Econ Hw
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Lect8s19MktFailure1.pptxLect8 Mkt Failure
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Theory of market failure
Economists have a framework for analyzing the role of government; it starts with the presumption that markets are engines of prosperity, efficiency, and growth
But there are things markets cannot do; there are market failures; in principle a government may be able to remedy market failures
Market failures (Box 5.1, p 133)
1. externalities (divergence of private and social costs and benefits) (taxes to internalize external costs, subsidies for ext benefits)
2. monopoly or market power (barriers to entry are critical) (most barriers are created by governments, hence are not market failures)
3. public goods
4. information asymmetries
Public goods: two definitions
Non-excludability: no member of the group can be feasibly excluded from the benefits; national defense, scientific discovery, weather forecast, controlling air and water pollution
Non-rival good: consumption by one person does not interfere with consumption by others; jointness of supply; zero marginal cost to allow another person to enjoy the good
Public goods
Non-excludable goods; this feature gives rise to the “free rider” problem; why should I contribute to the production of the good if I can enjoy it anyway?
Free market cannot supply such goods; there needs to be coercion: tax the members of the community; govt supplies the good (or hires a company to do it)
Which are public goods? By which definition?
Highways, bridges
Irrigation works
Water supply to households
Cable TV
Primary schooling
Look at Practice 4 on market failures
Public goods
| Rival | Non-rival (Zero MC, jointness of supply | |
| Excludable (feasible to exclude, feasible to charge for use) | Apples | Cable TV, sewage and water supply, empty highway or bridge |
| Non-excludable | Crowded parks, fisheries; congested highways | National defense mosquito eradication Information: science, new technology, diet advice |
Public goods: names for the categories
| Rival | Non-rival | |
| Excludable | Private goods (suitable for free market) | ? No good name Regulated industry? |
| Non-excludable | Common pool resources: Need to charge admission or license entry | True public good Private market cannot supply; Need coercion (tax, and govt supply) |
4. Asymmetric information
Another failure of markets; this condition arises when one party to the transaction has information not available to the other party
Insurance markets: adverse selection (sickly people are more likely to sign up for health insurance)
Insurance markets: moral hazard (once insured, you fail to take precautions)
CK9 CONVERGENCE
Market Failures and Other Shortcomings of Markets
The Theory of Market Failure is based on traditional assumptions of economists: that people are rational and forward-looking; does the market system give people what they want?
Behavioral Economics suggests that people don’t always act in their own self-interest
Markets and Income Distribution
A minimal state that takes care of market failures does not need to raise much revenue; the income distribution produced by such a market economy is likely to be very unequal.
Can you have equality of opportunity if income distribution is highly unequal?
Is there an ethical or moral case for government taxation of the rich to provide benefits for the poor?
Six potential justifications for govt action
Four mkt failures: 1.externalities 2.public goods 3.monopoly 4.asymmetric information
5. Human failures in decision making; paternalistic justification
6. Income redistribution; ethical argument; often based on idea that marginal utility of income is higher for the poor than the rich; also on idea of equality of opportunity
Conservatives
Many conservatives want small govt, but they are not philosophically consistent libertarians
They accept social security in principle
They want small govt mainly because they don’t want to pay taxes; typically they accept modest safety net
Liberals (progressives) accept mkt economy but want substantial income redistribution
Views of role of govt in a market economy
Libertarian
Conservative
Liberal
Welfare State
See Practice 5a
Share of govt in GDP in each view
Role of govt in a market economy
I want you to consider the libertarian view; if you don’t accept it, think carefully about why not; which of the six justifications are you relying on? See Reader, pp. 14-15
It would be possible to leave primary schooling to the private sector
Children’s immunization shots
Role of Government in Market Economy
Health care. Does the market work in providing doctor visits and hospital services?
Should the government do anything about obesity?
Think about the six potential justifications for government intervention; which ones apply?
Markets and Income Distribution
How can a government redistribute income toward the poor without weakening the efficiency properties of the free market?
1. The rich have so much that modest taxation of the rich is sufficient to provide for the poor
2. The govt can do for the poor what is in their best interest (schooling, health); hence no incentive problem arises
Markets and Income Distribution
3. Safety net: unemployment compensation, health insurance, emergency assistance; are there adverse incentive effects? (People prefer to stay on the dole rather than work?)
Survey 1 What is your view?
