1. WHEN MARKETS FAIL Chapters 7 1

2. Important Definitions: 2  Definition of Government:  Institutions to which people give over a monopoly of violence in return for the enforcement of law and order.  Definition of Market Failure:  This term describes the failure of the market economy to achieve an efficient allocation of resources.  Simply, the market should be working efficiently on its own. When a market failure happens, the market needs help from the government, in order to go back and work in efficiency.

3. Types of Government Intervention in the Market 3  Governmental policies, rules, regulations.  The military, police, the national weather service, and highway construction, space exploration and scientific research, etc.  Regulation of certain businesses (such as banking and drugs)  Subsidizing education and health care  Taxation

4. Three Important Governmental Roles : 4 1.Increase social efficiency by promoting competition, curbing externalities like pollution, and providing public goods. 1.Promote equity by using tax and expenditure programs to redistribute income toward particular groups. 1.Foster macroeconomic stability and growth - reducing unemployment and inflation while encouraging economic growth-through fiscal policy and monetary regulation.

5. Types of Market Failures: 5  There are several important circumstances under which markets fail to allocate resources with reasonable efficiencies:  1- Public goods  2- Externalities  3-Assymetric Information  4- Missing Markets  5-Monopoly and Imperfect Competition

6. Public Goods: 6  Non- excludable and non rivalrious or can be called collective consumption goods  Public goods are non excludable goods that are not provided by private firms but rather by governments (governments provide these goods by making citizens by taxes).  Examples of public goods:  national defense  police force

7. Externalities: (Negative and Positive) 7  Externalities are costs or benefits of a transaction that are incurred or received by other members of the society but not taken into account by the parties to the transaction. (third party effects or neighborhood effects) other parties, other than customers and producers participated in the transaction.  Negative externality happens when a party acts and based on his actions he harms people, although he did not mean to harm them. Example: When a factory generates pollution, the party is trying to maximise profit but at the same time is harming the society through a social cost: pollution.  Positive externality: happens when a party acts and based on such actions benefits the people, although this party did not mean to benefit the people. Example: painting your house, there is a private benefit and a social benefit.  Private costs: these costs that are incurred by the parties directly involved in some economic activities. Firms.  Social costs: costs incurred by the whole society  Private benefits: benefits received by those involved in the activity. utilities obtained by buyers.  Social benefits: benefits to the whole society.

8. 2- Externalities continued: 8  How can the government for example, control a negative externality such as pollution? 1) Pollution control though direct regulations: Direct controls are common method of environmental regulation. ex. Car emission test and laws that prohibit burnings stuff. 2) Control through emissions taxes: Pollution taxes which internalize the externality: increasing the firms private cost by the amount of external cost.

9. 3- Asymmetric Information: 9  Markets work when everyone is well informed;  In other words, people can’t make decision without full information.  The government will try to impose standards and testing requirements in the consumers own best interests.

10. 4- Missing Markets: 10  One important aspect of missing markets is risk.  For example:  As owners of houses, we have the ability to insure our house against burning.  A farmer on the other hand can ’ t insure his corps against bad weather.  Future events represent another set. You can buy oil or corn in future market. But not for cars and TVs because no one knows the models.

11. 6-Monopoly and Competition: 11  The Government encourages competition and employs economic regulation prescribing rules under which firms can do business.  The government can control the prices. How? 1) Direct Control of natural monopolies: One firm operates at the minimum efficient scale. Natural monopolists restrict output, raise prices, reap monopoly profit The government usually assumes ownership of the single firm, setting it up as a nationalized industry. 2) Regulation through privatization (telecommunication, Gas, water).

12. 12 Government objectives towards monopolies: 1) Protect life and property by exercising a monopoly of violence 2) Improve economic efficiency by addressing various cases of market failures 3) Achieve some accepted standard of equity. 4) Protect individuals from others and from themselves 5) Influence rate of economic growth 6) Stabilize economy against income and price level fluctuation. 6- Monopoly and Imperfect Competition

13. The Cost of Government Intervention: 13 1) Internal cost: When government uses resources it costs money when government inspectors visit a plant to (compliance with standards, industry safety) judges salaries and clerks. 2) Direct External costs: cost that government imposes on others. Direct external costs fall on agents with whom the governments is directly interacting. 3) Indirect external cost: Costs of government action spread beyond those immediately affected by it. Externalities (Safety and delay of new drugs)

14. Cases of Government Failure: 14  (1) The Pursuit of Governmental Self-Interest:  (2) Electoral Pressures: leading to inappropriate government spending and tax decisions.  (3) A Tendency to Look for Short Term Solutions  (4) Regulatory capture. This is when the industries under the control of a regulatory body begin to move policy options so as their outcome is in their favour.  (5) Imperfect information