Part 3: Public Goods and Social Preferences

Sakshi Upadhyay is a fourth year Ph.D. student in the Department of Economics and a summer research fellow at the Kellogg Center for Philosophy, Politics, and Economics at Virginia Tech.

Sakshi’s area of interest lies in understanding human behavior in the sphere of public goods provision in a society. Additionally, her research sheds light on how coalitions are formed among agents in a society.

This is a series of articles about Sakshi’s research interests, economics as a discipline, the methods and importance of experimental economics, and Sakshi’s most recent work. Please feel free to contact Sakshi if you are interested to learn more about her work.

Part 3

Public goods. Public goods are goods that are non-rival, meaning that more than one person can simultaneously benefit from them, and non-exclusive, meaning that it is difficult to prevent any individual from enjoying their benefits. A key theme in public goods research is deciding how much of a public good to produce and how to pay for it. Environmental protection, research and innovation, highways, public parks are just a few of important examples. Creation of such public goods requires coordinated actions of people who will later enjoy its benefits.

Experimental results. While public goods theory predicts free riding and inefficient outcomes, experimental results suggest cooperation does exist, with contribution rates at 40-60 percent of the efficient level. These experimental results motivated research on importance of institutional environment that can help in achieving the optimal outcome or reduce free riding. Institutional environment refers to the context or setting in which individuals would make their decisions. Communication between the participants, punishing the free riders, committing to contribute are some of the mechanisms to contribute to public good.

Coalitions. Coalitions represent a mechanism that can increase cooperation in public goods. Agents first decide whether or not to join a coalition, then members decide how much to contribute. Coalitions such as International Environmental Agreements (IEA) where countries cooperate for an environmental cause are also observed in practice. Agents in a coalition first decide whether or not to join a coalition, then members decide how much to contribute. Although coalitions such as IEA are observed in practice, the conditions under which they successfully form are not well understood. Social preferences, such as warm glow, altruism, inequality aversion, and Rawlsian preferences are well documented in other economic environments. However, their effect on formation likelihood and size of coalitions to produce public goods is not well understood.

Social preferences. My research uses both theory and experiments to incorporate social preferences into the study of coalition formation and how such coalitions affect the provision of the public good. Individuals are assumed to have heterogeneous Rawlsian preferences, i.e., they care about the income of the least well-off individual in the economy, but to a varying degree. We model an individual’s utility function as a weighted average of their own pecuniary payoffs and those of the worst-off individual in the group. Both social preferences and individual returns from the public good are assumed to be private information. The coalition formation process is, therefore, modeled as a two-stage game of incomplete information. In first stage individuals must decide whether to join a coalition or not. Before the stage two begins, the size of the coalition is announced to both the coalition members and non-coalition members (referred as fringe members). In stage two the coalition members vote on whether all coalition members will contribute or not, while fringe members decide independently whether or not to individually contribute.

Our findings. The study finds that individuals with stronger social preferences are more likely to join the coalition and vote for the coalition to contribute to the public good. Also, higher marginal benefits of contribution leads to more people joining the coalition and contributing to the public good. These results hold whether the coalition’s decision is determined by a majority voting or a unanimous voting rule. The results are also robust to different model specifications. The design of the model also allows for experimental testing of its predictions.

The number of players who join a coalition, and thus coalition size and outcome efficiency, are increasing in the return from the public good and strength of social preferences. Importantly, our two-stage mechanism allows individuals to sort themselves into either the coalition or fringe in the first stage, thus revealing information about their social preferences. Once individuals know the size of the coalition they can determine whether it is desirable for them to contribute. In this way, our mechanism helps increase the size of the public good and thus outcome efficiency.

Please click here for Part 1 and Part 2 of this series.