Based on work by American economists Charles Tiebout (1924-1968) and James M. Buchanan (1919- ), theory of clubs studies the optimal size of groups of people with a shared consumption (pools, clubs, museums), and the optimal provision of the goods or services.
A club good is excludable in that it is possible to prevent its consumption by entire groups of people, but it is also a non-rival good in that its consumption by one individual does not curb the consumption of another individual.
C Tiebout, ‘A Pure Theory of Local Expentures’, Journal of Political Economy, vol. LXIV (1954), 416-24
James M. Buchanan developed club theory (the study of club goods in economics) in his 1965 paper, “An Economic Theory of Clubs”. He found that in neo-classical economic theory and theoretical welfare economics is exclusively about private property and all goods and services are privately consumed or utilized. Just over the last two decades before his provision in 1965, scholars started to extend the theoretical framework and communal or collective ownership-consumption arrangements were considered as well.
Paul A. Samuelson made an important provision in this regard, making a sharp conceptual distinction between goods that are purely private and goods that are purely public. While it extended the previously existing theoretical framework, Buchanan found that there was still a missing link that would cover the whole spectrum of ownership consumption possibilities. This gap contained goods that were excludable, shared by more people than typically share a private good, but fewer people than typically share a public good. The whole spectrum would cover purely private activities on one side and purely public or collectivized activities on the other side. Therefore, according to Buchanan, a theory of clubs needed to be added to the field.
The goal of his theory was to address the question of determining the “size of the most desirable cost and consumption sharing arrangement”.
The model was based on the assumptions that individuals have similar preferences for both private and public goods, the size of the club good and equal sharing of costs. The economic theory of clubs further tries to answer the undersupply equilibrium of a public good provision. Provision of club goods may sometimes pose an alternative to public good provisions by the federal or central government. An issue of club theory is that it may not result in equal and democratic distribution of the good eventually due to its excludability characteristic. James M. Buchanan was primarily interested in voluntary clubs. In these cases club good theory can critically assess how to achieve an optimal number of members of a club as well as the maximum utility for club members.
Examples of private goods that Buchanan offered to illustrate this concept were hair cuts and shoes. Two people can’t wear the same exact pair of shoes at the same time, but two or more people can take turns wearing them. As the number of people sharing the same pair of shoes increases, the amount of utility each person derives from the shoes diminishes. For the case of service, like a haircut, the same logic applies. Sharing a haircut means, one-half haircut per month is consumed, or half a physical unit of service. Therefore, the utility for the person deriving from the service declines.
Using the example of a swimming pool facility, James M. Buchanan states that:
As more persons are allowed to share in the enjoyment of the facility, of given size, the benefit evaluation that the individual places on the good will, after some point, decline. There may, of course, be both an increasing and a constant range of the total benefit function, but at some point congestion will set in, and his evaluation of the good will fall.
But each new member (or co-owner) helps reduce the cost of the club good, so there will be some optimal size of the good that maximizes the benefit for its members.
In the 90s Richard Crones and Todd Sandler came up with three conditions to determine the optimal club size, which were based at equating costs and benefits at the margin. Firstly, the provision condition which requires determination of the benefits to members from reducing congestion costs and set them in comparison to the cost of capacity. Secondly a utilisation condition, which requires an efficient use of the capacity. Here the user fees equate the members marginal benefit from consumption and the congestion costs the member’s participation imposes on others. If the fee is set too low, the club’s capacity will be overused, if the fee is too high the capacity will be underutilized. Hence, the club good must be priced in a way that reflects members preferences for crowding.
The third condition is that new members are added to the club, until the marginal benefit from additional membership is equal to the marginal congestion costs.
Because of the three conditions, there is usually a two-part pricing of club goods. One is the fixed up-front membership fees and the other is the per unit charge to achieve an optimal utilisation. In the case of a pure public good, like political lobbying a two-part pricing is not feasible, but a club can provide selective incentives, also called Member-only privileges, like subscribing to the club’s magazine or journal. Since clubs compete for members, as long as clubs can be closed freely and members are free to exit, prices for clubs will be in line with costs. The free exit option prevents clubs from charging prices that are too high, but incentivizes free-riding. Members understate their benefits, reduce their effort they supply towards achieving the club’s collective goals and take advantage of other club members.
The theory of clubs has been intensively applied to the realm of international alliances. Olson and Zeckhauser (1967) published a cost-sharing analysis of the North Atlantic Treaty Organisation (NATO). In particular they identify the conditions under which it would be in the interest of the club members to increase the size of NATO. According to them every members pay contribution fees, based on their specific marginal values. Therefore, costs shares are computed based on the club’s total costs and group size. They point out that the United States is by far the largest contributor to NATO and by that to the collective goal of the institution. The question raised is whether the differences in membership contribution are reasonable given each country’s valuation of the provided good by the alliance. Otherwise the distribution of cost shares is unjust and several member states are free riding