Colander Ch15 MarketFailure

8/13/2019 Colander Ch15 MarketFailure

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Introduction

Should the government intervene inthe market? The framework presented might be called

the invisible hand framework. Invisible hand frameworkperfectly

competitive lead individuals to make

voluntary choices that are in societysinterest.


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Market Failures

A market failureoccurs when theinvisible hand pushes in such a way thatindividual decisions do not lead to

socially desirable outcomes.


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Market Failures

Any time a market failure exists, thereis a reason for possible governmentintervention into markets to improve

the outcome.


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Market Failures

Because the politics of implementingthe solution often leads to furtherproblems, government intervention may

not necessarily improve the situation.


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Externalities

Externalitiesare the effect of adecision on a third party that is nottaken into account by the decision-

maker. Externalities can be both positive and

negative.


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Externalities

Negative externalitiesoccur when theeffect of a decision on others that isnot taken into account by the decision-

maker is detrimental to the thirdparty.

Examples include second-hand smoke,

water pollution, and congestion.


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Externalities

Positive externalitiesoccur when theeffect of a decision on others that isnot taken into account by the decision-

maker is beneficial to others.

Examples include innovation,

education, and new businessformation.


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Negative Externalities

When negative externalities ensuethird parties are hurt.

Marginal social cost is greater thanmarginal private cost.


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Marginal social costincludes all themarginal costs borne by society.


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Marginal social cost is calculated byadding the negative externalitiesassociated with production to the

marginal private costs of thatproduction.


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The Effect of a Negative Externality

Marginal socialbenefit

Marginal private cost

Marginal social costCost

Quantity0 Q0

P0

Q1

P1

Marginal costfrom externality


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Positive Externalities

Private trades can benefit thirdparties not involved in the trade.

Marginal social benefitequals themarginal private benefit of consuminga good or service plus the positiveexternalities resulting from consuming

that good or service.


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A Positive Externality

Cost

Quantity0

Marginal benefit of an externality

D0= Marginal private benefit

D1= Marginal social benefit

Q0

P0

Q1

P1

S = Marginal private and social cost


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Alternative Methods of Dealing withExternalities

Externalities can be dealt with viadirect regulation, incentive policies,and voluntary solutions.


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Direct Regulation

A program of direct regulationiswhere the amount of a good people areallowed to use is directly limited by

the government.


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Direct Regulation

Economists do not like this solutionsince it does not achieve the desiredend as efficiently(at the lowest cost

possible in total resources withoutconsideration as to who pays thosecosts) and fairly as possible.


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Direct Regulation

Direct regulation is inefficientbecause it achieves a goal in a morecostly manner than necessary.


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Incentive Policies

Incentive programs are more efficientthan direct regulatory policies.

The two types of incentive policies areeither taxes or market incentives.


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Tax Incentive Policies

A tax incentive programuses a tax tocreate incentives for individuals tostructure their activities in a way that

is consistent with the desired ends. Often the tax yields the desired end

more efficiently than straight

regulation.


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This solution embodies a measure offairness about it the person whoconserves the most pays the least tax.


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Another way to handle a negativeexternality is through a pollution taxor effluent fees.

Effluent feescharges imposed bygovernment on the level of pollution

created.


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Regulation Through Taxation

Marginal socialbenefit

Marginal private cost

Marginal social costCost

Quantity0 Q0

P0

Q1

P1Efficient tax


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Market Incentive Policies

An alternative to direct regulation issome type of market incentiveprogram.

Market incentive programa planrequiring market participants tocertify total consumption their own

or others has been reduced by aspecified amount.


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A market incentive program is similarto the regulatory solution in that theamount of the good used is reduced.


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A market incentive program differsfrom a regulatory solution in thatindividuals who reduce consumption by

more than the required amount aregiven a marketable certificate that canbe sold to someone else.


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Voluntary Reductions

Voluntary reductions leave individualsfree to choose whether to follow whatis socially optimal or what is privately

optimal. Economists are dubious of voluntary

solutions.


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A persons social conscience andwillingness to do things for the good ofsociety generally depend on his or her

belief that others will also be helping.


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If a socially conscious person comes tobelieve a large number of other peoplewill not contribute, he or she will often

lose their social conscience.

This is another example of a free

rider problemindividualsunwillingness to share in the cost of apublic good.


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The Optimal Policy

An optimal policyis one in which themarginal cost of undertaking the policyequals the marginal benefit of that

policy.


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The Optimal Policy

Should pollution be totally eliminated?

Some environmentalists say yes.

Economists would answer that doingso is costly so marginal costs shouldbe balanced against marginal benefits.


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The Optimal Policy

The point where MC = MRis called theoptimal level of pollution.

Optimal level of pollutiontheamount of pollution at which themarginal benefit of reducing pollution

equals the marginal cost.


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Public Goods

Apublicgoodis one that isnonexclusive (no one can be excludedfrom its benefits) and nonrival

(consumption by one does not precludeconsumption by others.


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Public Goods

There are no pure examples of a publicgood.

The closest example is national defense. Technology can change the public

nature of goods.

Roads are an example.


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Public Goods

Once a pure public good is supplied toone individual, it is simultaneouslysupplied to all.

A private good is only supplied to theindividual who bought it.


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Public Goods

With public goods, the focus is ongroups.

With private goods, the focus is onthe individual.


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Public Goods

In the case of a public good, the socialbenefit of a public good is the sum ofthe individual benefits.


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Public Goods

Adding demand curves vertically iseasy to do in textbooks, but not inpractice.

This is because individuals do not buypublic goods directly so that theirdemand is not revealed in their

actions.


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The Market Value of a Public Good

0.50

Price

1 2 3 Quantity

.80

.60

.40

.20

1.00

Market demandDB

DA

0.10

0.40

0.10

0.60 0.50


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Informational Problems

Perfectly competitive markets assumeperfect information.

Real-world markets often involve

deception, cheating, and inaccurateinformation.


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When there is a lack of information,buyers and sellers do not have equalinformation, markets may not work

properly.


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Economists call such market failuresadverse selection problems.

Adverse selection problemsproblems that occur when a buyer ora seller have different amounts of

information about the good for sale.

Policies to Deal with Informational


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Policies to Deal with InformationalProblems

One policy alternative to deal withinformation market failures is toregulate the market and see that

individuals provide the correctinformation.



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Another alternative is for thegovernment to license individuals in themarket and require them to provide

full information about the good beingsold.



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Regulatory solutions may be overly slowor costly.


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A Market in Information

A market in information is one solutionto the information problem.

Information is valuable, and is an

economic product in its own right.


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Left on their own, markets will developto provide information that peopleneed and are willing to pay for it.


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Economists who do not like governmentinterference point out thatinformational problems are not a

problem of the market; it is a problemof government regulation.


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Licensing of Doctors

Licensing of doctors is a debate that ismotivated by information problems.

Currently all doctors practicing

medicine are required to be licensed this was not always so.

Licensing of doctors is justified by

informational problems.


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Some economists argue that licensingis as much a problem of restrictingsupply as it is to help the consumer.


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Why, if licensed medical training is sogreat, do we even need formalrestrictions to keep other types of

medicine from being practiced?


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An Informational Alternative to


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An Informational Alternative toLicensure

As an alternative, the governmentcould provide the public withinformation about which treatments

work and which do not. This would give rise to consumersovereigntythe right of the individualto make choices about what is consumedand produced.



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In this scenario, the government wouldprovide such information as:

Grades in college. Grades in medical school. Success rate for various procedures. References.

Medical philosophy. Charges and fees.



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This information alternative wouldprovide much more useful informationto the public than the present licensing

procedure.



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Here are some words of caution aboutthe informational alternative.

To get a true picture of whether thepresent system is best would requireexperts on real-life practices andinstitutions.

The problem is that the experts mayhave a vested interest in keeping thingsjust the way they are.

Government Failures and Market


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Government Failures and MarketFailures

Market failures should notautomatically call for governmentintervention.

Why? Because governments fail too.

Government Failures and Market


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Government Failures and MarketFailures

Government failureoccurs when thegovernment intervention in the marketto improve the market failure actually

makes the situation worse.


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Reasons for Government Failures

Governments do not have an incentiveto correct the problem.

Governments do not have the

information to deal with the problem. Intervention in the markets is almost

always more complicated than it

initially looks.


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Reasons for Government Failures

Government intervention does not allowfine-tuning, and so, when the problemschange, the government solution often

responds far more slowly.

Government intervention leads to

more government intervention.


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Government Policy and Market

Failures

End of Chapter 15


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Documents

Colander Ch15 MarketFailure