The Reason for Government Involvement in a Market Based Economy

Should our government be involved in business? Why or why not? monetary flow physical flow Circular Flow Diagram of a Market Economy Households Firms

A market failure is a situation in which the market, on its own, does not distribute resources efficiently. Free riders are an example of market failure Would the free market ensure that roads are built everywhere they are needed? It’s doubtful. Neither could individuals afford to pay for a freeway.

A public good is a shared good or service for which it would be impractical to make consumers pay individually and to exclude nonpayers. Public goods are funded by the public sector, the part of the economy that involves transactions of the government. A free rider is someone who would not choose to pay for a certain good or service, but who would get the benefits of it anyway if it is provided as a public good.

An externality is an economic side effect of a good or service that generates benefits or costs to someone other than the person deciding how much to produce or consume. The building of a new dam and creation of a lake generates: Positive Externalities A possible source of hydroelectric power Swimming Boating Fishing Lakefront views Negative Externalities Loss of wildlife habitat due to flooding Disruption of fish migration along the river Overcrowding due to tourism Noise from racing boats and other watercraft

A function of the government is to encourage positive externalities and discourage negative externalities. Why? Positive Externalities A possible source of hydroelectric power Swimming Boating Fishing Lakefront views Negative Externalities Loss of wildlife habitat due to flooding Disruption of fish migration along the river Overcrowding due to tourism Noise from racing boats and other watercraft

Public Goods: Market Failures

Advantages of the Free Market Economic Efficiency As a self-regulating system, a free market economy is efficient. Economic Growth Because competition encourages innovation, free markets encourage growth. Economic Freedom Free market economies have the highest degree of economic freedom of any economic system. Additional Goals Free markets offer a wider variety of goods and services than any other economic system. Don’t copy this…the point of today’s lecture is that although these facts exist, markets aren’t perfect for everything.

TRAGEDY OF THE COMMONS 1832 – Wm. Forster Lloyd – Observed the devastation of common pasture and the puny and stunted draft animals that grazed there. 1968 – Garrett Hardin created the economic term, tragedy of the commons. The commons refers to any resource shared by a group of people. Each household has the right to take resources from and to put waste into the commons. As population grows, greed runs rampant, and the commons collapses. Hence, the tragedy of the commons.

The problem with the commons According to market theory, the invisible hand should govern society well, but in cases like the commons it does not. This is known as… MARKET FAILURE: Services and goods that are important but would not be provided by private enterprise. What is another example of a market failure? Pause to discuss market failures

Please come up with a solution for the following problem: An industry is creating a pollutant. Who should be responsible for cleaning up the pollution (constant dirtying effects) in our society?

Pigouvian Tax is one way to address pollution. The government taxes the company for each unit of pollution it emits. Companies have an incentive not to pollute. Extra costs get passed on to the consumer. Government uses the funds to fight pollution.

Here’s an example of the market responding to pigouvian tax

Improve this diagram to account for Market failures and externalities