User Prices and Multiplicity in a Simple General Equilibrium Model

Abstract

We use a simple general equilibrium model with multiple equilibria in the form of a co-ordination failure in which the government has the option to finance the provision of a merit good by using user prices. Our main results, derived analytically, are as follows: First, the introduction of a price mechanism for the merit good forces agents to internalize the social cost of publicly provided goods and this allows for higher public expenditures other things equal. Second, if the economy happens to end up at a high-employment equilib-rium, the introduction of user prices further improves private incentives and enhances aggregate efficiency, whereas it further deteriorates private incentives and hurts aggre-gate efficiency if the economy happens to end up at a low-employment equilibrium. Third, the mechanism of user prices breaks down as the publicly provided good becomes more and more public so that free-riding problems dominate, or when there is a thresh-old minimum level for this good that is sufficiently high as in the covid-19 pandemic.