2 What is the Invisible Hand? What is the Free Market?A economic structure where supply and demand allocate resources. There is little to no government intervention.What is the Invisible Hand?The concept that society’s goals will be met as individuals seek their own self-interest.Competition and self-interest act as an invisible hand that regulates the free market.Example: People love the green shirts that a firm is making…..
3 What is a Free Market Failure? When the free-market system fails to satisfy society’s wants.Private markets do not efficiently bring about the allocation of resources.What’s the result…The government must step in to satisfy society’s wants.
4 Four Market Failures Public Goods 2. Externalities 3. Monopolies 4. Unfair distribution of incomeIn each of the above situations, the government MUST step in to fix the problem.
6 PUBLIC GOODS Why must the public sector provide goods and services? It is impractical for the free-market to provided these goods because there is no opportunity to earn profit.This is due to the Free-Rider ProblemFree Riders are individuals that benefit without paying.
7 What’s wrong with Free Riders? Free-Riders keep firms from making profits.If left to the free market, essential services would be under produced.
8 PUBLIC GOODS 1. Nonexclusion 2. Shared Consumption (nonrivalry) Two criteria of public goods:1. NonexclusionEveryone can use the good.Cannot exclude benefits of the good for those who will not pay.Ex: National Defense2. Shared Consumption (nonrivalry)One person’s consumption of a good does not reduce the usefulness to others.Ex: Kit Carson Park
10 They use Supply and Demand Can there every be too much of a public good?Can there be too many parks?How does the government determine what quantity of public goods to produce?They use Supply and DemandDemand for Public Goods-The Marginal Social Benefit of the good determined by citizens willingness to pay.Supply of Public Goods-The Marginal Social Cost of providing each additional quantity.
11 DEMAND FOR A NEW HIGHWAY Marginal Willingness to Pay Higher Taxes Adams’Willingnessto pay (price)Benson’sWillingnessto pay (price)Society’sWillingnessto pay (price)Quantity1$4+$5=$9
12 DEMAND FOR A NEW HIGHWAY Marginal Willingness to Pay Higher Taxes Adams’Willingnessto pay (price)Benson’sWillingnessto pay (price)Society’sWillingnessto pay (price)Quantity12$43+$54=$97
13 DEMAND FOR A NEW HIGHWAY Marginal Willingness to Pay Higher Taxes Adams’Willingnessto pay (price)Benson’sWillingnessto pay (price)Society’sWillingnessto pay (price)Quantity123$432+$543=$975
14 DEMAND FOR A NEW HIGHWAY Marginal Willingness to Pay Higher Taxes Adams’Willingnessto pay (price)Benson’sWillingnessto pay (price)Society’sWillingnessto pay (price)Quantity1234$4321+$5432=$9753
15 DEMAND FOR A NEW HIGHWAY Marginal Willingness to Pay Higher Taxes Adams’Willingnessto pay (price)Benson’sWillingnessto pay (price)Society’sWillingnessto pay (price)Quantity12345$4321+$54321=$97531
16 $ 9 7 5 3 1 0 1 2 3 4 5 OPTIMAL AMOUNT OF A PUBLIC GOOD Price The Demand is the equal to the marginal benefit to societyD=MSBQuantity of Highways
17 OPTIMAL AMOUNT OF A PUBLIC GOOD S=MSC$ 97531The public good’smarginal costD=MSBQ
18 $ 9 7 5 3 1 MSB = MSC 0 1 2 3 4 5 OPTIMAL AMOUNT OF A PUBLIC GOOD P S=MSC$ 97531Why shouldn’t 2 highwaysbe made?Theoptimum amountof the public goodMSB = MSCWhy shouldn’t 4 highwaysbe made?D=MSBQ
20 What are Externalities? Why are Externalities Market Failures? An externality is a third-person side effect.Externalities are when there are either EXTERNAL benefits or external costs to someone other than the original decision maker.Why are Externalities Market Failures?The free market fails to include external costs or external benefits causing misallocation of resources.Example: Smoking Cigarettes.The free market assumes that the cost of smoking is fully paid by people who smoke.The government recognizes external costs and makes policies to limit smoking.
22 Negative Externalities (aka: Spillover Costs) Decisions that result in a cost for a different person other than the original decision maker.The costs “spillover” to other people or society.EX: Zoram is a chemical company that pollutes the air when it produces its good.Zoram only looks at its INTERNAL costs.The firms ignores the social cost of pollutionSo, the firm’s marginal cost curve is its supply curveWhen you factor in EXTERNAL costs, Zoram is producing too much of its product.The government recognizes this and limits their production.
23 The marginal cost doesn’t include the costs to society. PSupply =MarginalPrivate CostD=MSBQQe
24 What will the MC look like when EXTERNAL cost are factor in? PSpillovercostsSupply =MarginalPrivate CostD=MSBQQe
25 This is the REAL supply curve Supply = Marginal Social Cost P Supply = Private CostD=MSBQQe
26 Compare MSB and MSC at Qe Is too much or too little being produced? S=MSCS= PrivateD=MSBOverallocationQQOptimalQe
28 Positive Externalities (aka: Spillover Benefits) Decisions that result in a benefit for someone other than the original decision maker.The benefits “spillover” to other people or society.(EX: Flu Vaccines, Education, Home Renovation)Example: A mom decides to get a flu vaccine for her childMom only looks at the INTERNAL benefits.She ignores the social benefits of a healthier society.So, her private marginal benefit is her demandWhen you factor in EXTERNAL benefits the marginal benefit and demand would be greater.The government recognizes this and subsidizes flu shots.
29 The marginal benefit doesn’t include the benefits to society. PS=MCDemand=Marginal Private BenefitQQe
30 What will the demand look like when EXTERNAL benefits are factor in? PS=MCSpilloverBenefitsDemand=Marginal Private BenefitQQe
31 This is the REAL demand curve P S=MCDemand=Marginal Social BenefitDemand=Marginal Private BenefitQQe
32 Compare MSB and MSC at Qe Is too much or too little being produced? S=MCD=MSBD=MPBUnderallocationQeQOptimal
37 Economics of Pollution Why are public bathrooms so gross?The Tragedy of the Commons(AKA: The Common Pool Problem)Goods that are available to everyone (air, oceans, lakes, public bathrooms) are often polluted since no one has the incentive to keep them clean.There is no monetary incentive to use them efficiently.Result is high spillover costs.
40 WHAT ARE ANTITRUST LAWS? Why are monopolies a Market Failure? Laws designed to prevent monopolies and promote competition.Why are monopolies a Market Failure?Monopolies destroy the key ingredient of the free market system- Competition.To fix this MARKET FAILURE the government must get involved.Identify the socially optimal and fair return points.
41 Market Failure #4 Unfair Distribution of Income
42 How does the government measure distribution of income? Income InequalityIn 2001, the average American family made $66,863. Everyone is obviously rich.What’s wrong with using the average?Averages reveal absolutely nothing about how income is distributed.How does the government measure distribution of income?
43 The LAST graph to learn for Microeconomics THE LORENZ CURVEThe LAST graph to learn for Microeconomics
44 Measuring Income Distribution Review the process:The government divides all income earning families into five equal groups (quintiles) from poorest to richest.Each groups represents 20% of the population.If there was perfect equality then 20% of the families should earn 20% of the income, 40% should earn 40% (and so on)The government compares how far the actual distribution is from perfect distribution then attempts to redistribute money fairly.
45 THE LORENZ CURVE Perfect Equality Percent of Income 10080604020Perfect EqualityPercent of IncomePercent of Families
46 THE LORENZ CURVE Lorenz Curve (actual distribution) Perfect Equality 100806055403020155Lorenz Curve(actual distribution)Perfect EqualityPercent of IncomePercent of Families
47 THE LORENZ CURVE Lorenz Curve (actual distribution) Perfect Equality 10080604020Lorenz Curve(actual distribution)Perfect EqualityPercent of IncomeArea betweenthe lines showsthe degree ofincome inequalityPercent of Families
48 We have a Market Failure. Income is extremely unfairly distributed. THE LORENZ CURVE10080604020Lorenz Curve(actual distribution)We have a Market Failure.Income is extremely unfairly distributed.How does this get fixed?Perfect EqualityPercent of IncomePercent of Families
49 after government re-distribution THE LORENZ CURVE10080604020Lorenz Curve(actual distribution)Perfect EqualityPercent of IncomeLorenz curveafter government re-distributionPercent of Families
51 What kind of taxes are these? (THINK % of Income) Three Types of Taxes1. Progressive Taxes -takes a larger percent of income as income rises (takes more from rich people)Ex: Current Federal Income Tax system2. Proportional Taxes (flat rate) –takes the same percent of income from all income groups.Ex: 20% flat income tax on all income groups3. Regressive Taxes –takes a larger percentage from low income groups. (takes more from poor people)Ex: Sales tax; any consumption tax.What kind of taxes are these? (THINK % of Income)Toll road tax ($1 per day)State income tax where richer citizens pay higher %$.45 excise tax on cigarettesMedicare tax of 1.45% of every dollar earned6% California sales tax