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Chapter 5Chapter 5

Difficult Cases for the Market Difficult Cases for the Market and the Role of Governmentand the Role of Government

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OverviewOverview

Economic efficiencyEconomic efficiency The role of government within the The role of government within the

marketmarket The four types of market failureThe four types of market failure

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Economic EfficiencyEconomic Efficiency

To be economically efficient:To be economically efficient:

1. All actions generating more 1. All actions generating more benefits then costs should be benefits then costs should be undertakenundertaken

2. No actions generating more costs 2. No actions generating more costs then benefits should be undertakenthen benefits should be undertaken

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Economic EfficiencyEconomic Efficiency

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Role for GovernmentRole for Government

The government should…The government should…

1. Protect individuals and their property 1. Protect individuals and their property rightsrights

2. Provide goods that cannot be easily 2. Provide goods that cannot be easily provided by the market (overcome provided by the market (overcome market failure)market failure)

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The Role of GovernmentThe Role of Government

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Market FailureMarket Failure

1.1. Lack of CompetitionLack of Competition

2.2. ExternalitiesExternalities

3.3. Public goodsPublic goods

4.4. Lack of informationLack of information

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1. Lack of Competition1. Lack of Competition

With no competition, a firm can hold With no competition, a firm can hold back production and raise priceback production and raise price

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1. Lack of Competition1. Lack of Competition

Role for Government?Role for Government?

1. Refrain from activities that reduce 1. Refrain from activities that reduce competition: licenses, price controls, competition: licenses, price controls, etc.etc.

2. Antitrust legislation:2. Antitrust legislation: Sherman Antitrust Act (1890)Sherman Antitrust Act (1890) Clayton Act (1914)Clayton Act (1914)

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2. Externalities2. Externalities

Externalities: Externalities: The effects of an The effects of an activity that influence the well-being activity that influence the well-being of non-consenting third partiesof non-consenting third parties

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2. Externalities2. Externalities

Negative externality: Producer gains Negative externality: Producer gains the benefit, everybody bears the costthe benefit, everybody bears the cost

ex. pollution, loud musicex. pollution, loud music

Producer will produce more than Producer will produce more than society wants (too much).society wants (too much).

Role for government: tax or regulate Role for government: tax or regulate negative externalitiesnegative externalities

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2. Externalities2. Externalities

Positive externality: producer bears the Positive externality: producer bears the cost, everybody gains the benefit.cost, everybody gains the benefit.

ex. education, vaccinationsex. education, vaccinations

Producer will produce less than Producer will produce less than society wants (too little)society wants (too little)

Role for government: subsidizes Role for government: subsidizes positive externalitiespositive externalities

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3. Public Goods3. Public Goods

Public goods have two characteristics:Public goods have two characteristics:

1. 1. Non-rival in consumptionNon-rival in consumption: making the : making the good available to one consumer does not good available to one consumer does not reduce its availability to others.reduce its availability to others.

2. 2. Non-excludableNon-excludable: it is impossible (or : it is impossible (or incredibly costly) to exclude nonpaying incredibly costly) to exclude nonpaying customers from receiving the good.customers from receiving the good.

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3. Public Goods3. Public Goods

Free-rider: A person who receives the Free-rider: A person who receives the benefit of a good without paying for benefit of a good without paying for itit

This will cause the good to become This will cause the good to become under- suppliedunder- supplied

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3. Public Good3. Public Good

Role for the Government?Role for the Government?

The government forces people to pay The government forces people to pay through taxes.through taxes.

Private market can provide a public Private market can provide a public good by tying it to a private good: good by tying it to a private good: radio broadcasts and advertising.radio broadcasts and advertising.

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4. Lack of Information4. Lack of Information

When purchasing a good, consumers When purchasing a good, consumers may not have the information may not have the information necessary to make an informed necessary to make an informed choice.choice.

Role for government?Role for government? Help provide information through Help provide information through

regulationsregulations However, the market may be able to However, the market may be able to

provide information as wellprovide information as well

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ReviewReview

1.1. What do we mean by economic What do we mean by economic efficiencyefficiency

2.2. What are the two roles that the What are the two roles that the government should play in the marketgovernment should play in the market

3.3. Know the 4 types of market failureKnow the 4 types of market failure

4.4. Understand the concept of externalitiesUnderstand the concept of externalities

5.5. Understand the characteristics of public Understand the characteristics of public goodsgoods