Private Goods, Club Goods and Public Goods

Charging home owners’ association dues based on the size of the property is common practice in many places across the world. Is that economically efficient and is it equitable? The short answer to the question raised by reader Mr Baransam1 is yes. The longer answer needs to start with distinguishing different categories of goods that are produced, traded and consumed.

Private Goods

The most common category are called “private goods.” These are formally defined by being “rival” and “excludable.” The rivalrous characteristic arises from the fact that one’s consumption of the good precludes any other person from consuming it. If you eat an apple, that apple is not available for consumption by others. Excludability means that one can be prevented from consuming the good. You can lock up the apple and exclude others from consuming it.

Apples are private goods. And so are shoes, and ships, and sealing wax. And an untold millions of other things that are produced in the world.

Public Goods

At the other extreme away from private goods are “public goods.” Pure public goods feature non-rivalry and non-excludability. Non-rivalry means one person’s consumption does not reduce the amount available for consumption by others. Your listening to an over-the-air radio broadcast does not preclude other people to listening to the broadcast. Also, you cannot prevent — exclude — others from listening to a radio broadcast.

Just by the way, let’s remember that public goods are not goods that are good for the public or goods that affect “the public good.” Nor are public goods that are produced by the public sector. The production of public goods (and the related “public bads”) can be done by the private sector, and conversely the public sector can (and does) produce private goods.

Non-rivalrous Excludable Goods

Moving on. You could have non-rivalrous goods that are excludable. The movie playing at a movie theater is a non-rivalrous good (many persons can watch the movie simultaneously) but is excludable (only ticket holders get to watch.) And you could have goods that are rivalrous but are non-excludable. An open forest without guards and fences is an example. The wood that you gather in the forest reduces the amount available to others, but no one is excluded from gathering wood either. This forest is an example of what is called a “common pool resource” or “common property resource.”

Common Property Resources

Common property resources usually have congestion or crowding problems. If too many people use the resource, it negatively impacts everyone’s ability to use it, and it degrades the resource itself. Toll-free streets and highways are examples of common property resources. That problem is well-understood and it leads to what is known as “the tragedy of the commons.” One solution to CPR problem is to charge for use.

Lighthouses

Pure public goods are rare. An illuminating example of a pure pubic good is the services of a lighthouse.

I took the picture of the lighthouse that appears at the start of this piece at Point Reyes, California, a favorite vista point to take out of town visitors to.

Any and all ships in the vicinity can benefit from it, and no ship can be prevented from using the lighthouse beacon to navigate. A more contemporary example would be the global positioning system (GPS.) Anyone with a GPS device can use the services of dozens of satellites for free.

National defense is also trotted out as an exemplar of a pure public good. Any amount of national defense that gets produced is available to everyone to that same amount. Another way of expressing it is that the amount available is “non-partitionable” in the sense that national defense cannot be handed out in little chunks to various people.

Who Pays

The consumption of public goods necessarily implies their production. Since pure public goods are non-excludable, who pays? The financing of public goods is generally done through taxes. The government collects taxes and then pays some entity to provide the good. That comes under the subject of “public finance”. I shall not go into that and other matters dealing with the production side of public goods, or with two important concepts involved in the production–namely that of externalities and scale economies. I have other matters to attend to: a category of goods economists call “club goods.”

Club Goods

Our commonsense understanding of what a club is provides an adequate definition of what club goods are. Consider the swimming pool at a club. Since you don’t use a pool very frequently, instead of the cost of having your own private pool in your backyard, you use the club pool. Through membership dues, all club members pay for the pool, which is a common property resource but for members only since non-members are not allowed into the club.

Of course, clubs do provide private goods too. The bars and restaurants inside clubs work similarly to those outside clubs; the cost of food and drinks are allocated based on private consumption. The gym or the golf course may attract some additional fees per use, etc. The logic behind club goods is simple. First, the amount consumed by each person is low but the aggregate consumption is high enough that the per unit production costs turns out to be low due to scale economies, and other technical reasons such as indivisibilities in production.

Bonus fact: A little private pool is called a jacuzzi, named after its inventor, Candido Jacuzzi.

Indivisibility in production here means that building a 200 square meter pool that is used by 200 people (with only 20 using it at any one point) is cheaper and more useful than producing 200 one-square-meter pools for each person in their own backyard patio.

HOA Dues

So a home-owners association (HOA) or housing society is like a club. Like clubs, membership is voluntary. You know the rules and you choose whether or not to join. (And Groucho Marx resolutely refused to be in any club saying that he’d never want to belong to any club that would have him as a member.) You know reasonably accurately how much membership costs and what the benefits are. How should the costs of club goods that the HOA provides (pool, gym, club house, grounds maintenance, street lights, street cleaning, garbage collection, etc) be allocated?

One scheme would be to charge every resident equally. So a family of four would pay twice as much as a family of two. But it would be costly to monitor that. Therefore based on a reasonable assumption that larger properties would be occupied by larger families, the size of the property is a handy proxy for the number of residents. Therefore charging HOA dues based on floor space is economically efficient. It is also equitable since costs are shared equally by each individual resident.

Taxes

Now to the other question that the reader Mr B asked: Both he and Ambani get the same benefit from national defense. Yet he pays a lot less in income taxes than Ambani does. Is that fair? Shouldn’t both pay the same amount since they “consume” the same amount of national defense?

Income taxes pay for more than just national defense. But let’s set that aside for the moment. Ambani as an individual is certainly enjoying the same amount of national defense as Mr B. However, national defense protects not just people; it protects property. Ambani’s property is valued at a few billion and Mr B’s property not as much. Therefore it is fair that Ambani pay more for national defense than Mr B.

Add to that the fact that taxes go to pay for other public goods such as law and order. Those public goods are necessary complements for the production and consumption of private goods. Since Ambani consumes more private goods than Mr B does, it stands to reason that Ambani pay more for the production of the public goods too. Hence Ambani should pay more taxes.

A final point. Taxes should be used only for the purposes of paying for government funded public goods. They should not be used for any other purposes. They should not be used for income-redistribution, or for charity, or for running schools or colleges, or hospitals, or airlines or railways, or hotels, etc etc. Those activities should be in the private sector or the social sector.

The state (meaning the government and its associated bureaucracy) should be the “protective state” and not attempt to be a “productive state.”

It’s all karma, neh?

Related post:

Of Kakistocracies, Principals and Agents. From Feb 2008. Where I write about club goods, and why some public utilities in India are provided as club goods.