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Lesson 21: Government and Public Goods

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1 Lesson 21: Government and Public Goods
Interventions Lesson 21: Government and Public Goods

2 The Rules of the Game Rule of Law exists when rules that govern behavior and interactions among individuals and groups of individuals apply to both the governed and the governing. Rule of Man exists when laws are applied at the discretion of the governing. Under the Rule of Force, people own what they can defend.

3 What Should Government Do?
Limited power of central government Life, liberty, pursuit of happiness (self interest, profit) Establish and enforce protection of property rights Government should do what citizens cannot do!

4 Private vs. Public Sectors
The private sector is made up of households, businesses, and the international sector. Producers and Consumers The public sector refers to activity by the various levels of government. Consumers and Thieves

5 Optimal Provision of Public Goods
With private goods, consumers decide what quantity to buy; market demand is the sum of those quantities at each price.

6 Optimal Provision of Public Goods
With public goods, there is only one level of output, and consumers are willing to pay different amounts for each level. The market demand for a public good is the vertical sum of the amounts that individual households are willing to pay for each potential level of output.

7 Optimal Production of a Public Good
The optimal level of provision for public goods means producing as long as society’s total willingness to pay per unit D(A+B) is greater than the marginal cost of producing the good.

8 The Economic Functions of Government
Enforce Laws and Contracts Protect Private Property

9 The Economic non-Functions of Government
Maintain Competition Redistribute Income Provide an Economic Safety Net Provide Public Goods Nonexclusion Shared consumption Correct Market Failures Provide market information Correct negative externalities Subsidize goods with positive externalities Stabilize the Economy Fight unemployment Encourage price stability Promote economic growth None of these are the functions of true government

10 All caused by Government
Market Failures? Public Goods and Bads (Externalities) Asymmetrical Information Moral Hazard Rule Violations Monopolies Business Cycles All caused by Government

11 How do we evaluate government’s role in the economy?
“Government should do those things people cannot do for themselves.” Abraham Lincoln

12 The Opportunity Cost of Government Spending?
At the margin, the opportunity cost of public spending is private spending. The opportunity cost of government spending on a particular program is the foregone benefit of the other program where the money would have been spent. Government spending is paid for by taxation, which is involuntary. Therefore, (some) citizens undertake actions to minimize their tax burden – using more resources! Rob Peter....Pay Paul?? Does this mean gov’t spending is a “bad”?

13 Public Goods or just Goods Provided by/for the Public?
MB > MC ?? Is it possible to exclude people who don’t pay? Examples of private production? Would people be motivated to pay for the service if it was only provided privately? Is it possible to exclude people who don’t pay? Are there examples of this good or service being provided privately?

14 Public Goods or just “publically-provided” goods?
MB > MC Public Goods or just “publically-provided” goods? “True” public goods are Non-rivalrous in consumption One person’s consumption doesn’t reduce the amount available for others to consume Non-exclusive in production The producer/provider cannot exclude people who do not pay (“free riders”) Therefore, there’s no incentive for private producers to provide the product

15 Public Goods Public goods have characteristics that make it difficult for the private sector to produce them profitably (market failure?). With private goods, the focus is on the individual. With public goods, the focus is on groups.

16 Public Goods Once a pure public good is supplied to one individual, it is simultaneously supplied to all. A private good is only supplied to the individual who bought it.

17 Public Goods In the case of a public good, the social benefit of a public good is the sum of the individual benefits. But how do we know???

18 Solutions to the Public Goods Problem
A common solution is for the government to provide the good, but government is not the only solution. Other solutions are charities and advertising.

19 Public Goods There are no pure examples of a public good.
The closest example is national defense. Technology can change the public nature of goods. Roads are an example.

20 Public or Private Production: The Guideline is the Same
Private Production should take place when the marginal benefit exceeds the marginal cost. Government Production should take place when the marginal benefit exceeds the marginal cost. MB MC

21 Example: National Defense
Would you pay?

22 What about health care?

23 Asymmetric Information
Exchange that occurs when one party has more information than the other is called Adverse selection: the problem that occurs when higher-quality consumers or producers are driven out of the market because unobservable qualities are incorrectly valued.

24 Solutions to Asymmetric Information
Asymmetric information can cause markets to fail – to not allocate goods and services to their highest value use. A seller must provide credible information about the quality of the good. One approach is to devote considerable resources—to spend money—to demonstrate that the seller is credible. Another way to inform consumers of the quality of the product is to provide a guarantee against product defects

25 The Impossibility Theorem
The impossibility theorem is a proposition demonstrated by Kenneth Arrow showing that no system of aggregating individual preferences into social decisions will always yield consistent, nonarbitrary results.

26 The Impossibility Theorem
Preferences of Three Top University Officials VP1 prefers A to B and B to C. VP2 prefers B to C and C to A. The dean prefers C to A and A to B. OPTION A OPTION B OPTION C Hire more faculty No change Reduce the size of the faculty Ranking 1 X 2 3 VP1 VP2 Dean If A beats B, and B beats C, how can C beat A? The results are inconsistent.

27 The Voting Paradox The voting paradox is a simple demonstration of how majority-rule voting can lead to seemingly contradictory and inconsistent results. A commonly cited illustration of inconsistency described in the impossibility theorem. Results of Voting on University’s Plans: The Voting Paradox VOTES OF: Vote VP1 VP2 Dean Result a A versus B A B A wins: A > B B versus C C B wins: B > C C versus A C wins: C > A aA > B is read “A is preferred to B.”

28 Moral Hazard A related issue is moral hazard—the problem that arises when people change their behavior from what was expected of them when they engage in a trade or contract.

29 Adam Smith and Efficiency
Everyone—consumers, firms, resource suppliers—attempts to get the most benefits for the least cost. As Adam Smith noted in 1776, self-interested individuals, wholly unaware of the effects of their actions, act as if driven by an invisible hand to produce the greatest social good.

30 Government as the Guardian
An efficient use of resources implies a maximum value of output from a resource base. This is called technical efficiency. When one person cannot be made better off without making someone else worse off is called economic efficiency. Government can have neither.

31 Protecting the Food Supply
The FDA has issued a rule on the maintenance of records to ensure the Security of the U.S. Food Supply against Bioterrorism. It requires persons who manufacture, process, pack, transport, distribute, receive, hold, or import food to maintain records identifying the source of all food received, and the subsequent recipient of all food released.

32 Lack of Competition Monopoly: a market with only one producer.
If one firm controls production economic efficiency can suffer. Governments often regulate monopolies to ensure economic efficiency. Remember only government can create monopolies.

33 Business Cycles Fluctuations in the economy impact employment rates and income. People call on the government to protect them against the periods of economic ill health and to minimize the damaging effects of business cycles. Business cycles create by money supply manipulation (only can be done by government)

34 The “Big Ideas” from Lesson 21
Government interferes with wealth-producing, voluntary exchange and secure property rights. The opportunity cost of government spending is private spending or what else could have been done. Government has been proven to do nothing better than the private sector, thus are there any real public goods? At best, government should be the referee to a superior game.

35 We exist to bear witness. We had to be. The infinite needs us to see it. Without the perceiver, the perceived does not exist. That gives us leverage. Don't look until you get what you want.

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