Fair division in upgrading internet service.

Students will explain the characteristics of a public good.

Students will demonstrate how the characteristics of a public good lead to incentives to understate the individual benefit of a good and "free-ride".

Students will explain how the free-rider problem can lead to underprovision of public goods and inefficient outcomes.

This activity is appropriate for a Principles of Microeconomics course. This activity assumes public goods are taught after students have learned demand and economic surplus, as students should already be familiar with the relationship between willingness to pay and demand for a good and
consumer surplus. If it has been a while since this topic was covered, a refresher may be useful. Students will have read or viewed a lecture about public goods and the free-rider problem. They should know the two characteristics of a public good.

Overview

In this exercise students will consider two roommates who have the opportunity to purchase a shared (public) good. Students will discuss the appropriate division of the cost of the good. In doing so, students will explain why the good fits the characteristics of a public good, explain why purchasing the good is efficient, and consider the free-rider problem and the incentives to understand individual benefit.

Information Given to Students

FairDivision.docx (Microsoft Word 2007 (.docx) 13kB Jan28 20)

Anthony and Susie are roommates and they are discussing upgrading their internet service to provide a faster speed. They currently have an internet connection, they both have access, but they have the opportunity to make it faster. Susie works from home and could really use the improved speed, so she is willing to pay up to $60 a month to pay for the improvement. Anthony is home less often, he would love faster speed for when he is home, but he would only pay $20 a month. Suppose the cost to upgrade the speed $50. How do you suggest the roommates to split the cost?

1) First, using the characteristic of a public good, explain why the upgraded fits the description of a public good if we are only considering these two roommates in this scenario.
2) Is upgrading the internet speed an efficient decision? Explain why or why not?
3) How do you suggest the roommates split the cost? Why?

A) Anthony $25 – Susie $25

B) Anthony $20 – Susie $30

C) Anthony $12.50 – Susie $37.50

D) Anthony $5 – Susie $45

E) Anthony $0 – Susie $50

4) Does Anthony have incentive to understate how much he is willing to pay for upgraded internet speed? Does Susie have incentive to understate how much he is willing to pay for upgraded internet speed? If their willingness to pay was different than what you were told, would it change your answer to 3)?

The students should arrive at the conclusion that even this omniscient view of fair division relies on an individuals willingness to pay, so there is incentive to understate the willingness to pay. The class discussion should back up from this apartment to an entire economy and how too many individuals trying to free-ride can lead to an underprovision of public goods and an inefficient outcome.

You can also have your students find the outcome (A-E) that evenly splits consumer surplus as a reminder of that topic. (Note: The answer is D) as the willingness to pay minus amount actually paid is equal. $60 - $45 = $20 - $5 = $15)

Ask your students if any of them had discussed who was wealthier Anthony or Susie. When we consider how to tax individuals to pay for public goods, we almost always reflexively point to progressive taxation without regard to the willingness to pay or how much use the individual will get out of the public good (like a park, school, or library).

1. For an exam or assignment this can lead to a bigger picture questions about public goods and the free rider problem. (What is the free-rider problem? What goods does it exist for? How do the characteristics provide the incentive for the free-rider problem? What tools can a government use to combat the free-rider problem?)
2. A more specific assessment question for an exam or assignment can have students recreating some of the important conclusions from this activity:

Adam and Brandy are roommates and the are discussing upgrading their DirectTV package to add HBO. They currently have DirecTV, they both have access, but they have the opportunity to add additional service. Adam is very much interested in HBO and is willing to pay an additional $40 per month for the service. Brandy is less interested, but would be willing to pay $10 per month. DirecTV charges $25 per month for HBO.

a) Explain why HBO is a public good in the context of these two roommates (use the characteristics of a public good in your answer).

b) Would it be efficient for the roommates to add HBO, why or why not?

c) Does Adam have incentive to lie or understate how much he is willing to pay for HBO, why or why not?

d) Does Brandy have incentive to lie or understate how much she is willing to pay for HBO, why or why not?

e) Explain how the free-rider problem could lead to these roommates missing out on some quality premium programming.