2Introduction Should the government intervene in the market? The framework presented might be called the invisible hand framework.Invisible hand framework – perfectly competitive lead individuals to make voluntary choices that are in society’s interest.
3Market FailuresA market failure occurs when the invisible hand pushes in such a way that individual decisions do not lead to socially desirable outcomes.
4Market FailuresAny time a market failure exists, there is a reason for possible government intervention into markets to improve the outcome.
5Market FailuresBecause the politics of implementing the solution often leads to further problems, government intervention may not necessarily improve the situation.
6ExternalitiesExternalities are the effect of a decision on a third party that is not taken into account by the decision-maker.Externalities can be both positive and negative.
7ExternalitiesNegative externalities occur when the effect of a decision on others that is not taken into account by the decision-maker is detrimental to the third party.Examples include second-hand smoke, water pollution, and congestion.
8ExternalitiesPositive externalities occur when the effect of a decision on others that is not taken into account by the decision-maker is beneficial to others.Examples include innovation, education, and new business formation.
9Negative Externalities When negative externalities ensue third parties are hurt.Marginal social cost is greater than marginal private cost.
10Negative Externalities Marginal social cost includes all the marginal costs borne by society.
11Negative Externalities Marginal social cost is calculated by adding the negative externalities associated with production to the marginal private costs of that production.
12The Effect of a Negative Externality CostQuantityMarginal social costMarginal social benefitMarginal private costMarginal cost from externalityQ1P1Q0P0
13Positive Externalities Private trades can benefit third parties not involved in the trade.Marginal social benefit equals the marginal private benefit of consuming a good or service plus the positive externalities resulting from consuming that good or service.
14A Positive Externality D0 = Marginal private benefitD1 = Marginal social benefitS = Marginal private and social costCostQuantityQ1P1Marginal benefit of an externalityQ0P0
15Alternative Methods of Dealing with Externalities Externalities can be dealt with via direct regulation, incentive policies, and voluntary solutions.
16Direct RegulationA program of direct regulation is where the amount of a good people are allowed to use is directly limited by the government.
17Direct RegulationEconomists do not like this solution since it does not achieve the desired end as efficiently (at the lowest cost possible in total resources without consideration as to who pays those costs) and fairly as possible.
18Direct RegulationDirect regulation is inefficient because it achieves a goal in a more costly manner than necessary.
19Incentive PoliciesIncentive programs are more efficient than direct regulatory policies.The two types of incentive policies are either taxes or market incentives.
20Tax Incentive Policies A tax incentive program uses a tax to create incentives for individuals to structure their activities in a way that is consistent with the desired ends.Often the tax yields the desired end more efficiently than straight regulation.
21Tax Incentive Policies This solution embodies a measure of fairness about it – the person who conserves the most pays the least tax.
22Tax Incentive Policies Another way to handle a negative externality is through a pollution tax or effluent fees.Effluent fees – charges imposed by government on the level of pollution created.
23Regulation Through Taxation CostQuantityMarginal social costMarginal social benefitMarginal private costQ1P1Efficient taxQ0P0
24Market Incentive Policies An alternative to direct regulation is some type of market incentive program.Market incentive program – a plan requiring market participants to certify total consumption – their own or other’s – has been reduced by a specified amount.
25Market Incentive Policies A market incentive program is similar to the regulatory solution in that the amount of the good used is reduced.
26Market Incentive Policies A market incentive program differs from a regulatory solution in that individuals who reduce consumption by more than the required amount are given a marketable certificate that can be sold to someone else.
27Voluntary ReductionsVoluntary reductions leave individuals free to choose whether to follow what is socially optimal or what is privately optimal.Economists are dubious of voluntary solutions.
28Voluntary ReductionsA person’s social conscience and willingness to do things for the good of society generally depend on his or her belief that others will also be helping.
29Voluntary ReductionsIf a socially conscious person comes to believe a large number of other people will not contribute, he or she will often lose their social conscience.This is another example of a free rider problem – individuals’ unwillingness to share in the cost of a public good.
30The Optimal PolicyAn optimal policy is one in which the marginal cost of undertaking the policy equals the marginal benefit of that policy.
31The Optimal Policy Should pollution be totally eliminated? Some environmentalists say “yes.”Economists would answer that doing so is costly so marginal costs should be balanced against marginal benefits.
32The Optimal PolicyThe point where MC = MR is called the optimal level of pollution.Optimal level of pollution – the amount of pollution at which the marginal benefit of reducing pollution equals the marginal cost.
33Public GoodsA public good is one that is nonexclusive (no one can be excluded from its benefits) and nonrival (consumption by one does not preclude consumption by others.
34Public 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.
35Public GoodsOnce 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.
36Public Goods With public goods, the focus is on groups. With private goods, the focus is on the individual.
37Public GoodsIn the case of a public good, the social benefit of a public good is the sum of the individual benefits.
38Public GoodsAdding demand curves vertically is easy to do in textbooks, but not in practice.This is because individuals do not buy public goods directly so that their demand is not revealed in their actions.
39The Market Value of a Public Good Price123Quantity.18.104.22.168.000.50Market demand0.100.60DBDA0.500.400.10
40Informational Problems Perfectly competitive markets assume perfect information.Real-world markets often involve deception, cheating, and inaccurate information.
41Informational Problems When there is a lack of information, buyers and sellers do not have equal information, markets may not work properly.
42Informational Problems Economists call such market failures adverse selection problems.Adverse selection problems – problems that occur when a buyer or a seller have different amounts of information about the good for sale.
43Policies to Deal with Informational Problems One policy alternative to deal with information market failures is to regulate the market and see that individuals provide the correct information.
44Policies to Deal with Informational Problems Another alternative is for the government to license individuals in the market and require them to provide full information about the good being sold.
45Policies to Deal with Informational Problems Regulatory solutions may be overly slow or costly.
46A Market in Information A market in information is one solution to the information problem.Information is valuable, and is an economic product in its own right.
47A Market in Information Left on their own, markets will develop to provide information that people need and are willing to pay for it.
48A Market in Information Economists who do not like government interference point out that informational problems are not a problem of the market; it is a problem of government regulation.
49Licensing of DoctorsLicensing of doctors is a debate that is motivated 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.
50Licensing of DoctorsSome economists argue that licensing is as much a problem of restricting supply as it is to help the consumer.
51Licensing of DoctorsWhy, if licensed medical training is so great, do we even need formal restrictions to keep other types of medicine from being practiced?
52Licensing of DoctorsWhom do these restrictions benefit: the general public or the doctors who practice mainstream medicine?What have the long-term effects of licensure been?
53An Informational Alternative to Licensure As an alternative, the government could provide the public with information about which treatments work and which do not.This would give rise to consumer sovereignty – the right of the individual to make choices about what is consumed and produced.
54An Informational Alternative to Licensure In this scenario, the government would provide such information as:Grades in college.Grades in medical school.Success rate for various procedures.References.Medical philosophy.Charges and fees.
55An Informational Alternative to Licensure This information alternative would provide much more useful information to the public than the present licensing procedure.
56An Informational Alternative to Licensure Here are some words of caution about the informational alternative.To get a true picture of whether the present system is best would require experts on real-life practices and institutions.The problem is that the experts may have a vested interest in keeping things just the way they are.
57Government Failures and Market Failures Market failures should not automatically call for government intervention.Why? Because governments fail too.
58Government Failures and Market Failures Government failure occurs when the government intervention in the market to improve the market failure actually makes the situation worse.
59Reasons for Government Failures Governments do not have an incentive to 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.
60Reasons for Government Failures Government intervention does not allow fine-tuning, and so, when the problems change, the government solution often responds far more slowly.Government intervention leads to more government intervention.
61Government Policy and Market Failures End of Chapter 15