IPE06.ppt

Local Public Goods Assume a population of H that allocate between two localities With population h in a locality income is a decreasing function M(h) Cost of the public good is G/h Utility is U = U(M(h) – G/h, G) Assume locality chooses G optimally given h so hUG/Ux = 1 Local Public Goods Fig. 6.5 assumes U(h) increases then decreases and U(H) U(0) Five potential equilibria a, b, c, d, e c is stable, b and d unstable a and e are stable but inefficient An inefficient equilibrium may be achieved Figure 6.6: Stability of the symmetric equilibrium Local Public Goods Fig. 6.7 has efficient size greater than H/2 Three potential equilibria a, b, c b is efficient but unstable a and c are stable but inefficient Beginning anywhere except b will lead to an inefficient equilibrium Figure 6.7: Inefficient stable equilibria Local Public Goods There is no reason why flows of population between localities will achieve efficiency The economy may get trapped in an inefficient equilibrium The reason is that the movement between localities of one consumer affects both the population they leave and the population they join These non-market linkages lead to the inefficiency The Tiebout Hypothesis Inefficiency may occur with local public goods The Tiebout hypothesis argues that it will not Tiebout argument Inefficiency because of difficulties of information transmission This causes free-riding If there is a choice of different communities Selected community reveals preferences There is no incentive to choose strategically Honest revelation takes place and efficiency achieved The Tiebout Hypothesis If there are enough communities with different provision levels And if there are enough consumers with each kind of preference All consumers can then locate in an optimal community which is efficient in size This is the efficiency claim of the Tiebout hypothesis The Tiebout Hypothesis Unlike the Theorems of Welfare Economics there is no single way to formalize this result I