The Lighthouse in Economics Pt. 3

Coase's "The Lighthouse in Economics" (1974)

• The lecture discusses Coase's critique of traditional public good analysis, focusing on the lighthouse as an example.

What is Coase's concern?

• Coase critiques the traditional analysis of public goods by Pigou and Samuelson.
• Public goods possess two key characteristics: non-rivalry in consumption and non-excludability.
• Non-rivalry means one person's use does not diminish another's utility, with a marginal cost of zero for additional users.
• Non-excludability exists when preventing non-payers from accessing the good is economically or technically unfeasible.

Classification of Goods

• Private goods are rival in consumption and exclusion is feasible (e.g., bread, beer, cars).
• Common pool resources are rival in consumption, but exclusion is not feasible (e.g., oceans, city streets).
• Club goods are non-rival in consumption, and exclusion is feasible (e.g., golf courses, swimming pools, pay-TV).
• Pure public goods are non-rival in consumption and exclusion is not feasible (e.g., national security, common standards, environmental goods, radio).
• Pure public goods are non-rivalrous without limits.
• Impure public goods can become rivalrous once a certain capacity is reached (e.g., movie theaters).

The Economic Problem with Public Goods

• Consider two flatmates, A and B, deciding whether to buy a dishwasher.
• Both have €500 and value the dishwasher at €300, while it costs €400.
• If both purchase, the outcome is (600; 600).
• If A purchases and B doesnt, the outcome is (800; 400).
• If B purchases and A doesnt, the outcome is (400; 800).
• If neither purchases, the outcome is (500; 500).

The Free Rider Problem

• Illustrates the payoff structure where individual i can contribute or not contribute, while others also contribute or not.
• If individual i contributes and others contribute, the payoff is 10 - 5 = 5.
• If individual i contributes and others do not contribute, the payoff is 0 - 5 = -5.
• If individual i does not contribute and others contribute, the payoff is 10 - 0 = 10.
• If individual i does not contribute and others do not contribute, the payoff is 0 - 0 = 0.

Public Goods and the Prisoner's Dilemma

• Cooperation increases welfare, making public goods "effective."
• In the example of a dike built with sandbags total sandbags equal the sum of individual contributions.
• The number of sandbags increases the quality of the dike
• Utility increases with the number of contributions.
• Without institutions, selfish behavior leads to a free-riding problem.

Why does Free-Riding Happen?

• Free-riding occurs due to human selfishness.
• It emerges from missing or costly institutions/rules.
• Institutions can ensure/increase cooperation, such as police or direct government provision.

The Lighthouse in Economics: Classical View

• Coase notes the lighthouse is a classical example of a public good needing government provision.
• John Stuart Mill believed building and maintaining lighthouses is a proper function of government.
• Arthur Pigou argued the marginal net product falls short of the marginal social net product due to difficulties in exacting payment for incidental services.
• Paul Samuelson highlighted the divergence between private advantage/money cost and true social advantage/cost.
• Samuelson noted zero extra cost to let one more ship use the lighthouse; discouraging ships via a positive price results in social economic loss.
• Coase identifies a paradox in Samuelson's position: the government must provide lighthouses as private firms supposedly cannot charge for services.

The British Lighthouse System

• Trinity House builds and operates British lighthouses.
• Expenses come from the General Lighthouse Fund.
• Fees are collected from shipowners at harbors based on tonnage and access.
• Additional 'Local Lights' exist outside Trinity House.

History of the British Lighthouse System

• Few lighthouses existed before the 17th century in Britain.
• In 1594, Trinity House gained the right to build and operate lighthouses.
• Two were built in the early 17th century, and one later.
• Trinity House stopped building lighthouses from 1610 to 1675.
• Due to demand, the British crown permitted private investors to build lighthouses and levy tolls on benefitting ships.
• Ten lighthouses were built during that time.
• In 1820, 24 lighthouses were operated by Trinity House and 22 by private entities.
• Only 11 of the 46 lighthouses had been initially built by Trinity House.
• In 1836, an Act of Parliament vested all lighthouses in England in Trinity House, empowering it to purchase remaining privately held lighthouses, completed by 1842.
• The goal was to lower fees through quasi-public ownership.
• Since 1898, Trinity House has operated British lighthouses as a public agency.

Coase's Conclusion on Lighthouses

• Coase questions why prominent economists made misleading statements about lighthouses in their writings.
• Economists' references to lighthouses are not based on detailed studies.
• The lighthouse is used merely as an illustration.
• Reality disproves the idea of the lighthouse as a public good.
• Lighthouses were privately provided, with the government protecting property rights and collecting fees.
• Government institutions (fee collection, property rights, investment incentives) enable private provision of lighthouses, despite non-rivalry and the infeasibility of exclusion.

Provision of Public Goods

• Private and club goods are provided both privately and publicly.
• Examples include university education, postal services, rail services, water provision.
• Public goods are often privately provided but publicly financed.
• Examples include garbage collection and public health services.
• Public goods can be privately provided when the user group is smaller/more homogenous, when the benefit-to-cost ratios are higher, when there are potential social sanctions, or when there is a high frequency of use.
• If a good isn't privately provided, the government can create it or incentivize private creation.

Market Failure vs. Government Failure Considerations

• Incentives of politicians and bureaucrats are a factor.
• Cost differences occur between public and private provision.
• There are incentives in contracts to provide a public good.
• Individual incentives exist to disclose one's preferences.
• Publicly and privately provided goods include libraries/video rental stores/Netflix, security services, and TV.