m03efa: economic environment of business government, market failure & market regulation: aims:...
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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
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THE CASE FOR GOVERNMENT INTERVENTION
• Immobility of factors and time lags
• Protecting people’s interests
– Dependants
– Merit goods
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THE CASE FOR GOVERNMENT INTERVENTION
• Externalities– External costs of production
MSC > MC
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External costs in production
O
MC = S
DP
Q1
Co
sts
and
be
nef
its
Quantity
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O
MC = S
DP
Q1
MSC
External costCo
sts
and
be
nef
its
Quantity
External costs in production
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O
MC = S
DP
Q1
MSC
Q2
Social optimum
Co
sts
and
be
nef
its
Quantity
External costs in production
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Beneficial Consumption Externality (training)
Quantity (training)
PriceMSC, MPC
DD
Qprivate
MSB
Qsoc
Net Social Benefits
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Defining Public Goods:
No singular agreed definition
Often welfare economists focus upon two characteristics……
* Non- excludability
* Non-rivalry in consumption
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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
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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
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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)
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THE CASE FOR GOVERNMENT INTERVENTION
• Market power
– Deadweight loss under monopoly
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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
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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
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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
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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
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Monopoly power
O
P1
MC
Q1
MRD = MSB
£
Q
Monopoly priceand output
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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
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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
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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