Presentation on theme: "An Exploration into the Dark Side"— Presentation transcript:
1 An Exploration into the Dark Side Market FailureAn Exploration into the Dark SideJoin me and together we will OWN the Universe!Too late, Vader…I already do!
2 Objectives Explain market failure. Identify the conditions under which market failure may occur.Compare Public and Private goodsCalculate the optimal provision of a public good.Evaluate the provision of public transportationRespond to the provision of health care offered in major health care plansExplain the economists definition of an externalityDescribe real-world conditions for externalitiesEvaluate solutions (pigovian tax, Coase theorem) for externalities
3 How do markets fail? Market inconsistency – the bumpy road Lack of provision of public goodsExistence of externalitiesInequality of income and wealth distributionMonopoly power concentrated into the hands of a few
4 Market InconsistencyMarkets are a constant battleground for customers, resources, and profit.Firms never act in the interest of anyone or anything but themselvesConsequence: The consumer and laborer faces firms entering and exiting markets, jobs being created and lost, and price flucuations
5 Public vs. Private Public goods are not necessarily government owned Two characteristicsRivalry – use of the good prevents its use by anotherExcludability – use of good requires some sort of mechanism for distribution: price systemPrivate Goods: Rivalrous and ExcludablePublic Goods: Non-rivalrous and non-excludableMarkets will not provide public goods…so who should?Government? Private companies forced?
6 Public GoodsA public good is one that cannot, by definition, profit directly from its existenceFees could be charged for the view of a statue, for example, but if there is no means of stopping someone from viewing the statue for free, it would reason that many people would look at the statue for freePublic goods are plagued by the problem of free riders.Free riders are those people who, when not required to pay for a good or service, do not!
7 Free Ride…Take it easy!That is a good song but really bad for economists!The problem of the free-riderDemand for a public good is not expressed by the marketNo profit-maximizing firm, in turn, would be willing to produce a public goodYet many in the market may greatly desire the public goodSo, the government will step in and provide the good…The government, however, cannot know what the demand for a public good is, so it must guessIn estimating the demand for a public good, the government would need to poll people and ask them how much they would be willing to pay marginally for an additional unit of the public good.How much would you pay for a 1 lane road? 2 lane road? 4 lanes?
8 Marginal Benefit 1 $4 $5 $9 2 $3 $7 3 $2 4 $1 5 $0 When we add up how much individuals would be willing to pay marginally for a new road, we can create a “demand” or “willingness to pay” curve for a this public goodIn this example, the “marginal collective willingness to pay” could be called the Marginal Benefit because it reflects how much value each person (and society as a whole) has for each unit of the public goodMilitary DivisionsPerson A’s Willingness to PayPerson B’s Willingness to PaySocial Willingness to Pay1$4$5$92$3$73$24$15$0
9 Optimum Provision of Public Goods MC = MR, right?WRONG!MB = MC, stupid!Sorry, I get mad sometimes.When deciding HOW much of a public good to provide, the government needs to know the marginal cost of the good.At the point where the marginal benefit and marginal cost curve intersect the optimum quantity of a public good is found and results in allocative efficiency!
10 Optimum Provision - Graphically Where MB = MC, the optimum net marginal benefit existsHence, government should produce a public good at this quantity to maximize the net marginal benefit.Military DivisionsMarginal Benefit (D)Marginal Cost (S)Net Marginal Benefit1$9$1$82$7$3$123$545$0MC = SMB = DOptimum Q
11 Impact of Optimum Provision Can the government provide too little of a public good?Can the government provide too much of a public good?Big problem: how do you measure the “social” benefit accurately?In Charlotte, we could analyze the costs of the light rail system vs. its marginal benefit…Costs?Benefits?
12 ExternalitiesBenefits and costs that affect those outside of private market modelsWhen not considered in the market model, ignores pushes and pulls that may drive pricesIf these are significant enough they must be consideredDifficult to measure in dollars
13 Positive Externalities Merit GoodsAny private good that has positive externalitiesExamples: Health care, education, entertainmentMarkets do not always provide merit goods in large enough quantitiesGovernment interventionIncrease demand for the merit goodLower or eliminate the price, supply the product directlySubsidize its production and increase the supplyQuestion: What is the cost of government intervention?Higher tax ratesWaste and inefficiencyPolitical interference with delivery
14 Positive Externalities Beneficial to those who are not part of the market structureExamplesColleges, Universities, Free museumsNatural resources, tourist attractionsArt in public placesI might be able to sell my house for a higher price than I paid if someone built a nice park next to it.In this example, I do not pay for the park, but I benefit from it.
15 I Can’t Get No… Satisfaction… The problem with positive externalities is that we, the consumer, can’t get enough of them…but the market has no incentive to provide large enough quantities of merit goods to satisfy this desire.Hence,Merit goods will always be underallocated
16 Positive Externality Graph The positive externality provides society with benefits that it does not pay for.Hence, we say that there are spillover benefits from merit goods.Spillover BenefitsS = MPCPDt = MSBUnderallocationD = MPBQeQt
17 Negative Externalities Costs of economic activity not born by the producer of the good or serviceNot reflected in the supply of the goodSociety becomes responsible for the costs
18 Negative Externalities Demerit GoodsPrivate goods that have negative externalitiesExamples: Alcohol, Drugs, Cars, etc.The market has a tendency to produce many of these goodsGovernment intervention:Reduce demand for goods (reduce demand)Tax the production of the good (reduce supply)Outlaw the goodConsequences of government interference…
19 Don’t Tread On Me!The problem with negative externalities is that there is little incentive for private firms to reduce the production of goods that have external costs.Because these costs are “paid for” by society, we would say that there is an overallocation of demerit goods.
20 Negative Externality Graph The negative externality is not paid for by the producing firm or consumer of the good. It is a cost that is inflicted on society.Hence, we say that there are spillover costs from demerit goods.St = MSCSpillover CostsS = MPCPD = MPBOverallocationQtQe
21 Problems in Measuring Externalities Subjectivity of ExternalitiesWhat is a merit good to one person/country could not be to another…The degree of merit or demerit is highly debatableSource of externalities and regulationinternational environmental degradationEstimation of values of externalitiesUse of social cost benefit analysis attempts to price on externalitiesIn most cases, externalities do not warrant banning the good, yet often governments look to do this.Future externalities are less of an issue for us today…less likely to consider
22 Responses to Externalities We will discuss more completely the responses that can be made to externalities later.But keep this in mind:Abatement of negative externalities has a cost as does provision of positive externalities.Hence, the marginal cost of a response to either problem has to be weighed against the marginal benefit of the response.In turn, there can be too much response (action) and too little response (action) to externalities. In either case, we do not achieve the socially optimal quantity of response.
23 Inequality of Income and Wealth The flow of economic payments: rent, wages, interest, and profitWealthThe stock of economic goods and services ownedGovernment intervention is better at equalizing these among people in a country…but at a cost… (dum dum dum!!)……TAXES!!!!! Welfare! Transfer payments! Oh My!!!
24 Abuse of Monopoly Power Concentration of power is the goal of firmsMonopoly power does not allow the economy to function most efficiently…(my commentary)Government anti-trust or anti-monopoly laws help eliminate monopoly power…But is Bill Gates all that bad…???
25 Central PlanningA solution to economic inequality and abuse of power is government interventionSome forms of intervention take on a planning model -> Soviet style Planning
26 Central Planning Characteristics Planners appointed to allocate resourcesWhich resources is dependent upon the countryPrices for goods set to match supplyOwnership transferred from private to publicDevelopment plans implementedGrow the economyEqualize the economy
27 Types of Planning Public Sector Planning Indicative Planning Occurs in market economiesAllows only for the planning of public goods and some merit goodsIndicative PlanningLow impact planning that involves directing the method of the economy but not directly controlling itCentral PlanningHigh impact planning that involves making direct decisions about the means of productionDevelopment PlanningPlanning in LDCs where growth into modern economies is the chief focus.