Markets and Government CHAPTER 13 © 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE.

Market Failure © 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE. A market failure occurs when the market outcome is not the socially efficient outcome. Some action by the government is sometimes necessary to ensure that the market does work well.

© 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE. Private Property Rights Private property rights are the rights of individuals to own property. When private property rights are secure, others are not allowed to steal or damage your private property. Private property rights are crucial to a market.

Private, Public, Commons, and Club Goods © 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE. The principle of mutual excludability states that the owner of private property is entitled to enjoy the consumption of that property privately. The principle of rivalry states that when one consumes or uses a good or service, less remains for others.

Private, Public, Commons, and Club Goods © 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE. Private good – a good that is both excludable and rivalrous. Club good – a good that is excludable but nonrivalrous Public good – a good that is nonexcludable and nonrivalrous. Commons good – a good that is rivalrous but nonexcludable.

Classification of Goods © 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE.

Free Rider © 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE. When goods are nonexcludable, an individual has an incentive to be a free rider. A free rider is a consumer or producer who enjoys the benefits of a good or service without paying for that good or service.

Externalities © 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE. Private costs and benefits are costs and benefits that are borne solely by the individuals involved in the transaction. An externality is a cost or benefit of a transaction that is borne by someone who is not directly involved in the transaction. If externalities exist, it means that those involved in the demand and supply in the market are not considering all the costs and benefits when making their market decisions. As a result, the market fails to yield optimal results.

Positive and Negative Externalities © 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE. A positive externality may result when some of the benefits of an activity are received by consumers or firms not directly involved in the activity. A negative externality may result when some of the costs of an activity are borne by consumers or firms not directly involved in the activity.

Social Cost © 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE. Social cost: the total social cost of a transaction is the private cost plus the external cost. If all of the costs of a transaction are borne by the participants in the transaction, the private costs and the social costs are the same.

Externalities and Market Failure © 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE. When there is a divergence between social costs and private costs, the result is either too much or too little production and consumption. In either case, resources are not being used in their highest-valued activity and market failure can occur.

Negative Externalities © 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE.

Positive Externalities © 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE.

Lambs on the Commons © 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE.

Asymmetric Information © 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE. Exchange that occurs when one party has more information than the other is called exchange with asymmetric information. One manifestation of this is called adverse selection: the problem that occurs when higher-quality goods, consumers, or producers are driven out of the market because unobservable qualities are incorrectly valued. Lemons market: a market in which adverse selection occurs.

Adverse Selection © 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE.

Moral Hazard © 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE. A related issue is moral hazard—the problem that arises when people change their behavior from what was expected of them when they engaged in a trade or contract.

Network Externalities and Locked In © 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE. Network externalities – each additional user increases the value of the entire network Locked in – the cost of changing to a more efficient technology is higher than the benefit

Solutions to Market Failure © 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE. If all the costs or benefits of a private transaction belonged to the people creating them, then externalities would be no problem. When people causing externalities pay for them, we say the externality has been internalized.

Government’s Role © 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE. ◦Tax or subsidize the externality ◦Command and control ◦Marketable pollution permits: Cap and trade

Pollution Tax © 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE.

Subsidy © 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE.

The Market for Pollution Permits © 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE.

Two Schools of Thought © 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE. Public choice economists argue that there is no need for a government to solve a market failure because having the government attempt to do so leads to greater costs than did the market failure. The Austrian school supports free markets and opposes government intervention in the economy.