The Lighthouse in Economics

• The lecture discusses "The Lighthouse in Economics," focusing on institutional economics.
• The lecture is part of the Foundations of Institutional Economics course (BW21, Course 1).
• The lecture date is October 22, 2024.

Roadmap

• The lecture roadmap includes a review of R. Coase's 1974 paper "The Lighthouse in Economics."
• The lecture touches on public goods.
• The lecture covers the free rider problem.

Introduction and Coase's Concerns

• Coase critiques traditional analyses of public good problems by Pigou and Samuelson.
• Public goods are characterized by two properties: lack of rivalry in consumption and the infeasibility of excluding non-payers.
• The usage by one person does not reduce the utility of the good or service to others, meaning the marginal cost of serving another person is zero.

Classification of Goods

• Goods can be classified based on rivalry and excludability

• The categorization results in four types of goods:

  • Private goods: rivalrous and excludable (e.g., bread, beer, cars).
  • Common pool resources: rivalrous but not excludable (e.g., oceans, city streets.)
  • Club goods: excludable but non-rivalrous (e.g., golf courses, swimming pools, pay-TV.)
  • Pure public goods: non-rivalrous and non-excludable (e.g., national security, common standards like language, environmental goods like clean air, radio.)

• Pure public goods are non-rivalrous without limits, while impure public goods become rivalrous once a certain capacity is reached (e.g., movie theaters.)

Public Goods and Economic Problems

• Two flatmates consider buying a dishwasher that costs 400€; both have 500€ and value the dishwasher at 300€.
• If both purchase, their outcome is (600;600), both purchasing and the outcome is(500;500).

The Free Rider Problem

• The free rider problem illustrates a scenario where individual i can contribute or not contribute to a public good and others also contribute or not contribute.
• If both individual and all others contribute, the payoff is 5; if the individual doesn't contribute but others do, the payoff is 10; if the individual contributes but others don't, the payoff is -5; if no one contributes, the payoff is 0.
• Central characteristic of pure public goods: cooperation increases welfare and effectiveness.
• A dike built with sandbags is used as an example.
  • The total number of sandbags is the sum of individual contributions.
  • The number of sandbags increases the quality of the dike.
  • Utility increases along with the number of contributions.
• In the absence of institutions, the free-riding behavior will arise.

Why Free-Riding Occurs

• Free-riding is motivated by human selfishness.
• Either missing or costly institutions may also be a factor .
• Government intervention, such as police or direct provision of public goods, can mitigate free-riding by ensuring or increasing cooperation.

The Lighthouse in Economics - Contrasting Views

• Coase notes that the lighthouse example is often cited as a classic public good that a government needs to provide.
• John Stuart Mill stated government should build and maintain lighthouses.
• Arthur Pigou argued that the marginal net product of lighthouses falls short of the marginal social net product because it is difficult to exact payment for incidental services.
• Paul Samuelson highlighted the divergence between private advantage, total lighthouse costs, and extra costs for additional ships using the warning light.
• Samuelson also stated no extra cost to let one extra ship use the service; hence any ships discouraged from those waters by the requirement to pay a positive price represents a social economic loss.
• Coase found a paradox in Samuelson's position, stating that while the government must provide lighthouses, the inability of private firms to charge is the issue, also calling for government action.

The British Lighthouse System

• Trinity House builds and operates British lighthouses.
• Expenses are covered by the General Lighthouse Fund, with fees charged at harbors from ship owner.
• There are 'Local Lights' that are not part of Trinity House.

History of the British Lighthouse System

• There were few lighthouses in Britain before the 17th century.
• In 1594, Trinity House gained the right to build and operate lighthouses, constructing two in the early 17th century and one later.
• Trinity House stopped building lighthouses from 1610-1675.
• The British crown allowed private investors to build lighthouses and charge tolls on ships due to continued demand.
• 10 lighthouses were built during that time.
• In 1820, 24 lighthouses were Trinity House and 22 by private entities, with only 11 of the 46 originally built by Trinity House.
• In 1836, an Act of Parliament vested all lighthouses in England in Trinity House, empowering it to purchase remaining private lighthouses; done in 1842.
• The aim was to lower fees through quasi-public ownership.
• Since 1898, Trinity House has operated British lighthouses as a public agency.

Coase's Conclusion

• Coase questioned why economists like Mill, Pigou, and Samuelson have made misleading statements about lighthouses, implying a potentially flawed policy conclusion.
• Coase suggest economists haven't thoroughly investigated or studied lighthouses; they're often used merely as illustrations.
• Actual data suggests the lighthouse example being considered a public good is incorrect.
• Lighthouses have been privately provided in the past, with the government protecting property rights and collecting fees.
• Government-provided institutions (fee collection, property rights, incentives) allow for private lighthouse even with non-rivalry and possible exclusion.

Provisions of Public Goods

• Private and club goods are not only privately supplied, but often publicly.

• University education, postal services, rail services and water provisioning are examples.

• Public services are often privately provided but publicly financed.

• Garbage collection and public health services are examples.

• Important to not confound public goods with publicly provided goods.

• Private provisioning more likely if:

  • The group the group of users are a smaller and homogeneous
  • There are relatively high cost-to-benefit ratios
  • There are potential social sanctions.
  • There is a frequency of use of the good.

• If a good is not privately provided, government can create good itself or incentivise private creation.

Market Failure vs. Government Failure

• Consider politicians and bureaucrats, for Coase this was admittedly the primary motive of projectors was personal gain, but at least they got things done.
• Consider costs between public and private provisioning.
• Consider incentives in contracts for private companies delivering a public project.
• Consider individual incentives to disclose preferences.
• Libraries/video or DVD stores or Private security companies/public police forces.
• Private and public tv.