Answer to Question #152772 in Economics for yahya

Question

The Great White Hall: Flatland Views city council has advertised for proposals to build a new community center, a library and a theatre but the city council cannot agree on how to evaluate the submitted proposals. The request for proposal (RFP) specified that respondents had to meet certain basic needs, although optional items could be included. The RFP also asked that each respondent calculate a benefit/cost (B/C) ratio using a discount rate of 12%. What are the options for analyzing and making decisions on this public funding proposal? What are the opportunities for negotiation? How do you arrive at the best combination from submitted proposals?

Answer 1

In the case of private goods, the choice of directions for the use of resources completely depended on the preferences of individuals, i.e., as one of the axioms, we took the provision of consumer sovereignty - consumer preferences set the structure of production and provision of goods.

The situation is different with public goods. If in choosing the volume of their provision, we will be based only on the decisions of individual individuals made on the basis of the utility maximization hypothesis, it is obvious that, from the point of view of the entire set of individuals, public goods will be insufficiently provided.

Partial equilibrium analysis involves determining the supply and demand functions and finding the point at which the volume of demand will be equal to the volume of supply.

The demand function for the public good is the dependence of the marginal benefit received by an individual on the volume of consumption of the good. In this case, the marginal benefit is the utility of an individual from the consumption of an additional unit of the public good, expressed in monetary units. The marginal benefit reflects an individual's willingness to pay for a given additional unit. In deriving the demand function, we must assume that the individual's preferences, that is, his willingness to pay, are identified accurately and without distortion. In other words, none of the consumers of the public good is considered to behave like a hare. Having this assumption, not required in the case of a private good, makes the demand function somewhat conditional. For this reason, it is often referred to as a pseudo-demand function for the public good.

The model of the optimal allocation of resources in the economy in the presence of two types of goods (private and public) was proposed by P. Samuelson in the mid-1950s. Samuelson's model contains an abstract planner (analog of Walras' auctioneer), who has comprehensive information about the production capabilities of the economy and consumer preferences and also has his own value system.

Let us first consider a graphical solution to the problem of optimal resource allocation in the presence of a public good.

Suppose that only two consumer goods are produced in the economy — private (P) and public (G). There are two consumers (A and B) with their own utility functions, which correspond to the indifference curves UA and UB. The transformation function is plotted on the production capability curve Z1Z2.

To derive the Pareto optimality condition, we fix the utility received by individual A at the UA level (Fig. Above). Then, knowing the production opportunity curve Z1Z2, we can find the amount of private good P available to the second individual, B (by definition, the entire volume of the public good is available to both individuals, there is no competition for its consumption.) In the figure below, the boundary of the set of consumption capabilities of individual B is designated C1C2. It is obtained as the vertical difference between the production capacity curve Z1Z2 and the fixed customer indifference curve A.