Optimality in Producing and Distributing Public Outputs

The problem of determining the optimal level of output for goods and services produced by government and determining the best means of rationing these among people is an important one. The level of aggregate economic welfare depends on both the output level chosen and the mechanism used to distribute this output. Public decisions make implicit judgments on both output and rationing devices without consideration of their interrelationship and their impact on economic welfare. This paper presents a framework for analyzing these two kinds of public decisions where a comprehensive economic welfare criterion is adopted. This criterion includes not only the standard economic welfare components of willingness to pay and production costs but also incorporates consideration of equity, equality of opportunity, stigma effects, and exclusion and administration costs. With this comprehensive framework, the efficiency of alternative rationing devices can be analyzed and evaluated. Application of this framework emphasizes the need for joint determination of the optimal rationing device. and output level in a world in which economic welfare is multi-dimensional. OPTIMALITY IN PRODUCING AND DISTRIBUTING PUBLIC OUTPUTS Charles J'. Cicchetti and Robert H. Haveman* Introduction Defining the conditions for an optimal allocation of goods and service flows among final demanders is a standard welfare economics problem. With maximum economic welfare as the objective and with the distribution of income given, economic theory suggests the optimality of the free, competitive market solution in which the price of service flows is equal to marginal costs. l On the basis of this solution, optimal administered pricing rules have been derived for distributing the outputs of decreasing cost activities, governments, "nature", and for correctigg externalities. While these rules form the basis for recommendations of economically efficient government policy, one is struck by the very few instances in which prices of any kind--much less marginal cost prices--are used to allocate public services or facilities. Failure to ration use by the imposition of charges is defended on several grounds--considerations of equity, equality of opportunity, excessive exclusion and administrative costs, and so on. To be sure, if such considerations indicate the existence of real economic costs and benefits, the simple marginal cost pricing rule based on production cost and willingness to pay functions must be modified to account for them. Such modification will likely result in an altered optimal level of output and may entail abandonment of price as a rationing device and the implementation of an alternative rationing system. This paper addresses the problem of determining the optimal level of output and the choice of rationing device when a comprehensive economic welfare criterion is adopted. 2 *The authors are respectively Research Associate, Resources for the Future and Professor of Economics, University of Wisconsin, Madison.