Market Failure April

The Case for the Market Markets have their place – they are a reasonably open and orderly way to assure the distribution of services and goods. They are not a general formula for the expression of social will and the working out of social problems. J.K. Galbraith Politics is not the art of the possible. It consists in choosing between the disastrous and the unpalatable. J.K. Galbraith

The Case for the Market The case for the market system The case for intervention – market failure monopoly externalities public goods asymmetric information: moral hazard, adverse selection social goals: redistribution Government Intervention tools costs government failure Social and Environmental Regulation the economics of pollution economic rationale for pollution control pollution control in practice health and safety regulation Taxation progressive vs. regressive efficiency vs. equity – competing goals tax incidence

The Case for the Market 1. Pareto efficiency: allocative, productive productive efficiency - firm level - industry level allocative efficiency –Goods worth more than they cost to produce get produced; P=MC –noone can be better off… –sum of consumer and producer surplus maximized 2. Compared to alternatives, the market exhibits flexible and automatic coordination what to produce (goods, variety) simplicity of knowledge required by participants

The Case for the Market 3. Stimulus to innovation and growth profit motive leads to innovation [Apple Inc][NASDAQ]AppleNASDAQ 4. Self-correction of disequilibrium immediate response vs. inertia price and inventory as automatic signals flexible, repeals possible [Belgian Central Bank]Belgian Central Bank planners are a use of resources 5. Decentralization of power and decision-making diffuse economic power large firms, unions [GM]GM competition, technology

The Case for Intervention The Case for Intervention – Market Failure Monopoly Externalities Public goods Asymmetric information: moral hazard, adverse selection Social goals: income distribution

The Case for Intervention Monopoly May be inefficient allocative inefficiency; P>MC; deadweight loss costs may be higher technological progress may be slower The case for monopoly natural monopoly(fig. 1) possesses profits to innovate(fig. 2) –resources ۰ –incentives? regulatory price and output [i]i –capture and EOS –variable mc –long run innovation

The Case for Intervention Externalities occur when marginal social cost ≠ marginal social benefit i.e. costs or benefits received by parties outside transaction negative: traffic congestion, DUI, pollution positive: 911 mobile calls, pretty yards Fig. 3 short term and long term environmental concerns property rights, voluntary agreements & the Coase theorem in the absence of bargaining costs outcome independent of ownership rights; distribution –honey & apples, lawn mower & movie producer government taxes and subsidies as last resort

The Case for Intervention Public Goods non-rival: consumption by one consumer does not limit availability to others; cost of production independent of # of consumers e.g. TV signal non-excludable: a good that once produced, cannot be denied to nonpayers e.g. clean-er air –the free rider problem e.g. national defense, police force fig. 2 pg. 17 of handout merit goods: provided as a norm because of underconsumption e.g. vaccination, education, the lighthouse

The Case for Intervention Asymmetric information One party to a transaction has more or better information than the other party. 1.buyer: health insurance, microlending 2.seller: used car market, real estate, labor market The market for lemons: probability of lemons priced in by buyers adverse selection: bad products or customers are more likely to be selected uncertainty; assurances information is expensive (whither perfect information) –goods: the internet, in-store trial moral hazard: a change in behavior after risk is insured

The Case for Intervention Social goals Preferences for public provision ›justice system, police protection, national defense Protecting individuals from others ›parental preference and the education level of children Paternalism ›drugs Social obligations ›jury duty, compulsory soldiering

The Case for Intervention Social goals Income Inequality may be an unfair outcome low wages when services are not in high demand relative to supply low wages dealt to people as a result of changed market conditions beyond their control unemployed, aged, sick Income inequality: disparities in the distribution of income Lorenz curve: x% of income, y% of households [ 1 ] 1 Gini coefficient: area between the Lorenz curve of the distribution and the uniform distribution line divided by the area under the uniform distribution line. [ 2 ] 2 –low, high; 0, 1. issue, action (poverty vs. inequality) communal trust & involvement, homicides, relative/absolute