m03efa: economic environment of business government, market failure & market regulation: aims:...

M03EFA: Economic Environment of Business

Government, Market Failure &Market Regulation:

Aims:

a) Evaluate the causes of government interventionb) Focus on externalities & public goods powerc) Assess policy solutions including taxation

THE CASE FOR GOVERNMENT INTERVENTION

• Immobility of factors and time lags

• Protecting people’s interests

– Dependants

– Merit goods

THE CASE FOR GOVERNMENT INTERVENTION

• Externalities– External costs of production

MSC > MC

External costs in production

O

MC = S

DP

Q1

Co

sts

and

be

nef

its

Quantity

O

MC = S

DP

Q1

MSC

External costCo

sts

and

be

nef

its

Quantity

External costs in production

O

MC = S

DP

Q1

MSC

Q2

Social optimum

Co

sts

and

be

nef

its

Quantity

External costs in production

Beneficial Consumption Externality (training)

Quantity (training)

PriceMSC, MPC

DD

Qprivate

MSB

Qsoc

Net Social Benefits

Defining Public Goods:

No singular agreed definition

Often welfare economists focus upon two characteristics……

* Non- excludability

* Non-rivalry in consumption

Pay -offs from Public Goods: Voluntary Contribution versusfree - riding: (Buchanan, 1968)

Outcomes

Strategies Others contribute Others free - ride(good provided) (good not provided)

Doncontributes (£10-£5) = £5 - £5

Don free £10 £0-rides

One solution to the free - rider: is the Clarke Tax:

This involves making a large group case appear a small groupcase

The Mechanics of the Clarke Tax

1. Ask willingness to pay2. Sum total for each option3. Select option with greatest willingness4. Apply Clarke Tax, i.e. absolute difference between options

Voter High Spending Low Spending

1 50 02 0 703 30 0

Total 80 70

A. High level winsB. Voter 1 pays Clarke Tax of 40C. If Voter 1 free rides, Voter 2 is 70 better off and Voter 3 is 30 worse offD. Voter 3 pays Clarke Tax of 20E. Voter 2 has Clarke Tax of 0 (free - riding = 0 effect)

THE CASE FOR GOVERNMENT INTERVENTION

• Market power

– Deadweight loss under monopoly

O

£

Q

Ppc

Qpc

MC(= S under perfect competition)

AR = D

(a) Industry equilibrium under perfect competition(a) Industry equilibrium under perfect competition

ConsumerConsumersurplussurplus

ProducerProducersurplussurplus

a

O

£

Q

Ppc

Qpc

MC(= S under perfect competition)

AR = D

a

Pm

Qpc

MR

b

(b) Industry equilibrium under monopoly(b) Industry equilibrium under monopoly

ConsumerConsumersurplussurplus

O

£

Q

Ppc

Qpc

MC(= S under perfect competition)

AR = D

a

Pm

Qpc

MR

b

(b) Industry equilibrium under monopoly(b) Industry equilibrium under monopoly

ConsumerConsumersurplussurplus

ProducerProducersurplussurplus

O

£

Q

Ppc

Qpc

MC(= S under perfect competition)

AR = D

a

Pm

Qpc

MR

b

(b) Industry equilibrium under monopoly(b) Industry equilibrium under monopoly

ConsumerConsumersurplussurplus

ProducerProducersurplussurplus

DeadweightDeadweightwelfare losswelfare loss

Monopoly power

O

P1

MC

Q1

MRD = MSB

£

Q

Monopoly priceand output

O

MC

Q1

MR AR = MSB

£

Q

AC

AC

P =AR

ProfitProfit(no tax)(no tax)

Using a lump-sum tax to reduce monopoly profits

O

P1

MC

Q1

MR AR = MSB

£

Q

AC

AC + lump-sum tax

AC

AC + tax11

22

1. 1. Acceptable profit Acceptable profit2. 2. Lump sum taxLump sum tax

necessary to achieve necessary to achieve acceptable profitacceptable profit

Readings:

Begg, D. et al, (2008), Economics, Chpt. 15

Boyes, W., (2004), The New Managerial Economics, Chpt. 15

Cook, M. & Farquarson, C., (1998) Business Economics, Chpt. 20

Griffiths, A. & Wall, S. (2005), Economics for Business &Management, Chapter 8

Hanley, N., et al, (1997), Environmental Economics, Chpts. 2, 4 & 5