible goods and services, with interactions limited to groups of critically small size  For a good or service that may be classified in this way, there must be some substitutability among consumption units, as among separate persons, but this is not one-for-one. If the total supply available to the group is fixed, the increase in consumption by one person will reduce the amount available to some other person, or persons, but not precisely by one unit, as in the purely private-good case, and not by zero, as in the purely public-good case. The "nonprivateness" extends, however, only over a relatively small number of persons. As the group size extends beyond these limits, all publicness elements vanish.


Examples of goods and services falling in this classification are those that involve small-number externalities. Fire extinguishers may be an illustration. A transfer of a fire extinguisher to my neighbor does not reduce my own fire protection from the extinguisher to zero, as would be the case with a purely private or divisible good or service. My neighbor's possession of the extinguisher continues to reduce somewhat the probability of fire damage to my property. However, this interaction is limited in range. The transfer of a fire extinguisher to someone who lives three miles from my house does reduce my own benefits from that extinguisher to zero, in which case the exchange becomes equivalent to that of a purely private good.


(3) Partially divisible goods and services, with interactions extending over groups of critically large size  This category includes the large-number externalities, or Pigovian externalities. There are both publicness and privateness elements in a good or service, but the publicness or indivisibility elements extend over a group that is critically large in size. An example is inoculation against communicable disease. The securing of a shot provides me with some privately divisible benefits but, also, it provides some benefits to all other potentially exposed persons in a large group. By comparison with the small-number interaction, in this instance many persons are effectively my neighbors. As we shall demonstrate later, the organizational-institutional differences between goods and services falling in (2) and (3) may be significant.


(4) Fully indivisible goods and services, but with interaction limited to groups of critically small size  This includes those goods and services that are characterized by the fact that there can be no increase or decrease in the quantity available for one person independently, so long as we are limited to groups of small size. Outside the common-sharing group, however, this pure publicness does not hold, and among separate small groups there may be no publicness elements at all.


Examples for this category are drawn from club-like arrangements, which provide the organizational norm for this set of goods and services. Swimming pools may be mentioned. The single pool may be equally available to all members of the swimming club, provided only that the size of the membership is limited.

Political-Group Size and the Structure of Property Rights


Before proceeding to use the classification scheme for purposes of trying to answer the organizational question posed in the chapter's title, two important additional qualifications must be introduced. Any actual classification of goods and services on the two-dimensional surface represented by Figure 9.1, along with the five numbered categories, must presume that the size of the overall political group is fixed exogenously and, also, that there is some existing structure of property rights.


The importance of the size of the political group can be shown easily. Suppose, initially, that the political group is of size P, that shown by the limits of interaction on Figure 9.1. Assume, now, that we classify a good as falling at point T, at or near the interaction limits. Suppose that the political unit is then incorporated into a larger jurisdiction of size 100 P. Clearly, the good falling at T no longer falls within category (5) or even nearly so. The extension in the size of the group has, in effect, shifted the classification from (5) to (4).


The relevance of some existing structure of property rights for any such classification scheme is also evident, but this is not so readily demonstrable. We may introduce an example. If the existing property laws do not allow landowners to prosecute poachers, then all wooded areas are indivisible among many potential users. "Hunting land" would be classified as falling, say, at R, high on the indivisibility spectrum. On the other hand, if landowners can prosecute poachers, hunting land may be shifted to R', much lower on the divisibility scale.


For our purposes, we may specify simply that the size of the political group as well as the structure of property rights are fixed exogenously. This allows the two-dimensional classification of Figure 9.1 to be made without major inconsistencies or contradictions.

The Functions of Organization


Before we proceed to utilize this classification in answering the basic organizational question, it is helpful to recall the functions that any organization of supply must perform. Varying somewhat the familiar listing in Chapter 2 of almost every elementary economics textbook, these functions may be listed as follows:

1. determination of how much to produce—the allocation function
2. determination of how to cover the costs—the financing function
3. determination of how to distribute the benefits—the distribution function.

We shall, for simplicity, refer to these three functions as those of allocation, financing and distribution. The institutional-organizational structure selected, whether this be public, private or in-between, must perform all of these functions, jointly or separately.

A Pure Distribution Model


In order to simplify our analysis and to get somewhere with our two-dimensional classification, let us isolate only one of these three functions, that of distributing the benefits among persons. To do this, we resort to a highly unreal model that involves only the distributive function. Assume that goods and services falling anywhere on the classification matrix of Figure 9.1 are provided externally to the choosing group in fixed quantities. By this manna-from-heaven assumption, we rule out both the allocation and the financing problems.


What does the classification tell us about the problem of distributing supplies of goods and services among separate persons in the group?


Look first at goods and services classified in category (1). Unless the total amount supplied is sufficient to satiate the demands of all members of the group, there will arise some problem of distributing the scarce quantity among the separate users. If property rights are initially assigned to individuals in some fashion not related to their own evaluations, and if utility functions differ, efficiency criteria dictate that some transfers take place among separate persons. If a fully divisible numeraire good exists, trades among persons can be expected to emerge almost automatically. A pricing structure will arise out of the ordinary utility-maximizing behavior of individuals.


For goods and services that are roughly classified in category (2), there will exist some problem of distribution, both within the limits of the indivisibility interaction (which here is only partial) and among the separate small groups. A pricing-exchange system can be predicted to emerge to insure the resolution of the second of these problems in a manner equivalent to that for goods in (1). Within the limits of the small group itself, the partial indivisibility or publicness of the good or service requires that some bargained solution to the distribution problem be reached. Strategic behavior along with negotiating costs may prevent this in-group function being efficiently performed, but pressures toward efficiency will always be present. This case may be illustrated by the fire extinguisher. Suppose that the fixed quantity made available for distribution to the inclusive group, of size N, is N/5 . How will this quantity come to be distributed both among and within small subgroups? Initially, we may presume that individuals will give consideration to the privately divisible elements inherent in the good. A market structure will emerge that will distribute the fire extinguishers to those consumers who place the highest evaluations on these, as privately divisible commodities. Such a distribution will not, however, take into account any of the spillover elements in benefits. All residents in some areas may possess fire extinguishers, and no residents in other areas. Faced with this prospect, we should expect cooperative small groups to form and to bid among themselves and among individuals for the scarce quantity. This will take place until some distribution is achieved that does take the benefit spillovers into account. Within the limits of each cooperating group, however, there remains a distribution problem. In whose residence shall the fire extinguisher be located? This must be the subject of negotiations within the group, and exchanges or compensations can be expected to resolve the issues. But significant negotiation costs are likely to arise.


Let us now examine goods and services that are classified in (4), leaving aside for the moment those in (3). For (4), the degree of indivisibility is great, but the range of the interaction is small. These goods are purely public but only for a small group of sharers. These are club-type goods and services, and we should expect sharing clubs to emerge as the appropriate organizational arrangements. Consider this in the context of our pure distribution model. Suppose that the quantity of a good made available to the all-inclusive political group is again N/5 . Although a bit far-fetched here, let us remain consistent and use the swimming-pool example.


As with (2), we should expect prospective swimming clubs to be formed and to bid against each other, in units of a numeraire, until some distribution of the available pools is achieved. Within each sharing group, however, there will be no problem of distribution. This sharply distinguishes category (4) from (2). If, by classification, the goods fall in (4), there are no privately divisible elements present within the common sharing group, and, hence, the individual's utility cannot be affected by in-group distributional variations.


Remaining within the pure distribution model, we must now examine goods and services falling in category (3). Some problem of distributing any scarce quantity of a good will arise here because, by definition, there are privately divisible elements along with publicness elements. Given any fixed total quantity available to the inclusive group, along with some structure of property rights in this quantity, we should expect that an exchange system would emerge. Individuals would trade among themselves, in units of a numeraire, until the scarce quantity is distributed in accordance with the relative evaluations placed on the privately divisible elements.


As distinct from goods in category (2), however, no further voluntary behavior on the part of individuals could be expected to emerge. Somewhat paradoxically, the distribution in accordance with the relative evaluations placed on the privately divisible elements alone will be efficient, at least in the limiting model. Consider an example of inoculations for a communicable disease. The scarce supply comes to be distributed in accordance with the private-goods aspects alone; spillover benefits are wholly neglected. However, because the publicness elements extend over the whole of the large group, and because every person secures a spillover benefit equal to every other person no matter who gets an inoculation, no distributional change will modify the utility secured from the spillover benefits. This seemingly paradoxical conclusion holds only to the extent that a change in the distribution does not, in itself, modify the basic characteristics of the good itself. *10


There remain only those goods and services that are found in category (5) in our two-dimensional classification. These are the polar public goods in which there are no privately divisible elements and for which the range of indivisibility is sufficiently large to include the whole of the membership of the political community. A useful statement can be made about such goods and services in this pure distribution model. The distribution problem wholly disappears. In fact, one means of defining a purely public good is to say that distribution costs are zero. Since, by definition and classification, the benefits are wholly indivisible among all members of the group, there will arise no problem of distributing the quantity that is available. The purely public good in this polar sense becomes equivalent to a "free good." This does not imply that individual demands for the good are satiated. Individual marginal evaluations may all be positive, but, so long as the benefits are wholly indivisible, no in-group pricing structure will emerge.


This approach emphasizes the inefficiency that must arise if any attempt is made to impose user prices on such a good or service. Since no problem of distributing scarce supplies among separate persons arises, any attempt at user pricing would be equivalent to converting such a good into one that falls within one of our other categories. However, this is only one of the sorts of inefficiencies that must be considered in any organizational comparison. We shall refer to this as distributional inefficiency.

Allocation and Financing


The pure-distribution or manna-from-heaven model has been discussed in some detail because it provides a helpful preliminary stage in using the two-dimensional classification scheme developed. It is only a preliminary stage, however, and the assumptions must be abandoned before serious organizational comparisons can be made.


Assume now that units of any good or service, falling anywhere in our classification, can be secured, from either domestic or foreign sources, at constant cost. (Our theory of public goods is sufficiently complex as it stands without introducing the additional problems that arise when decreasing or increasing costs on the production or supply side are present.) Assume further that this cost per unit is invariant over the separate organizational alternatives that are to be examined.


In this modified model, the organizational arrangement that is finally chosen for any good or service must perform the other two functions in addition to the limited distributional task isolated in the previous section. Some means must be found for determining how much of the good is to be provided; some allocation of resources to this good must be made. The securing of resources involves costs, and some means must be found for covering these; the financing function must be performed.


In the model which isolated the distribution function, it was shown that some market or pricing system would tend to emerge even in the performance of this limited task, at least for all goods save those in category (5). To the trained economist, orthodox micro-economic theory suggests that market or pricing structures can perform the other two functions simultaneously.


With goods and services that fall either in category (1), (2) or (4), collective or public activity in the strict sense may be limited to some establishment and enforcement of property rights, including contracts, and some policing of market structures against fraud and monopolistic combination. To an individual who tries to make the appropriate institutional-organizational comparison at some conceptual constitutional stage of decision, it seems unlikely that collective supply in the standard sense would be appealing for goods and services so classified. And if, for any reason, governmental organization is selected, efficiency criteria would dictate a structure that would closely parallel the working of a market.


Serious consideration for explicit collectivization of supply seems likely to be limited to goods and services that are descriptively classified in categories (3) and (5). Goods and services in (3) contain both privately divisible and indivisible elements. An efficient organizational structure may embody some direct user pricing to facilitate the distributional task. To the extent that user pricing is employed, all three functions are simultaneously performed. Revenues are collected from consumers, and the total of these provides some indication as to the total quantity to be purchased by the community. However, precisely because of the publicness or spillover effects simple efficiency criteria dictate that exclusive reliance on direct user pricing may be undesirable. In a broad institutional setting, more complex efficiency criteria may still suggest exclusive reliance on direct user pricing. This would be the case when the commonality or publicness features are relatively insignificant. In such situations, organizational arrangements will not be different from those for goods in the categories (1), (2) and (4). These arrangements can be predicted to emerge from the voluntary interactions of individuals in trading processes.


But when the commonality elements are considered to be significant, direct user pricing may be supplemented by tax-pricing. This combination necessarily implies that the organization of supply be collectivized, at least in the financing sense. The activity now lies within the domain of "public finance." Examples have already been mentioned, but these can be recalled here. Inoculations against communicable diseases may be provided at nominal fees to the individuals getting the shots, but the main share of the costs of financing the program of immunization may be tax financed. Other examples may be public park facilities, garbage collection services, soil erosion for farmers, college education.


There remain the goods and services classified in category (5). These are purely public with the interaction extending all over members of the politically organized community. In some in-group behavioral sense, these goods are "free." No problem arises in distributing any given supply among individual consumers, since, by definition, each consumer has available to him the full quantity provided. No allocation of shares is necessary.


Concentration on the divisibility characteristic and on the distributional problem alone might suggest that collective organization of supply is strongly implied for such goods and services. A priori, no such implication can be derived. No presumption can be established for either of the two broad institutional alternatives. The necessity that any organization perform the allocative and financing functions, along with the distributive one, removes any apparent presumption that collective organization is necessarily more efficient.


As we have previously shown, any attempt to charge prices for goods classified under (5) must involve distributional inefficiency. The marginal cost of allowing users access to the good is zero; efficiency criteria at this level dictate that the supply should be collectivized and "given away" to all potential users. But let us suppose that attention to these criteria of efficiency causes a good or service to be collectively organized. A decision is made to provide the good free to all users. Somehow the community must also determine how much to supply, and how to finance this quantity. If no user prices are to be charged, resort to the taxing mechanism is necessary. Any real-world taxing scheme must involve its own inefficiencies. The economist's benchmark of the lump-sum tax remains just that, an economist's benchmark. Any tax financing must produce the familiar excess-burden inefficiencies.


Additional inefficiencies are also likely to arise when the allocational decision is faced. If the supply is organized collectively, the allocation question must be settled, finally, by resort to some rule for making collective or group choices. Since separate individuals are likely to prefer different quantities of the good provided, under almost any taxing scheme, and since all persons must adjust to the same quantity, some persons are likely to be disappointed in each direction. For some individuals, the group choice will determine a level of public-goods provision that is below preferred levels. For other individuals, the level will be above preferred levels. These allocational inefficiencies must be considered along with the financing and distributional inefficiencies in any final organizational comparison.


If the provision or supply of a good is collectivized, the distributional efficiencies are reduced to zero in the case of the polar public good. But both financing and allocational inefficiencies emerge. If, on the other hand, arrangements are introduced which, in effect, convert the category (5) good into one that is privately divisible, distributional inefficiencies are necessarily introduced. Against this, however, the conversion of the good into one that allows for direct user pricing tends to reduce both the financing and allocational inefficiencies. To the extent that user financing replaces tax financing, the excess burden is reduced. And to the extent that revenues collected from users provide a criterion for determining the quantity of good provided, no explicit resort to a uniformly imposed and collectively chosen quantity is indicated.


The summary results of this analysis suggest that comparisons must be made on a case-by-case basis, even for goods and services that independently qualify as purely public in the category (5) sense. For such goods and services any attempt to introduce user prices will exclude some persons from access although the real costs of such access to the community do not exist. On the other hand, financing such goods through a tax structure and determining the quantity through a political-choice process introduce inefficiencies of other sorts. By necessity, comparisons are made in a world of second bests.

Public Supply and Public Production


In one sense, the title of this book may seem misleading despite the warning in the Preface. "The Demand and Supply of Public Goods" remains a discussion of demand with little reference to the organization of supply. This comment is relevant to this chapter where the basic elements of a theory of organizational choice are discussed. Here we have referred to public or collective organization of public-goods supply, but precisely what does this mean? Collectivization, or public organization, refers to the provision of the good, its financing and its distribution among separate demanders. Nothing in the discussion implies anything at all about the actual organization of production. Whether or not the good is purchased from privately organized firms and individuals in the domestic economy, purchased from privately or publicly organized supplying agencies abroad, or produced directly by government itself should depend on an efficiency calculus which compares these various alternatives. Collectivization of the supply, to meet individuals' private demands, says nothing about the relative efficiency of producing the good in any one of the several ways. This is a self-evident point, and it would not be necessary to mention here were it not for the widespread confusion that seems to exist.


The advantages of collectivization of supply, to be compared with the advantages of the institutional alternatives, stem from the possible indivisibility of a good or service over separate persons as demanders. This indivisibility, which arises in the consumption or utilization of a good or service, should not be confused with the more orthodox type of indivisibility that arises only in production, that which extends over discrete units of production. It is the second type of indivisibility that may exert some influence on the efficiency of organizational alternatives in producing the good. Once a decision is made to collectivize the supply of a good or service, the choice among alternative means of producing this supply is important, and careful analysis is required. This analysis, however, does not properly belong to the theory of public goods as we have interpreted it here.



This chapter has done little more than introduce some of the complexities of the question posed in its title: "Which Goods Should Be Public?" Any positive approach to this question must proceed on a case-by-case basis and provisional conclusions reached only after careful comparison of institutional alternatives in the broadest sense. The descriptive characteristics of a good or service, the technology of common-sharing and the range of such sharing, are important determinants of organizational efficiency. Care should be taken, however, not to presume that these characteristics, taken alone, allow a priori judgments to be made. The pound of ceteris paribus must be used with caution here, since other things are not at all likely to remain equal over the institutional variants that may be examined. The predicted working properties of the institutional structures, imposed as constraints on individual behavior, must be evaluated.


The modern theory of public goods, as it is widely interpreted, tends perhaps to overemphasize the descriptive characteristics of a good or service as a determinant of the efficient organizational arrangements to the neglect of other relevant factors. Analysis must start somewhere, however, and the modern theory can be extremely useful in providing the foundations upon which a more complete analysis can be built. Hopefully, some elements in such extended analysis have been suggested here, but this short book cannot include more than this.

Bibliographical Appendix


The recent exchange between Jora R. Minasian and Paul A. Samuelson is directly relevant to the question posed in Chapter 9 [Minasian, "Television Pricing and the Theory of Public Goods," Journal of Law and Economics, VII (October 1964), 71-80; Samuelson, "Public Goods and Subscription TV: Correction of the Record," Journal of Law and Economics, VII (October 1964), 81-84]. Otto A. Davis and Andrew Whinston have also provided a recent contribution ["On the Distinction Between Public and Private Goods," American Economic Review Proceedings, LVII (May 1967), 360-73]. The paper by R. N. McKean and Minasian also bears on some of the points ["On Achieving Pareto Optimality—Regardless of Cost," Western Economic Journal, V (December 1966), 14-23].


Other works that may be cited refer less directly to the central question and for the most part these analyze goods and services falling within particular sub-categories of the classification scheme presented. The recent work on small-number externalities by R. H. Coase deserves special mention ["The Problem of Social Cost," Journal of Law and Economics, III (October 1960), 1-44]. Other works in this same area of analysis include papers by James M. Buchanan and Wm. Craig Stubblebine ["Externality," Economica, XXIX (November 1962), 371-84]; by Ralph Turvey ["On Divergencies Between Social Cost and Private Cost," Economica, XXX (August 1963), 309-13]; by Davis and Whinston ["Externalities, Welfare, and the Theory of Games," Journal of Political Economy, LXX (June 1962), 241-62].


Large-number externalities, goods and services classified under (3) in Chapter 9, have been the subject of much practical interest in terms of air pollution and water pollution. Only a limited amount of this discussion is of theoretical interest, but especial note should be made of the works by Allen V. Kneese [ The Economics of Regional Water Quality Management (Resources for the Future, 1964); "Quality Management of Water Supply," in The Public Economy of Urban Communities, edited by J. Margolis (Resources for the Future, 1965), pp. 170-91].


Three papers explore the predicted differences in results under different forms of organizing the provision of impure public goods [James M. Buchanan and Milton Z. Kafoglis, "A Note on Public Goods Supply," American Economic Review, LIII (June 1963), 403-14; James M. Buchanan and Gordon Tullock, "Public and Private Interaction Under Reciprocal Externality," in The Public Economy of Urban Communities, edited by J. Margolis (Resources for the Future, 1965), pp. 52-73; Wm. Craig Stubblebine, "Institutional Elements in the Financing of Education," Education and the Southern Economy, edited by J. W. Mackie, Southern Economic Journal Supplement, XXXII (July 1965), 15-34].


The problems raised by limited publicness in the spatial sense, where the range of common consumption does not extend over the entire area of the inclusive political jurisdiction, has been explicitly discussed by Albert Breton ["A Theory of Government Grants," Canadian Journal of Economics and Political Science, XXXI (May 1965), 175-87]. Some implications of this problem in a slightly different context are discussed in my paper ["An Economic Theory of Clubs," Economica, XXXII (February 1965), 1-14]. Some of the models developed by Mancur Olson are also relevant here [Mancur Olson, The Logic of Collective Action (Cambridge: Harvard University Press, 1965)]. In a somewhat more general setting, Mark Pauly has examined some of the organizational problems for goods in the (4) category with tools of modern game theory ["Clubs, Commonality, and the Core," Economica, XXXIV (August 1967), 314-24].


Some aspects of public-goods theory in application to local government finance are found in papers by Charles Tiebout and by Alan Williams [Tiebout, "The Pure Theory of Local Expenditure," Journal of Political Economy, LXIV (October 1956), 416-24; "An Economic Theory of Fiscal Decentralization," in Public Finances: Needs, Sources, and Utilization (National Bureau of Economic Research, 1961), pp. 79-96; Williams, "The Optimal Provision of Public Goods in a System of Local Government," Journal of Political Economy, LXXIV (February 1966), 18-33].


The degree of divisibility over units of production is relevant to the organization of production. Given full divisibility of this sort, production of a good may be competitively organized even if the supply is fully collectivized. By combining full divisibility in this respect with complete indivisibility among separate consumers, Earl Thompson has developed an extremely interesting variant of the standard public-goods theory. Under this combination of circumstances, he argues that collectivization is not suggested, even for the usual "market failure" reasons, because competitive sellers of the good will offer their services, unit by unit, to the common demanders and they bid prices down to such an extent that an oversupply rather than an undersupply will be generated. Here collectivization as an alternative institutional form might arise for reasons just opposite to those presumed relevant in the orthodox treatment. This model seems to be of limited relevance in the general case, but it may be applicable to particular kinds of public goods, notably those relating to research and education. This summary is offered as my own interpretation of Earl Thompson's complex analytical model [ The Perfectly Competitive Allocation of Collective Goods, MR-49, Institute of Government and Public Affairs, University of California, Los Angeles, September 1965].


Neither in this book nor in most of the recent discussion is a distinction made between public goods as consumption goods, and public goods as intermediate goods that enter into the production of final private goods. The theory, in its essentials, is not modified, but this distinction has been precisely formulated by Keimei Kaizuka ["Public Goods and Decentralization of Production," Review of Economics and Statistics, XLVII (February 1965), 118-20].

Ch. 10, Toward a Positive Theory of Public Finance

These questions, and other similar ones that could be raised, can only be answered in part and guessed at in the large. Socialist and nonsocialist scholars alike tended to accept the dichotomy between the public and the private sectors of the economy. Socialist proposals aimed at shifting the private production of private goods to collective management. Few questions were raised about "public" supply of "public" goods, for the most part, those which had been collectivized from the outset. This sector was not, presumably, subject to economic analysis; it received little attention from socialists or nonsocialists. In this sector, decisions were presumed to be made "politically" and not to be subjected to the analysis applied to decisions on the demand and supply of private goods, whether these should be provided in markets or by governments.


In conclusion, I return to the first paragraph of this chapter. The theory of "The Demand and Supply of Public Goods" remains in a preparadigm stage of development. Herein lies its current interest. Also for this reason, no single treatment or presentation is likely to command universal assent among informed scholars nor is it likely to be free of its own ambiguities, confusions and contradictions. This book is surely no exception. It is based on my current (February 1967) interpretation of the central subject matter. On the basis of my own experience in discussing these materials in graduate seminars for more than a decade, I can make only one prediction with certainty. My own views and interpretation in 1977 will not be in full accord with those presented in this book.