2Laugher CurveQ. How many economists does it take to screw in a light bulb?A. Eight. One to screw it in and seven to hold everything else constant.
3IntroductionEconomists use the invisible hand framework to determine whether the government should intervene in the market.Invisible hand framework – perfectly competitive markets lead individuals to make voluntary choices that are in society’s interest.
4Market FailuresMarket failure – the invisible hand pushes in such a way that individual decisions do not lead to socially desirable outcomes.
5Market FailuresWhen a market failure exists, government intervention into markets to improve the outcome is justified.Government failure occurs when government intervention does not 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 either positive or negative.
7ExternalitiesNegative externalities occur when the effects of a decision not taken into account by the decision-maker are detrimental to others.
8ExternalitiesPositive externalities occur when the effects of a decision not taken into account by the decision-maker is beneficial to others.
9A Negative Externality Example When there is a negative externality, marginal social cost is greater than marginal private cost.A steel plant benefits the owner of the plant and the buyers of steel.The plant’s neighbors are made worse off by the pollution caused by the plant.
10A Negative Externality Example Marginal social cost includes all the marginal costs borne by society.It is the marginal private costs of production plus the cost of the negative externalities associated with that production.
11A Negative Externality Example When there are negative externalities, the competitive price is too low and equilibrium quantity too high to maximize social welfare.
12A Negative Externality CostQuantityS1 = Marginal social costD = Marginal social benefitS = Marginal private costMarginal cost from externalityQ1P1Q0P0
13A Positive Externality Example Private trades can benefit third parties not involved in the trade.A person who is working and taking night classes benefits himself directly, and his co-workers indirectly.
14A Positive Externality Example Marginal social benefit equals the marginal private benefit of consuming a good plus the positive externalities resulting from consuming that good.
15A Positive Externality D0 = Marginal private benefitD1 = Marginal social benefitS = Marginal private and social costCostQuantityQ1P1Marginal benefit of an externalityQ0P0
16Alternative Methods of Dealing with Externalities Externalities can be dealt with via:Direct regulation.Incentive policies.Voluntary solutions.
17Direct RegulationDirect regulation –the amount of a good people are allowed to use is directly limited by the government.
18Direct Regulation Direct regulation is inefficient, not efficient. Inefficient – achieving a goal in a more costly manner than necessary.Efficient achieving a goal at the lowest cost in total resources without consideration as to who pays those costs.
19Incentive PoliciesIncentive policies 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.The tax often 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 A way to handle pollution is through a tax called an effluent fee.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 Market incentive program – market participants certify they have reduced total consumption – their own and/or other’s – by a specified amount.
25Market Incentive Policies A market incentive program is similar to the regulatory solution.The amount of the good consumed is reduced.
26Market Incentive Policies A market incentive program differs from a regulatory solution.Individuals who reduce consumption by more than the required amount receive marketable certificates that can be sold to others.
27Voluntary ReductionsVoluntary reductions allow individuals to choose whether to follow what is socially optimal or what is privately optimal.Economists are dubious of voluntary solutions.
28Voluntary ReductionsA person’s willingness to do things for the good of society generally depends on the belief that others will also be helping.
29Voluntary ReductionsThe socially conscious will often lose their social conscience when they believe a large number of other people are not contributing.This is 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 PolicyResources are being wasted if a policy isn’t optimal.What is saved by reducing the program is worth more than what is lost from the reducing the program.
32The Optimal PolicySome environmentalists want to totally eliminate pollution.Economists want to reduce pollution to the point where marginal costs of reducing pollution equals the marginal benefits.
33The Optimal PolicyOptimal level of pollution – the amount of pollution at which the marginal benefit of reducing pollution equals the marginal cost.
34Public Goods A public good is nonexclusive and nonrival. Nonexclusive – no one can be excluded from its benefits.Nonrival – consumption by one does not preclude consumption by others.
35Public 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.
36Public 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.
37Public Goods With public goods, the focus is on groups. With private goods, the focus is on the individual.
38Public GoodsIn the case of a public good, the social benefit of a public good is the sum of the individual benefits.
39Public 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.
41Informational Problems Perfectly competitive markets assume perfect information.Real-world markets often involve deception, cheating, and inaccurate information.
42Informational Problems When there is a lack of information, buyers and sellers do not have equal information, markets may not work properly.
43Informational 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.
44Policies to Deal with Informational Problems Regulate the market and see that individuals provide the correct information.Government licenses individuals in the market and requires them to provide full information about the good being sold.
45A Market in Information Information is valuable, and is an economic product in its own right.Left on their own, markets will develop to provide information that people need and are willing to pay for it.
46A Market in Information If the government regulates information, then markets for information will not develop.
47Licensing of DoctorsCurrently all doctors practicing medicine are required to be licensed.Licensing of doctors is justified by informational problems.
48Licensing of DoctorsSome economists argue that licensure laws were established to restrict supply, not to help the consumer.Instead of licensing doctors, the government could give the public information about which treatments work and which do not.
49Licensing of DoctorsProviding information rather than licensing would give rise to consumer sovereignty.Consumer sovereignty – the right of the individual to make choices about what is consumed and produced.
50An Informational Alternative to Licensure In this scenario, the government would require doctors to post their:Grades in college.Grades in medical school.Success rate for various procedures.References.Medical philosophy.Charges and fees.
51An Informational Alternative to Licensure This information alternative would provide much more useful information to the public than the present licensing procedure.
52Government Failures and Market Failures Market failures should not automatically call for government intervention.Why? Because governments fail too.
53Government Failures and Market Failures Government failure occurs when the government intervention in the market to improve the market failure actually makes the situation worse.
54Reasons 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.
55Reasons for Government Failures The bureaucratic nature of government intervention does not allow fine tuning.Government intervention leads to more government intervention.
56Government Policy and Market Failures End of Chapter 18