Public goods have two distinct aspects: nonexcludability and nonrivalrous consumption. “Nonexcludability” means that the cost of keeping nonpayers from enjoying the benefits of the good or service is prohibitive. If an entrepreneur stages a fireworks show, for example, people can watch the show from their windows or backyards. Because the entrepreneur cannot charge a fee for consumption, the fireworks show may go unproduced, even if demand for the show is strong. The fireworks example illustrates the related free-rider problem. Even if the fireworks show is worth ten dollars to each person, arguably few people will pay ten dollars to the entrepreneur. Each person will seek to “free ride” by allowing others to pay for the show, and then watch for free from his or her backyard. If the free-rider problem cannot be solved, valuable goods and services—ones people otherwise would be willing to pay for—will remain unproduced. The second aspect of public goods is what economists call “nonrivalrous consumption.” Assume the entrepreneur manages to exclude noncontributors from watching the show (perhaps one can see the show only from a private field). A price will be charged for entrance to the field, and people who are unwilling to pay this price will be excluded. If the field is large enough, however, exclusion is inefficient. Even nonpayers could watch the show without increasing the show’s cost or diminishing anyone else’s enjoyment. In other words, the relevant consumption is nonrivalrous. Nonetheless, nonexcludability is usually considered the more important of the two aspects of public goods. If the good is excludable, private entrepreneurs will try to serve as many fee-paying customers as possible, charging lower prices to some customers if need be. One of the best examples of a public good is national defense. To the extent one person in a geographic area is defended from foreign attack or invasion, other people in that same area are likely defended also. This makes it hard to charge people for defense, which means that defense faces the classic free-rider problem. Indeed, almost all economists are convinced that the only way to provide a sufficient level of defense is to have government do it and fund defense with taxes. Many other problems, though, that are often perceived as public-goods problems are not really, and markets handle them reasonably well. For instance, although many people think a television signal is a public good, cable television services scramble their transmissions so that nonsubscribers cannot receive broadcasts easily. In other words, the producers have figured out how to exclude nonpayers. Both throughout history and today, private roads have been financed by tolls charged to road users. Other goods often seen as public goods, such as private protection and fire services, are frequently sold through the private sector on a fee basis. Excluding nonpayers is possible. In other cases, potentially public goods are funded by advertisements, as happens with television and radio. Partially public goods also can be tied to purchases of private goods, thereby making the entire package more like a private good. Shopping malls, for instance, provide shoppers with a variety of services that are traditionally considered public goods: lighting, protection services, benches, and restrooms are examples. Charging directly for each of these services would be impractical. Therefore, the shopping mall finances the services through receipts from the sale of private goods in the mall. The public and private goods are “tied” together. Private condominiums and retirement communities also are market institutions that tie public goods to private services. They use monthly membership dues to provide a variety of public services. Some public goods are provided through fame incentives or through personal motives to do a good job. The World Wide Web offers many millions of home pages and informational sites, and most of their constructors have not received any payment. The writers either want recognition or seek to reach other people for their own pleasure or to influence their thinking. The “reciprocity motive” is another possible solution, especially in small groups. I may contribute to a collective endeavor as part of a broader strategy to signal that I am a public-minded, cooperative individual. You may then contribute in return, hoping that we develop an ongoing agreement—often implicit—to both contribute over time. The agreement can be self-sustaining if I know that my withdrawal will cause the withdrawal of others as well. A large body of anecdotal and experimental evidence suggests that such arrangements, while imperfect, are often effective. Roommates, for instance, often have implicit or explicit agreements about who will take out the trash or do the dishes. These arrangements are enforced not by contract but rather by the hope of continuing cooperation. Other problems can be solved by defining individual property rights in the appropriate economic resource. Cleaning up a polluted lake, for instance, involves a free-rider problem if no one owns the lake. If there is an owner, however, that person can charge higher prices to fishermen, boaters, recreational users, and others who benefit from the lake. Privately owned bodies of water are common in the British Isles, where, not surprisingly, lake owners maintain quality.

Public choice applies the theories and methods of economics to the analysis of political behavior, an area that was once the exclusive province of political scientists and sociologists. Public choice originated as a distinctive field of specialization a half century ago in the works of its founding fathers, Kenneth Arrow, Duncan Black, James Buchanan, Gordon Tullock, Anthony Downs, William Niskanen, Mancur Olson, and William Riker. Public choice has revolutionized the study of democratic decision-making processes. Foundational Principles As James Buchanan artfully defined it, public choice is “politics without romance.” The wishful thinking it displaced presumes that participants in the political sphere aspire to promote the common good. In the conventional “public interest” view, public officials are portrayed as benevolent “public servants” who faithfully carry out the “will of the people.” In tending to the public’s business, voters,

The fact that trade protection hurts the economy of the country that imposes it is one of the oldest but still most startling insights economics has to offer. The idea dates back to the origin of economic science itself. Adam Smith’s The Wealth of Nations, which gave birth to economics, already contained the argument for free trade: by specializing in production instead of producing everything, each nation would profit from free trade. In international economics, it is the direct counterpart to the proposition that people within a national economy will all be better off if they specialize at what they do best instead of trying to be self-sufficient. It is important to distinguish between the case for free trade for oneself and the case for free trade for all. The former is an argument for free trade to improve one nation’s own welfare (the so-called national-efficiency argument). The latter is an argument for free trade to improve every trading country’s welfare (the so-called cosmopolitan-efficiency argument). Underlying both cases is the assumption that free markets determine prices and that there are no market failures. But market failures can occur. A market failure arises, for example, when polluters do not have to pay for the pollution they produce (see externalities). But such market failures or “distortions” can arise from governmental action as well. Thus, governments may distort market prices by, for example, subsidizing production, as European governments have done in aerospace, as many other governments have done in electronics and steel, and as all wealthy countries’ governments do in agriculture. Or governments may protect intellectual property inadequately, leading to underproduction of new knowledge; they may also overprotect it. In such cases, production and trade, guided by distorted prices, will not be efficient. The cosmopolitan-efficiency case for free trade is relevant to issues such as the design of international trade regimes. For example, the General Agreement on Tariffs and Trade (GATT), incorporated into the World Trade Organization (WTO) in 1995, oversees world trade among member nations, just as the International Monetary Fund oversees international macroeconomics and exchange rates. The national-efficiency case for free trade concerns national trade policies; it is, in fact, Adam Smith’s case for free trade. Economists typically have the national-efficiency case in mind when they discuss the advantage of free trade and the folly of protectionism. This case, as refined greatly by economists in the postwar period, admits two main theoretical possibilities in which protection could improve a nation’s economic well-being. First, as Adam Smith himself noted, a country might be able to use the threat of protection to get other countries to reduce their protection against its exports. Thus, threatened protection could be a tool to pry open foreign markets, like oysters, with “a strong clasp knife,” as Lord Randolph Churchill put it in the late nineteenth century. If the protectionist threat worked, then the country using it would gain doubly: from its own free trade and from its trading partners’ free trade. However, both Smith and later economists in Britain feared that such threats would not work. They feared that the protection imposed as a threat would be permanent and that the threat would not lower the other countries’ trade barriers. U.S. trade policy today is premised on a different assessment: that U.S. markets can, and should, be closed as a means of opening new markets abroad. This premise underlies sections 301–310 of the 1988 Omnibus Trade and Competitiveness Act, which permit, and sometimes even require, the U.S. government to force other countries to accept new trade obligations by threatening tariff retaliation if they do not. But those “trade obligations” do not always entail freer trade. They can, for instance, take the form of voluntary quotas on exports of certain goods to the United States. Thus, they may simply force weak nations to redirect their trade in ways that strong nations desire, cutting away at the principle that trade should be guided by market prices. The second exception in which protection could improve a nation’s economic well-being is when a country has monopoly power over a good. Since the time of Robert Torrens and John Stuart Mill—that is, since the mid-1800s—economists have argued that a country that produces a large percentage of the world’s output of a good can use an “optimum” tariff to take advantage of its latent monopoly power, and thus gain more from trade. This is, of course, the same as saying that a monopolist will maximize his profits by raising his price and reducing his output. Two objections to this second argument immediately

Recycling is the process of converting waste products into reusable materials. Recycling differs from reuse, which simply means using a product again. According to the Environmental Protection Agency (EPA), about 30 percent of U.S. solid waste (i.e., the waste that is normally handled through residential and commercial garbage-collection systems) is recycled. About 15 percent is incinerated and about 55 percent goes into landfills. Recycling is appealing because it seems to offer a way to simultaneously reduce the amount of waste disposed in landfills and save natural resources. During the late 1980s, as environmental concerns grew, public opinion focused on recycling as a prime way to protect the environment. Governments, businesses, and the public made strenuous efforts to recycle. By 2000, the recycling rate had nearly doubled the 1990 rate of 16 percent. A big portion of the increase has been in yard trimmings and food scraps collected for composting. Recycling, however, is not always economically efficient or even environmentally helpful. The popular emphasis on recycling stems partly from misconceptions. One misconception is that landfills and incinerators are environmentally risky. It is true that at one time landfills were constructed to fill in swamps (sometimes to reduce insect infestation). If material leaked out from the landfill, it could contaminate nearby waters. But today landfills are sited away from wetlands. They are designed to keep their contents dry, and monitoring programs ensure that any leakage that does occur is caught before it causes harm. Another misconception is that we are running out of landfill space. The truth is that landfills today are large enough to accommodate the solid waste produced by the United States until 2019, even if no new ones are established. Economist Daniel Benjamin (2003) reports that the fear of running out of landfill space stems from an EPA study in the 1980s that counted landfills rather than landfill capacity. In fact, the report omitted the fact that landfill space was actually increasing because sites were getting larger. Indeed, the EPA continues to publish a chart showing the declining number of landfills even while stating that “at the national level, capacity does not seem to be a problem, although regional dislocations sometimes occur” (EPA 2002, p. 14). People also tend to overestimate how much space is required to bury our trash. Numerous studies have shown that it is not all that much. Statistician Bjørn Lomborg has calculated that a ten-mile-square, 255-foot-deep landfill could contain all the trash produced in the United States over the next century. The Economics of Recycling In the absence of government regulation, the economics of each material determines how much of it is recycled. For example, about 55 percent of all aluminum cans were recycled in 2000. Recycling of beverage cans goes back to 1968, when the Reynolds Metals Company started a pilot project. The chief motivation was to respond to public concerns about litter, which were spurring laws that required deposits on beverage containers. But energy prices began to rise during the 1970s and, because producing new aluminum from bauxite requires large amounts of energy, recycling aluminum cans became economically attractive. About 56 percent of paper and cardboard was recycled

One of the most fundamental requirements of a capitalist economic system—and one of the most misunderstood concepts—is a strong system of property rights. For decades social critics in the United States and throughout the Western world have complained that “property” rights too often take precedence over “human” rights, with the result that people are treated unequally and have unequal opportunities. Inequality exists in any society. But the purported conflict between property rights and human rights is a mirage. Property rights are human rights. The definition, allocation, and protection of property rights comprise one of the most complex and difficult sets of issues that any society has to resolve, but one that must be resolved in some fashion. For the most part, social critics of “property” rights do not want to abolish those rights. Rather, they want to transfer them from private ownership to government ownership. Some transfers to public ownership (or control, which is similar) make an economy more effective. Others make it less effective. The worst outcome by far occurs when property rights really are abolished (see tragedy of the commons). A property right is the exclusive authority to determine how a resource is used, whether that resource is owned by government or by individuals. Society approves the uses selected by the holder of the property right with governmental administered force and with social ostracism. If the resource is owned by the government, the agent who determines its use has to operate under a set of rules determined, in the United States, by Congress or by executive agencies it has charged with that role. Private property rights have two other attributes in addition to determining the use of a resource. One is the exclusive right to the services of the resource. Thus, for example, the owner of an apartment with complete property rights to the apartment has the right to determine whether to rent it out and, if so, which tenant to rent to; to live in it himself; or to use it in any other peaceful way. That is the right to determine the use. If the owner rents out the apartment, he also has the right to all the rental income from the property. That is the right to the services of the resources (the rent). Finally, a private property right includes the right to delegate, rent, or sell any portion of the rights by exchange or gift at whatever price the owner determines (provided someone is willing to pay that price). If I am not allowed to buy some rights from you and you therefore are not allowed to sell rights to me, private property rights are reduced. Thus, the three basic elements of private property are (1) exclusivity of rights to choose the use of a resource, (2) exclusivity of rights to the services of a resource, and (3) rights to exchange the resource at mutually agreeable terms. The U.S. Supreme Court has vacillated about this third aspect of property rights. But no matter what words the justices use to rationalize such decisions, the fact is that such limitations as price controls and restrictions on the right to sell at mutually agreeable terms are reductions of private property rights. Many economists (myself included) believe that most such restrictions on property rights are detrimental to society. Here are some of the reasons why. Under a private property system the market values of property reflect the preferences and demands of the rest of society. No matter who the owner is, the use of the resource is influenced by what the rest of the public thinks is the most valuable use. The reason is that an owner who chooses some other use must forsake that highest-valued use—and the price others would pay him for the resource or for the use of it. This creates an interesting paradox: although property is called “private,” private decisions are based on public, or social, evaluation. The fundamental purpose of property rights, and their fundamental accomplishment, is that they eliminate destructive competition for control of economic resources. Well-defined and well-protected property rights replace competition by violence with competition by peaceful means. The extent and degree of private property rights fundamentally affect the ways people compete for control of resources. With more complete private property rights, market exchange values become more influential. The personal status and personal attributes of people competing for a resource matter less because their influence can be offset by adjusting the price. In other words, more complete property rights make discrimination more costly. Consider the case of a black woman who wants to rent an apartment from a white landlord. She is better able to do so when the landlord has the right to set the rent at whatever level he wants. Even if the landlord would prefer a white tenant, the black woman can offset her disadvantage by offering a higher rent. A landlord who takes the white tenant at a lower rent anyway pays for discriminating. But if the government imposes rent controls that keep the rent below the free-market level, the price the landlord pays to discriminate falls, possibly to zero. The rent control does not magically reduce the demand for apartments. Instead, it reduces every potential tenant’s ability to compete by offering more money. The landlord, now unable to receive

In a capitalistic society, profits—and losses—hold center stage. Those who own firms (the capitalists) choose managers who organize production efforts so as to maximize their income (profits). Their search for profits is guided by the famous “invisible hand” of capitalism. When profits are above the normal level, they attract additional investment, either by new firms or by existing firms. New investment enters until profits are competed down to the same level the investment could earn elsewhere. In this way, high profits attract firms to invest in areas where consumers are signaling that they want the investment to occur. Capitalists earn a return on their efforts by providing three productive inputs. First, they are willing to delay their own personal gratification. Instead of consuming all of their resources today, they save some of today’s income and invest those savings in activities (plant and equipment) that will yield goods and services in the future. When sold, these future goods and services will yield profits that can then be used to finance consumption or additional investment. Put bluntly, the capitalist provides

The world’s population increased by 50 percent between 1900 and 1950 and by 140 percent between 1950 and 2000, and is projected by the United Nations to increase by just under 50 percent between 2000 and 2050. Of the 3.44 billion increase in the number of people between 1950 and 2000, only 8 percent was in developed (i.e., rich) countries. The remaining 92 percent of the increase was in less-developed, or poor, countries (LDCs), reflecting the large difference in fertility levels and, to some degree, the different age distributions. Life expectancy in developed countries rose from 66.1 years during the period from 1950 to 1954, to 75.3 years in 2000. For LDCs, life expectancy rose from only 41.0 years during the same period to 63.0 years in 2000. Over that same time, the number of births per woman fell from 2.8 to 1.6 in developed countries and from 6.2 births per woman to 3.0 in LDCs. Birthrates in LDCs remain high enough to contribute substantially to population growth. Population Aging Lower birthrates and longer lives lead to “population aging” (i.e., more elderly people and fewer children). Population aging is most rapid, and has gone furthest, in the developed world. The median age in developed countries rose from 28.6 in 1950 to 37.3 in 2000, while in the United States it rose from 30.0 to 35.2. In LDCs, by contrast, the median age in 1950 was only 21.3, rising to 24.1 in 2000. Of course, individual countries vary. In Japan, Italy, and Switzerland the median age was over 40 in 2000, whereas in Uganda, Yemen, Niger, and Somalia it was under 16. Population aging matters for many reasons, but first and foremost because of the costs of retirement (pensions and health care). In the developed countries, these costs are borne principally by the central government and funded through taxes on the working-age population. The old-age-dependency ratio—that is, the population aged 65 and over divided by the population aged 15 to 64—is a key indicator of population aging. Other things being equal, the tax rate for pensions will be proportional to this ratio.

There is general agreement that we must control pollution of our air, water, and land, but there is considerable dispute over how controls should be designed and how much control is enough. The pollution control mechanisms adopted in the United States have tended toward detailed regulation of technology, leaving polluters little choice in how to achieve the environmental goals. This “command-and-control” strategy needlessly increases the cost of pollution controls and may even slow our progress toward a cleaner environment. In 1970, popular concern about environmental degradation coalesced into a major political force, resulting in President Richard Nixon’s creation of the federal Environmental Protection Agency (EPA) and the first of the major federal attempts to regulate pollution directly—the Clean

The fact of scarcity, which exists everywhere, guarantees that people will compete for resources. Markets are one way to organize and channel this competition. Politics is another. People use both markets and politics to get resources allocated to the ends they favor. Even in a democracy, however, political activity is startlingly different from voluntary exchange in markets. People can accomplish many things in politics that they could not accomplish in the private sector. Some of these are vital to the broader community’s welfare, such as control of health-threatening air pollution from myriad sources affecting millions of individuals or the provision of national defense. Other public-sector actions, such as subsidies to farmers and restrictions on the number of taxicabs in a city, provide narrow benefits that fall far short of their costs. In democratic politics, rules typically give a majority coalition power over the entire society. These rules replace the rule of willing consent and voluntary exchange that exists in the marketplace. In politics, people’s goals are similar to the goals they have as consumers, producers, and resource suppliers in the private sector, but people participate instead as voters, politicians, bureaucrats, and lobbyists. In the political system, as in the marketplace, people are sometimes (but not always) selfish. In all cases, they are narrow: how much they know and how much they care about other people’s goals is necessarily limited. An advocate of the homeless working in the political arena typically lobbies for a shift of funding (reflecting a move of real resources) from other missions to help poor people who lack housing. The views of such a person, while admirable, are narrow. He or she prefers that the government (and other givers) allocate more resources to meet his or her goals, even though it means fewer resources for the goals of others. Similarly, a dedicated professional, such as the director of the National Park Service, however unselfish, pushes strongly for shifting government funds away from other uses and toward expanding and improving the national park system. His or her priority is to get more resources allocated to parks, even if goals espoused by others, such as helping the poor, necessarily suffer. Passionate demands for funding and for legislative favors (inevitably at the expense of other people’s goals) come from every direction. Political rules determine how these competing demands, which far exceed the government’s ability to provide them, will be arbitrated. The rules of the political

Present value is the value today of an amount of money in the future. If the appropriate interest rate is 10 percent, then the present value of $100 spent or earned one year from now is $100 divided by 1.10, which is about $91. This simple example illustrates the general truth that the present value of a future amount is less than that actual future amount. If the appropriate interest rate is only 4 percent, then the present value of $100 spent or earned one year from now is $100 divided by 1.04, or about $96. This illustrates the fact that the lower the interest rate, the higher the present value. The present value of $100 spent or earned twenty years from now is, using an interest rate of 10 percent, $100/(1.10)20, or about $15. In other words, the present value of an amount far in the future is a small fraction of the amount. The fact that a dollar one year from now is less than a