market government government failure intervention failure externality -public goods market power...

MARKET GOVERNMENT GOVERNMENTFAILURE INTERVENTION FAILURE EXTERNALITY -PUBLIC GOODSMARKET POWER INEQUITIES DYNAMIC MKT. FAIL. INDIVISIBILITYINFORMATION ASYMMETRYFAILURE TO RATION

EXTERNALITIES: impacts on third parties besides the buyer and seller.

CONSUMPTION EXTERNALITIES: impactson third parties as a result of the consumptionof a good.=>Divergence of social and private demand

PRODUCTION EXTERNALITIES: impactson third parties as a result of the production ofa good.=>Divergenece of social and private supply

SmokingPrivate Demand Private Supply

# of packs

$10/Pack

Price

Market equilibriumPrice

The Consumption Externality of Smoking:Suppose everyone who smokes a pack costs $5 in costs on everyone else who breathes the fumes. Private demand (the hooked) is in black. Social demand is in RED (deduct health cost). Private Demand Private Supply

$5 perpack

# of packs

$10/Pack

Price

The Consumption Externality of Smoking:Suppose everyone who smokes a pack costs $5 in costs on everyone else who breathes the fumes. Private demand (the hooked) is in black. Social demand is in RED (deduct health cost). Private Demand Private Supply

$5 perpack

# of packs

The Consumption Externality of Smoking:Suppose everyone who smokes a pack costs $5 in costs on everyone else who breathes the fumes. Private demand (the hooked) is in black. Social demand is in RED (deduct health cost). Private Demand Private Supply

$5 perpack

# of packs

Socially Desirable Price=$8.46 per pack

Tobacco Production:

Production Externality Private Demand Private Supply

Pounds of tobacco

$2 perpound

Price

Market equilibriumPrice

Tobacco Production: Every pound sold builds sound community of the U.S.A.: value of moral fiber= $1 per $2 sold (50% ad valorem)

Private Demand Private Supply

Pounds of tobacco

$3 perpound

Price

50% above private market price:Ad valorem sales subsidy

Contradictory policy on production and consumption: other examples:

-Car production ($50 billion for GM, emission controls and clunker taxes)-Electric Power (subsidize production, tax consumption (carbon tax))-Oil (subsidize production (depletion allowance, foreign tax exemption), tax consumption at pump)-Steel (tax pollution, subsidize production (tariff))-Medical education (subsidize doctor education, tax physician incomes & malpractice insurance requirement)

MARKET POWER: a downward sloping demand curve from the point of view of theseller; the power over the market price.

includes: MONOPOLY, OLIGOPOLY,MONOPOLISTIC COMPETITION,MONOPSONY, OLIGOPSONY,BILATERAL OLIGOPOLY, ANDBILATERAL MONOPOLY.

DEAD WEIGHT WELFARE LOSS OF MONOPOLY

DEMAND

MARGINAL COST

MonopolyCase

CompetitiveCase

transferred to producerA

Loss to Consumers+Gain to Producers=Increased profit to producers

Railroad Rates ($/ton mile)

Price Due to higher prices

Due to lower costs

Deadweight loss: due to lower output neither gains

DYNAMIC MARKET FAILURE: the failurethrough time to achieve technological changeand the failure of the market to achieve stable,equilibrium outcomes.

examples:- Stagnation

- Lack of technological change. -The cobweb problem - Instability

0

1 0

2 0

3 0

4 0

5 0

6 0

7 0

8 0

0 5 1 0 1 5 2 0

COBWEB MODEL

Ao

B3

CHEMICALS (millions of pounds/year)

Price

Suppose a shock knocks the price on theMarket higher to Ao.

0

1 0

2 0

3 0

4 0

5 0

6 0

7 0

8 0

0 5 1 0 1 5 2 0

COBWEB MODEL

AoA1

B3

CHEMICALS (millions of pounds/year)

Price

Because of higher prices, more firms enterThe market to produce more quanity supplied

0

1 0

2 0

3 0

4 0

5 0

6 0

7 0

8 0

0 5 1 0 1 5 2 0

COBWEB MODEL

AoA1

A2

B3

CHEMICALS (millions of pounds/year)

Price

With so much production, there is a surplusOn the market and prices fall.

0

1 0

2 0

3 0

4 0

5 0

6 0

7 0

8 0

0 5 1 0 1 5 2 0

COBWEB MODEL

AoA1

A2

A3

B3

CHEMICALS (millions of pounds/year)

Price

With such low prices firms get out of theMarket and there is very little supplied.

0

1 0

2 0

3 0

4 0

5 0

6 0

7 0

8 0

0 5 1 0 1 5 2 0

COBWEB MODEL

AoA1

A2

A3

Bo

B3

CHEMICALS (millions of pounds/year)

Price

With so little production, people pay a lotFor what is available

0

1 0

2 0

3 0

4 0

5 0

6 0

7 0

8 0

0 5 1 0 1 5 2 0

COBWEB MODEL

AoA1

A2

A3

Bo

B1

B3

CHEMICALS (millions of pounds/year)

Price

High prices induce firms to enter… withA lag

0

1 0

2 0

3 0

4 0

5 0

6 0

7 0

8 0

0 5 1 0 1 5 2 0

COBWEB MODEL

AoA1

A2

A3

Bo

B1

B2B3

CHEMICALS (millions of pounds/year)

Price

Overexpansion causes the price to drop

0

1 0

2 0

3 0

4 0

5 0

6 0

7 0

8 0

0 5 1 0 1 5 2 0

COBWEB MODEL

AoA1

A2

A3

Bo

B1

B2B3

CHEMICALS (millions of pounds/year)

Price

Such a low price provides no incentiveto produce any product at all.

WHAT PREVENTS THE UNSTABLE CYCLE?

- MORE INELASTIC SUPPLY- A LONG TIME HORIZON- INSTANTANTANEOUS FEEDBACK ABOUT PRICES- IMMEDIATE ADJUSTMENT OF PRODUCTION- COUNTERCYCLICAL INVENTORY POLICY (requiring storable goods) - EXTRA CAPACITY- MARKET POWER- COMMUNICATION, PLANNING OF MEMBERS IN MARKET. INFORMATION ON MARKET- MARKETS THAT ALLOW SPECULATION AGAINST UNSTABLE BEHAVIORGovernment intervention: BUFFER STOCKS

Quintiles Based on Per Capita Income

Quin- tile

Cumu- lative %

% of World GNP

Cumu- lative % GNP

Inequal- ity (2)-(4)

Average Inaequal- ity/%

Inequal- ity %

(1) (2) (3) (4) (5) (6) (7)

0 0 0

20 20 1.80 1.80 18.2 9.1 1.82

30 50 2.58 4.38 45.62 31.91 9.57

10 60 2.53 6.91 53.09 49.36 4.94

20 80 17.22 24.13 55.87 54.48 10.90

20 100 75.87 100 0 27.94 5.59

Total 100.00 Measure of Inequality

32.81

0

1 0

2 0

3 0

4 0

5 0

6 0

7 0

8 0

9 0

1 0 0

0 2 0 4 0 6 0 8 0 1 0 0

Cumulative % of:Coun- GNPtries

0 0 20 1.8 50 4.4 60 6.9 80 24.1100 100

WORLD INCOME DISTRIBUTION

0

10

20

30

40

50

60

70

80

90

100

0 20 40 60 80 100

WORLD INCOME DISTRIBUTION

LINE OFEQUALITY

USA

WORLD

FOUR FAILURES TO RATION

QUANTITY

P

R

I

C

E

QUANTITY

P

R

I

C

E

QUANTITY

P

R

I

C

E

QUANTITY

P

R

I

C

E

Demand Supply

Glut

Se-vere

Shor-tage

Not a Problem Infeasibility

GOVERNMENT STUDIESType ofStudy

Objective of Study Definition andFocus

ImplicitConstraints

Problem________

Cost BenefitAnalysis

Net Social Benefit Benefits & costsincluded towhomeveroccurring

None Comprehensivemeasurement ofbenefits & costs ishard

Regulatory ImpactAnalysis

Net Social Benefit& other socialobjectives

Includes costbenefit analysis andother studies

Environmental &other constraints

Goes beyond cost-benefit, butbecomes verysubjective

Economic ImpactAnalysis

Describe allregulatoryt impacts

Examines price,output, financial, &employmentimpacts

Assumes impactsshould be minimal

Regulationdiscouraged.Limited weighingof costs/benefits

Closure Analysis Maximizeregulatoryobjective

Defines degree ofregulation that willshut firms down

Implicitly, firmsare not to be shutdown

Overregulatesprofitable,underregulatesunprofitable

Cost EffectivenessAnalysis

Maximize pollutionabatement, etc.

Avoids $ value onbenefits ofgovernmentintervention

Budget or costconstraint limitsamount ofintervention

Comparisonsdifficult acrossdifferent types ofintervention

Fiscal ImpactAnalysis

Up to decisionmakers

Focuses only ongovt. unit

Govt. revnue mustexceed cost

Ignores costws &benefits to society

PRIVATE (for profit) STUDIESType of Study

Objective of Study

Definition and Focus Implicit Constraints

Problem ________

Private Cost Benefit Analysis***

Net Social Benefit must be positive

Private benefits & costs ONLY

None Requires measurement of all benefits & costs. Ignores unmeasurable ones

Regulatory Impact Analysis

Multiple social objectives

Includes cost benefit analysis and other studies

Environmental & other constraints

Goes beyond cost-benefit, but becomes very subjective

Economic Impact Analysis***

Maximizes costs on the regulated

Examines price, output, financial, & employment impacts

arbitrary limits on acceptable costs of compliance

Regulation discouraged. Ignores most social benefits and costs

Closure Analysis***

Minimizes regulatory objective

Defines degree of regulation that will shut firms down

Implicitly, firms are not to be shut down

Over regulates profitable, under regulates unprofitable

Cost Effectiveness Analysis

Minimizes ratio of net cost to net effectiveness

Maximizes efficiency in achieving objective

Budget or cost constraint of organization

Comparisons difficult when objectives (“effectiveness”) differ across programs

Fiscal Impact Analysis

Maximize net govt. surplus

Focuses only on government finances

Govt. revenue must exceed cost

Ignores full costs & benefits to society

*** Focuses only on private costs and benefits, not public costs and benefits

PRIVATE (for profit) STUDIESType of Study

Objective of Study

Definition and Focus Implicit Constraints

Problem ________

Private Cost Benefit Analysis***

Net Social Benefit must be positive

Private benefits & costs ONLY

None Requires measurement of all benefits & costs. Ignores unmeasurable ones

Regulatory Impact Analysis

Multiple social objectives

Includes cost benefit analysis and other studies

Environmental & other constraints

Goes beyond cost-benefit, but becomes very subjective

Economic Impact Analysis***

Maximizes costs on the regulated

Examines price, output, financial, & employment impacts

arbitrary limits on acceptable costs of compliance

Regulation discouraged. Ignores most social benefits and costs

Closure Analysis***

Minimizes regulatory objective

Defines degree of regulation that will shut firms down

Implicitly, firms are not to be shut down

Over regulates profitable, under regulates unprofitable

Cost Effectiveness Analysis

Minimizes ratio of net cost to net effectiveness

Maximizes efficiency in achieving objective

Budget or cost constraint of organization

Comparisons difficult when objectives (“effectiveness”) differ across programs

Fiscal Impact Analysis

Maximize net govt. surplus

Focuses only on government finances

Govt. revenue must exceed cost

Ignores full costs & benefits to society

*** Focuses only on private costs and benefits, not public costs and benefits

MARKET GOVERNMENT GOVERNMENTFAILURE INTERVENTION FAILURE EXTERNALITY PUBLIC ENTERPRISE ADMINISTRATIVE-PUBLIC GOODS-NATIONALIZATION COSTMARKET -PRIVATIZATION COMPLIANCE POWER REGULATION COSTINEQUITIES - OUTPUT EFFICIENCY COSTDYNAMIC - PRICE - NEGATIVE EXTER. MKT. FAIL. - STANDARDS -PUBLIC BADSINDIVISIBILITY ANTITRUST - MKT POWERINFORMATION -STRUCTURE - INEQUITIES ASYMMETRY -CONDUCT - DYNAMICFAILURE TO TAXES (SUBSIDIES) - INDIVISIBILITY RATION PROVISION OF - INFORMATION INFORMATION RATIONING (MONEY)