4. Public Goods, Mechanism Design, and the Social Multiplier

This chapter focuses on uncompensated external effects and coordination failures, particularly in the context of public goods and common property resources. It introduces the tools of mechanism design, which involve starting with some desired outcome or a set of desiderata for a good outcome such as Pareto efficiency and fairness, and then reverse-engineering the rules of the game that will support this outcome as a Nash equilibrium. The chapter emphasizes that human actions often confer uncompensated external benefits or costs on others, presenting a challenge for policy design.

Key topics explored by the problems in this chapter include the concept of the social multiplier, illustrating how direct policy effects can be amplified or diminished by indirect behavioral responses. The chapter also illustrates the private under-provision of public goods and how optimal subsidies can internalize external benefits. It further examines conflicts arising from the production of household public goods and the role of optimal contracts in teamwork scenarios, also introducing power, which is here represented by the advantages of being the first mover in a game.