Chapter 13: Q.13 (page 316)
What are the two key characteristics of public goods?
Public goods are nonexcludable and non-rival.
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HighFlyer Airlines wants to build new airplanes with greatly increased cabin space. This will allow HighFlyer Airlines to give passengers more comfort and sell more tickets at a higher price. However, redesigning the cabin means rethinking many other elements of the airplane as well, like engine and luggage placement, and the most efficient shape of the plane for moving through the air. HighFlyer Airlines has developed a list of possible methods to increase cabin space, along with estimates of how these approaches would affect the plane's operating costs and ticket sales. Based on these estimates, Table 13.5 shows the value of R&D projects that provide at least a certain private rate of return. Column 1 = Private Rate of Return. Column 2 = Value of R&D Projects that Return at Least the Private Rate of Return to HighFlyer Airlines. Use the data to answer the following questions.
| Private rate of return | Value of R&D |
| 12% | \(100 |
| 10% | \)200 |
| 8% | \(300 |
| 6% | \)400 |
| 4% | $500 |
a. If the opportunity cost of financial capital for HighFlyer Airlines is 6%, how much should the firm invest in R&D?
b. Assume that the social rate of return for R&D is an additional 2% on top of the private return; that is, an R&D investment that had a 7% private return to HighFlyer Airlines would have a 9% social return. How much investment is socially optimal at the 6% interest rate?
What is the free rider problem?
Provide two examples of goods/services that are classified as private goods/services even though they are provided by a federal government.
The Gizmo Company is planning to develop new household gadgets. Table 13.4 shows the company’s demand for financial capital for research and development of these gadgets, based on expected rates of return from sales. Now, say that every investment would have an additional 5% social benefit—that is, an investment that pays at least a 6% return to the Gizmo Company will pay at least an 11% return for society as a whole; an investment that pays at least 7% for the Gizmo Company will pay at least 12% for society as a whole, and so on. Answer the questions that follow based on this information.
| Estimated rate of return | Private profits of the firm from an R&D project (in \( millions) |
| 10% | \)100 |
| 9% | \(102 |
| 8% | \)108 |
| 7% | \(118 |
| 6% | \)133 |
| 5% | \(153 |
| 4% | \)183 |
| 3% | $223 |
a. If the going interest rate is 9%, how much will Gizmo invest in R&D if it receives only the private benefits of this investment?
b. Assume that the interest rate is still 9%. How much will the firm invest if it also receives the social benefits of its investment? (Add an additional 5% return on all levels of investment.)
Why is a football game on ESPN a quasi-public
good but a game on the NBC, CBS, or ABC is a public good?
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