1. Market Failures and the Role of the Government
Unit 6:
Market Failures and the Role of the Government 1

2. When should the government get involved in the economy?
Picture is from the Triangle Shirt Fire
Worker Safety Laws Barber Shop Licenses Bank Bailouts
Every society needs to decide how much government involvement is desirable 2

3. Picture is from the Triangle Shirt Fire3

4. What is the Free Market?
(CAPITALISM)

5. 5 Characteristics of FREE MARKETS
Little government involvement in the economy. (Laissez Faire = Let it be, by Adam Smith)
Individuals OWN resources and determine what to produce, how to produce, and who gets it.
The opportunity to make PROFIT gives people INCENTIVE to produce quality items efficiently.
Wide variety of goods available to consumers.
Competition and Self-Interest work together to regulate the economy.
The government’s job is to enforce contracts, secure property rights, and defend the country.

6. The INVISIBLE HAND of the FREE MARKET:
If society wants computers and people are willing to pay high prices then…
Businesses have the INCENTIVE to start making computers to earn PROFIT.
This leads to more COMPETITION.
Which means lower prices, better quality, and more product variety.
To maintain profits, firms find most efficient way to produce goods and services.
The government does NOT need to get involved since the needs of society are automatically met.

7. Does the Free Market ever FAIL to meet society’s needs?

8. What is a Market Failure? (When the invisible hand doesn’t work.)
A situation in which the free-market system fails to satisfy society’s wants.
(When the invisible hand doesn’t work.)
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.

9. Goods & services Purchased
Resource Market
Income
Cost $
Resources
Resources
4 factors of production:
Land
Labor
Capital
Entrepreneur
Businesses supply in product market & demand in resource market.
Individuals demand in the product market & supply in the resource market.
Businesses
Goods & services sold
Goods & services Purchased
Individual
Product Market
Spending
Revenue
(Not Profit)

10. Gov’t Spending Resources Tax $ Tax $ Subsidies G & S G & S
Resource Market
Gov’t Spending
Resources
Government
Tax $
Tax $
Transfer payment
Subsidies
G & S
G & S
Businesses
4 factors of production:
Land
Labor
Capital
Entrepreneur
Businesses supply in product market & demand in resource market.
Individuals demand in the product market & supply in the resource market.
Individual
Gov’t Spending
G & S
Product Market

11. How does the free market FAIL?

12. The Four Market Failures
We’ll focus on 4 different market failures:
Public Goods
2. Externalities (3rd person side effects)
3. Monopolies
4. Unfair distribution of income
In each situation,
the government will step in to allocate resources efficiently.

13. Market Failure #1: PUBLIC GOODS

14. Definition of Public Goods
To be considered a true public good, it must meet two criteria:
Non-exclusion
Everyone can use the good.
Cannot exclude people from enjoying the benefits (even if they don’t pay).
Ex: National Defense
Shared Consumption (Non-rivalry)
One person’s consumption of a good does not reduce the usefulness to others.
Ex: Public Park

15. D Hamburgers Satellite TV Homes Street lights Public transportation
Identify which of the following is
TRUE public goods
(have non-exclusion & non-rival consumption):
Hamburgers
Satellite TV
Homes
Street lights
Public transportation D D.

16. Private vs. Public Goods
Non-exclusion
Shared consumption
Bought through the use of tax dollars
Private Goods
Exclusion possible
Can not be shared
Bought in marketplace

17. Private, Public, or Mixed Goods
Haircut
College Education
National Defense
Canine rabies shots
Cable television
Street Lights
Health Care
Toothbrush
Auto airbags
Spraying for mosquitos
Police and Fire Protection
National Forest Campgrounds
Potato Chips
Public toll roads

18. Public Goods Video: Fire Department Auction
If there was no government, how would schools, parks, and freeways be different?
Would there be enough to meet our needs?
Video: Fire Department Auction

19. Public Goods
Why must the government provide public goods and services?
It is impractical for the free-market to provide these goods because there is little opportunity to earn profit.
This is due to the Free-Rider Problem 19

20. What’s wrong with this picture?20

21. Free Riders are individuals that BENEFIT WITHOUT PAYING.
The Free Rider Problem
Free Riders are individuals that BENEFIT WITHOUT PAYING.
Examples:
People who download music illegally
People who watch a street performer and don’t pay
Teenagers that live at home and don’t have a job

22. Does anyone free ride off you?
2012 Global Military Spending:
Canadian $22.5 Billion
US $645.7 Billion
Why doesn’t Canada spend more on their military? 22

23. 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.
To solve the problem, the government can:
1. Find new ways to punish free-riders.
2. Use tax dollars to provide the service to everyone.

24. EVERYONE pays a mandatory tax and all receive the same benefits.
The Final Exam
I am willing to give an 100% on the final exam to whichever class gives me $3000.
Everyone in the class will get 100% even if they don’t pay.
Who is willing to pay?
What about those that refuse to pay?
Solution?
EVERYONE pays a mandatory tax
and all receive the same benefits.

25. How does the government decide how many public goods to provide?
How do we decide how many public goods we need?
Can the government…
Prevent wild fires in San Diego forever?
Ensure that no one ever speeds on the freeway?
Create a research station on Mars?
Stop pollution from fossil fuels?
Completely stop illegal immigration?
Make sure everyone in the US has a job?
YES! But the costs outweigh the benefits.
How does the government decide how many public goods to provide?

26. They use Supply and Demand
How does the government determine what quantity of public goods to produce?
They use Supply and Demand
Demand 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.
Video: Dam Tragedy

27. Marginal willingness to pay higher taxes
Demand for a New Park
Marginal willingness to pay higher taxes
Assume:
There are only two people in society.
Each additional park costs $5
How many parks should be made?
# of Parks
Luis is willing to pay
Jesus is willing to pay
Society’s Demand (MSB)
Marginal Social Cost 1 $4 $5 $9 2 $3 $7 3 $2 4 $1 5 $0

28. Supply and Demand for Public Parks
The Demand is the equal to the marginal benefit to society
Price
What if the government made 1 park?
What if the government made 4 parks?
D=MSB
$ 9 7 5 3 1
MSB = MSC
S=MSC
The supply is the public good’s marginal cost to society
Quantity of Parks

29. Review List the characteristics of the Free Market.
Define Market Failure.
What is the “invisible hand”?
List the 4 Market Failures.
Why must the government provide public goods?
Define Free Rider.
What is wrong with having free riders?
List 10 streets in by 32nd St/ USC CAT.

30. Private, Public, or Mixed Goods
Haircut
College Education
National Defense
Canine rabies shots
Cable television
Street Lights
Health Care
Toothbrush
Auto airbags
Spraying for mosquitos
Police and Fire Protection
National Forest Campgrounds
Potato Chips
Public toll roads

31. Private, Public, or Mixed Goods
Haircut
College Education
National Defense
Canine rabies shots
Cable television
Street Lights
Health Care
Toothbrush
Auto airbags
Spraying for mosquitos
Police and Fire Protection
National Forest Campgrounds
Potato Chips
Public toll roads

32. Private, Public, or Mixed Goods
Haircut
College Education
National Defense
Canine rabies shots
Cable television
Street Lights
Health Care
Toothbrush
Auto airbags
Spraying for mosquitos
Police and Fire Protection
National Forest Campgrounds
Potato Chips
Public toll roads

33. Private, Public, or Mixed Goods
Haircut
College Education
National Defense
Canine rabies shots
Cable television
Street Lights
Health Care
Toothbrush
Auto airbags
Spraying for mosquitos
Police and Fire Protection
National Forest Campgrounds
Potato Chips
Public toll roads

34. Private, Public, or Mixed Goods
Haircut
College Education
National Defense
Canine rabies shots
Cable television
Street Lights
Health Care
Toothbrush
Auto airbags
Spraying for mosquitos
Police and Fire Protection
National Forest Campgrounds
Potato Chips
Public toll roads

35. Private, Public, or Mixed Goods
Haircut
College Education
National Defense
Canine rabies shots
Cable television
Street Lights
Health Care
Toothbrush
Auto airbags
Spraying for mosquitos
Police and Fire Protection
National Forest Campgrounds
Potato Chips
Public toll roads