Journal of Public Economics 52 (1993) 217-235. North-Holland Exclusion and moral hazard The case of identical demand Emilson CD. Silva and Charles M. Kahn* zyxwvutsrqponmlkjihgfedcbaZYXW Department of Economics, University of Illinois, Champaign-Urbana, IL 61820, USA Received September 1991, tinal version received July 1992 This paper examines the problem of costly exclusion of individuals from a public good. Previous analyses of exclusion have treated it as solely a question of technologies; in our analysis exclusion depends on technology and incentives. In this paper providers of the good design a mechanism to provide an optimal level of deterrence to free riders. If individuals are heterogeneous optimal deterrence may allow some free riders. We examine the effect of costs of exclusion on the Samuelson condition for optimal provision, and see that the desire to deter free riding leads to underprovision of the good irrespective of the degree of rivalry of the good. 1. Introduction Economics textbooks distinguish among goods according to levels of excludability of consumption benefits. Private goods are perfectly excludable; the seller of a private good can always prevent people who do not purchase the good from enjoying its benefits. Pure public goods are perfectly non- excludable; the seller of a pure public good is unable to prevent any agent from enjoying the good. However, almost all goods lie between these two extremes. It is neither absolutely costless nor absolutely impossible to prohibit non-purchasers from enjoying the benefits of most goods. Software computer packages are a natural example of imperfect exclusion. Designers incorporate copy- protection in their computer programs to prevent non-purchasers from using them. Nevertheless, exclusion is not perfect because the more secure the program is made the less valuable it is to legitimate users. The services of satellite television provide another instance of imperfect exclusion, since it is costly to employ scramblers that impede viewers’ reception of channels not Correspondence to: CM. Kahn, Department of Economics, University of Illinois, Box 111, 330 Commerce W. Building, 1206 South 6th Street, Champaign, IL 61820, USA. *We thank Jan Brueckner, Myrna Wooders, two referees of this journal and participants in the Public Finance workshop of the University of Illinois for useful comments. We also thank Christine M. Silva for typing assistance. Kahn’s research was funded by NSF grant SES 8821723 and Silva’s research was funded by CNPq (Conselho National de Desenvolvimento Cientifico e Tecnolbgico-Brazil) scholarship 200883/87.9. 0047-2727/93/$06.00 0 1993-Elsevier Science Publishers B.V. All rights reserved