ADJUSTMENT, SHORT-RUN AGGREGATE MARKET: Disequilibrium in the short-run aggregate market induces changes in the price level that restore equilibrium. If the price level is above the short-run equilibrium price level, economy-wide product market surpluses cause the price level to fall. If the price level is below the short-run equilibrium price level, economy-wide product market shortages cause the price level to rise. In both cases short-run equilibrium is restored. You might want to compare adjustment, long-run aggregate market. Price level changes induce changes in both aggregate expenditures and real production. Unlike the long-run aggregate market, changes in the price level can induce changes in short-run aggregate supply, making it greater or less than full-employment real production.
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The economy produces four distinct types of goods based on two key characteristics -- consumption rivalry and nonpayer excludability. Consumption rivalry arises if consumption of a good by one person prevents another from also consuming. Nonpayer excludability means potential consumers who do not pay for a good can be excluded from consuming. Private goods are rival in consumption and easily subject to the exclusion of nonpayers. Public goods are nonrival in consumption and the exclusion of nonpayers is virtually impossible. Near-public goods are nonrival in consumption and easily subject to exclusion. Common-property goods are rival in consumption and not easily subject to exclusion. Private goods can be efficiently exchanged through markets. Public, near-public and common-property goods cannot, but require some degree of government involvement for efficiency. The means of efficiently allocating scarce resources to the production of goods consumed by members of society ultimately depend on the type of good produced. All goods are not created equal when it comes to efficient allocation. Some types of goods can be efficiently allocated through market exchanges. Other goods require some degree of government involvement to achieve efficiency.
The reason underlying these differences rests with two characteristics of goods -- consumption rivalry and nonpayer excludability. For some goods, the consumption of a good by one person prevents the consumption by another. For other goods, several people can consume the good simultaneously. For some goods, nonpayers can be readily excluded from enjoying the benefits of consumption. For other goods, nonpayers cannot be excluded from consumption.
Different goods combine these two characteristics of consumption rivalry and nonpayer excludability in different ways, giving rise to four distinct types of goods produced and consumed throughout society. The four goods are private (rival consumption and nonpayers can be excluded), public (nonrival consumption and nonpayers cannot be excluded), common-property (rival consumption and nonpayers cannot be excluded), and near-public (nonrival consumption and nonpayers can be excluded).
This distinction might very well be lost on the cantankerous and fictional Roland Nottingham, founder of the Shady Valley Public Sector Reform League. He might think that the Shady Valley city government (and all governments for that matter) exists only to make his life difficult and possibly create employment for the incumbent Mayor (and his arch enemy) Victor Thurgood. But such is not the case.
The hypothetical government of Shady Valley functions to provide citizens with assorted goods and services. Some of the goods provided by the Shady Valley government would not exist otherwise. Others would not be provided as efficiently though markets.
While private goods are ideally suited for market exchanges, public goods require direct government production. Common-property goods need government oversight for efficiency and near-public goods can be traded through markets, but efficiency necessitates government provision.
Two CharacteristicsRoland Nottingham might be surprised to discover that governments (the public sector) can provide some types of goods more efficiently than markets (the private sector). The reason rests with two characteristics that differentiate goods -- consumption rivalry and nonpayer excludability.
- Consumption Rivalry: This characteristic indicates whether the consumption of a particular good by one person prevents simultaneous consumption by another person. In other words, it poses the question: does consumption by one impose an opportunity cost on others? Rival consumption occurs if the consumption by one imposes an opportunity cost on others because others are prevented from consuming the good. For example, when the cantankerous Roland Nottingham enjoys a delicious chocolate covered, caramel nougat filled candy bar, then Mayor Victor Thurgood is prevented from enjoying this tasty treat. Nonrival consumption occurs if the consumption by one does not impose an opportunity cost on others because others are not prevented from consuming the good. For example, when Roland Nottingham gazes upon a spectacular Shady Valley celebratory fireworks display, doing so does not prevent Victor Thurgood from also enjoying this sight.
- Nonpayer Excludability: This characteristic indicates whether or not nonpayers, those how have not paid, can be excluded from consuming a good. Nonpayer excludability is based on the ability to possess and transfer property rights or ownership of a good. For some goods, nonpayers can be easily excluded from consumption because property rights are well-defined and easily controlled. Roland Nottingham has legal ownership of his chocolate covered, caramel nougat filled candy bar and can exclude nonpayers such as Victor Thurgood from gaining possession. For other goods, nonpayers cannot be easily excluded from consumption because property rights are not well-defined and cannot be easily controlled. The spectacular Shady Valley celebratory fireworks display can be enjoy by anyone and everyone in Shady Valley, including both Roland Nottingham and Victor Thurgood, whether or not they pay.
Matching up consumption rivalry and nonpayer excludability in alternative combinations gives rise to four distinct types of goods. Much to the consternation of Roland Nottingham, three of the four goods are pivotal to the study of public finance and help to explain the very existence of governments.
The chart to the right presents a two-by-two matrix that combines these two characteristics. At the left is consumption rivalry (rival and nonrival) and along the top is nonpayer excludability (yes or no). The four goods contained in this chart are private (top left), public (bottom right), common-property (top right), and near-public (bottom left).
- Private: Private goods are characterized by rival consumption and the ability to exclude nonpayers. Such goods have well-defined property rights that can be transferred to others, but only if others pay to acquire ownership. Private goods can be easily, effectively, and efficiently exchanged through markets. Examples of private goods range far and wide, from Roland Nottingham's candy bar to cars to comic books to Victor Thurgood's corduroy sport coat. Most, not all but most, goods traded through markets are private goods.
- Public: Public goods are characterized by nonrival consumption and the inability to exclude nonpayers. These goods are, in essence, owned by everyone, which is actually okay because everyone can benefit from simultaneously consuming the goods. Public goods cannot be exchanged through markets. The only efficient way to provide public goods is through governments. Examples of public goods include first and foremost national defense, as well as public health and environmental quality. Many, not all but many, of the services provided by governments (the "public" sector) fall in the category of public goods.
- Common-Property: Common-property goods are characterized by rival consumption and the inability to exclude nonpayers. These goods are owned by everyone, meaning property rights are not controlled by anyone in particular. Even though consumption by one imposes an opportunity cost on others, one person cannot prevent another from consumption. These goods cannot be efficiently exchanged through markets and governments are often called upon to control their use. The best examples of common-property goods come from the assorted natural resources available to the planet, including the atmosphere, oceans, lakes, rivers, and wilderness areas. Because individuals and businesses in the private sector cannot effectively exclude nonpayers from consumption, governments step in to regulate and oversee the use of common-property goods.
- Near-Public: Near-public goods are characterized by nonrival consumption and the ability to exclude nonpayers. While nonpayers can be excluded from consumption, nonrival consumption means there is no efficiency reason to do so. These goods are often exchanged through markets but also provided by governments. Markets exchange near-public goods because they can, but government provision is needed for efficiency. Examples of near-public goods exemplify the provision by both the public and the private sector, including education, transportation, and communication. In some cases governments and markets compete in the provision of near-public goods (education) and other cases they work as partners (air transportation).
The Free-Rider ProblemThe inability to exclude nonpayers from the consumption of public goods (as well as common-property goods) gives rise to what is termed the free-rider problem. As the name suggests the free-rider problem means that people are able to effectively "ride" the benefits of a good for "free," without paying. This is a problem for the efficient allocation of resources.
Consider the case of national defense. By design, national defense protects EVERY member of society. If the country is protected from enemy attack, then EVERYONE is protected from enemy attack. There is no discrimination based on who pays and who does not. As such, voluntary payment for this good is unlikely to generate sufficient revenue to finance production. The inability to exclude nonpayers means that nonpayers can ride the benefits for free.
Suppose, for example, that Roland Nottingham's "voluntary" payment for his share of national defense is $100. If Roland spends $100 on national defense, then he receives national defense. However, if he decides to spend this $100 on a private good such as a rocking chair for his front porch (ideal for yelling at neighborhood kids), then he can have both the rocking chair and national defense. He's better off spending his $100 on the rocking chair then riding the benefits of national defense for free.
The problem arises because everyone else is bound to think the same way. The voluntary payment for national defense will not generate sufficient revenue to pay for production. As such, the only way to pay for such goods is through coerced or forced payments, that is government taxes.
Markets and GovernmentPrivate goods are ideally suited for efficient market exchanges. Nonpayers can be excluded from consumption and they should be. Efficiency is achieved if those who consume a private good pay a price equal to the marginal cost of rival consumption imposed on others.
Public goods, in contrast, scream out for the coercive powers of government. Nonpayers cannot be exclude from consumption nor should they. Efficiency dictates that price be set equal to marginal cost. However, because nonrival consumption means the marginal cost is zero, so too should be the price. Tossing in the free-rider problem means that nonpayers won't voluntarily pay a nonzero price in the first. Unfortunately if no one voluntarily pays, then the only way to finance the production of public goods is through the coercive powers of government taxes.
Common-property goods also need government intervention. Rival consumption means marginal cost is greater than zero. Efficiency is served if users then pay a price equal to marginal cost. Unfortunately the inability to exclude nonpayers means that a price cannot be charged. Then end result is that common-property goods are overused or overconsumed. In the case of many natural resources, such as the atmosphere, oceans, and wildlife, they can be overconsumed to the point of complete exhaustion. Governments need to regulate their use. In some cases they can do so effectively and efficiently. In other cases they can not.
Near-public goods with the ability to exclude nonpayers can be and are commonly exchanged through markets. Unfortunately, like public goods nonrival consumption means the marginal cost is zero and efficiency is achieved if the price is also zero. This mixed up nature of near-public goods, sort of a public good, but also sort of a private good, generally leads to controversy. Some contend that if private businesses can sell near-public goods through markets, then governments need not be involved. Others see the government revenue generated from selling near-public goods as a means of lessening the tax burden on the public. Moreover, fairness seems served in that those consuming are also the ones paying for near-public goods.
Unfortunately the controversy over the provision of near-public is bound to persist as long there are near-public goods.
GOOD TYPES, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2024. [Accessed: March 5, 2024].
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