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Trading, Externalities and Public Goods: The Market Overcomes its Shortcomings. Because nations and people have varying aptitudes it follows that some.

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Presentation on theme: "Trading, Externalities and Public Goods: The Market Overcomes its Shortcomings. Because nations and people have varying aptitudes it follows that some."— Presentation transcript:

1 Trading, Externalities and Public Goods: The Market Overcomes its Shortcomings. Because nations and people have varying aptitudes it follows that some will be better at some things while others are better at other things and if left to themselves would miss out on getting the greatest possible returns from the market for their aptitudes (and hence welfare), unless they trade with each other! From time to time something that occurs outside the market system has an impact inside the market system such that resources are reallocated inside the market system and welfare is affected, unless they are internalized within the market system. Not all goods and services are rival, one person does not benefit exclusively and all of society is better off from this good or service, but each person, individually could not afford to benefit on their own unless everyone participates in designating the good or service as a public domain.

2 Markets Corrections Due to Relative Advantage When Nations Trade they do so one–to-one and so the trade is seen as a microeconomic platform. Not all nations should produce all goods and services and in cases where a world price is greater than the domestic price, those nations will be encouraged to export and welfare will be increased in aggregate due to comparative advantage and producers will gain some surplus from consumers but also some surplus beyond what was at first attainable. Where the world price is below the domestic price, those nations will be encouraged to import the and welfare will be increased in aggregate due to the comparative advantage of the other trading nation and consumers will gain surplus from producers but also from regions that were otherwise unattainable. The more inelastic the demand the greater is the potential gain from trade for everyone which is why most food and natural products (energy and metals) have a single world price, while the more elastic the supply the greater is the instability in these markets. The more elastic the demand the lesser is the potential fort gains from trade for everyone which is why most secondary manufactured products have indeterminate pricing in local markets and there is no world price while the more inelastic the supply the less is there a possibility for gains from trade.

3 Gains from Trade The World Price for a commodity sets the non arbitraged reference price for all producers and can increase welfare [A] (Consumers to Producers) or increase welfare [B] (Producers to Consumers) depending on the comparative advantage or disadvantage of the nation. Price Quantity Domestic Demand Domestic Supply World Price Greater Than Domestic Price Exports Domestic Price World Price Less Than Domestic Price Domestic Quantity Imports A B

4 Government Policy and Trade When a nation imports a product or service many people see this as exporting jobs and a result governments pursue tariffs that always result in a deadweight loss but may be compensated for if government redistributes the revenue taken. [Revenue is E and Deadweight Loss is D + F.. Consumers loose C+D+E+F and Producers gain C.] Price Quantity World Price Plus Tariff Domestic Demand Domestic Supply Imports without tariff Imports with tariff A B C D E F G

5 Government Issues Trade benefits everyone if there is a reason why some nations can do better than others in producing certain things. There is also an increased variety of choices for the consumer, lower costs due to economies of scale, increased competition which strengthens industry, and an enhanced flow of ideas. On the other hand business controls the jobs market and when there is a comparative disadvantage politicians consider this exporting jobs and seek to introduce tariffs to protect local industry. Because: - some nations are at a more advanced state of development than others and in order to grow infant industries special treatment may be necessary until there is a level playing field, - some industries are of crucial national security importance and therefore require protection afforded by tariffs, -other countries may subsidize the costs of their industries and therefore have an unfair advantage which exists only because other governments are involved and so they must be counteracted at least in the domestic market and - it may be necessary to protect a few industries in order to have some elements to negotiate away if international agreements are top be undertaken. Very few governments actually redistribute taxes to the areas from which they are derived and tariffs persist in spite of the obvious benefits.

6 Externalities: Including everything in Costs and Benefits From time to time a market must compensate for an external influence such as pollution or public education and this is based on the differences that exist between private and social evaluations of the total costs and benefits from the market. In cases where there is a negative externality the social cost will exceed the supply curve at every point and the result will be a less than equilibrium quantity of product with a resultant loss in economic surplus. In cases where there is a positive externality, such as public health or education, the social value will exceed the private valuation and there will be a demand in the market that exceeds the equilibrium quantity with a resultant expansion in economic surplus. In all cases the solution is to internalize these externalities in order to ensure that the economic surplus generated is indeed the best outcome for everyone.

7 Negative Externalities Deadweight Losses occur because those who supply product must pay for damage caused by others. Consumers loose A+B+C and Producers loose A+B+C+H so the Deadweight Loss is H Price Quantity Supply (Private Cost) Supply (Private Cost Plus Externality) Demand (Private Value) Social Price Market Price Market Quantity Social Quantity AB C F G H

8 Positive Externalities Welfare gains occur because those who supply product do not pay for advantages generated by others. Consumers may gain if A+E> C and Producers will certainly gain C+F+H and the overall welfare gain is always favorable to producers and sometimes consumers as well. Price Quantity Supply (Private Cost) Demand (Private Value Plus Externality) Demand (Private Value) Social Price Market Price Market Quantity Social Quantity A B C D E F G H

9 Government Initiatives Government responses to externalities are based on the assertion that most externalities are bad… such as pollution and that these issues can be resolved through regulation and the application of corrective taxes and subsidies. Governments have been notorious at not regulating for positive effect. The Coase Theorem argues that when people can bargain without cost, they will be able to solve all of the problems associated with externalities both positive and negative. However, many of these externalities are not readily addressable especially in the health and environment field and therefore transactions costs are difficult to measure. One solution has been to propose that firms bid on tradable pollution permits in which the incentive to reduce pollution will depend on the costs of reducing it and firms will bid on these permits either to earn money from competitors without collusion (illegal) if they have exceeded their target and pay for the pollution that they contribute over and above the target. However, many have objected that this licenses pollution and that is morally wrong but economists have argued that they are one piece in a larger puzzle that should operate to make environmental protection cheaper which will increase the public demand.

10 Public and Private Goods: The Consumers Perspective Goods can be excludable if they are storable and one consumer having it in their possession excludes others from deriving benefits form it. Goods are rival if they are non storable and one person possesses it in order to consume it or use it up. Goods are public if they are neither excludable or rival and possession and use do not alter it. Common Resources are rival in consumption but not excludable and relate to items such as fish in the sea. A good that is excludable but not rival it is a natural monopoly and is primarily exemplified by public services such as police and fire protection. When goods and services are made public they are transformed not in terms of the goods themselves but in terms of access to them and as such conditioned by the nature of ownership control over the production process. Health care is an example that physician care is rival and is excludable through fees but can be made into a natural monopoly through health care insurance (HMO) or a common resource through Medicare. The tragedy of the commons is an argument that states that common resources are always overused when they are freely accessible and the free rider receives the benefits without earning consideration appropriate for access to the service or good. Control systems in the public interest then easily develop into the principle agent problem where the controller receives more benefit than those who access the service and decision rules become arbitrary.

11 Analytics of Public Goods The public demand is given by the vertical summation of the demand curves of each individual producing a shared pricing for a set quantity. Note Total Surplus is increased for each participant paying the same or approximately equivalent individual price. Any proportional fee (tax) will expand Supplier Surplus (Government Revenue) proportionately but only if supply is inelastic. Price Quantity Fixed Quantity Supplied A B C Total Price is the sum of A : B : C

12 Government Issues Government ownership and intrusion is used in many cases to protect or develop industries and as such is most effective in cases where a common resource can be protected through regulation or training of the providers of the service or good. In cases where the supply curve is elastic the contributions to welfare will depend on relative elasticities with demand and the outcomes will not be certain in terms of economic surplus. Public ownership is often seen as an efficient approach to blocking out and industry and forcing an optimum competitive solution, but in practice it has not been successful on a large scale. Moreover the issues involved in government market participation do not always resolve the scarcity challenge that the industry is designed to meet and financially government crowding out has investment impacts that may result in accelerating the opportunity costs that all citizens face with a most profound impact on the least privileged in society thereby accelerating welfare losses due to government deficits.

13 Markets are Robust in Accommodating Changes Market interactions create tensions that must be resolved either through trade, accounting for things usually ignored, or attempting to improve social performance of certain industries through ownership by public authorities. With a progressive tax system and one in which expenditures and revenues are freely reported and reviewed, most modern democratic economies are able to respond to these pressures through a combination of free markets and public controls including ownership. The implicit concern is that markets may collapse as technology changes and no amount of government intrusion would appear to be sufficient, The solution is entrepreneurship that sees opportunities and capitalizes on the apparent diseconomies that present the possibility of earning a profit - no matter how short lived.


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