1. It’s All About Efficiency…

2. And so we begin again…
Public policy encourages, discourages, prohibits, or prescribes private actions
We base everything on the idea of a perfectly competitive economy
Market failures are private choices that violate the perfect economy

3. The Benchmark Utility Assumptions of consumption:
More we have, the more utility we have
Declining marginal utility
Assumptions of production:
Buy factor inputs to produce goods for sale
Additional unit of output requires same units of input as predecessor
Leads to Pareto Efficiency
Can’t find an allocation that makes one person better without making at least one worse

5. How Do We Measure Changes in Efficiency?
Social Surplus
Net benefits from competing in markets

9. Caveats General equilibrium model is static rather than dynamic
Can never be complete
Assumptions are often violated in reality

10. What if the Invisible Hand Gets Confused???
Market failures are private choices that violate the perfect economy
Market failures constitute the most commonly advanced rationales for public policy
Collective action can allow us to improve efficiency
Social surplus is larger under alternative than under market equilibrium

11. 1) Public Goods
Nonrivalrous, nonexcludable, congestable
Shoe example

13. Public Goods Follow-Up
P example
Prisoner’s dilemmas and Nash equilibriums

14. 2) Externalities
Positive or negative
Examples?

15. 3) Natural Monopoly
Single firm can produce at lowers cost than any other arrangement
If you force it to price efficiently, it leaves. If you allow it to price where it wants, you take a deadweight loss.
X-Inefficiency
Natural monopoly that doesn’t reach minimum costs

16. 4) Information Assymetry
Amount of information about the characteristics of a good varies in relevant ways across persons
Search v. experience v. post-experience
Examples?

17. So Those Are the Big Four…
But there are many other limitations of the competitive framework…

18. Thin Markets
Few buyers or sellers
Monopsony
Oligarchy

19. Preference Problems Endogenous Self-regarding Other-regarding
Process-regarding

20. Uncertainty Problems Two-period worlds lead to more complex decisions
Ski example
Insurance
Risk v. uncertainty
Law of large numbers
Moral hazards
Subjective perception of risk (flood/earthquake)

21. Uncertainty Problems
Prospect Theory

22. Intertemporal Allocation Problems
Contracts in present for future production and delivery
What about future generations?
How do we know their wants/needs?

23. Adjustment Costs Economy is never static like we wish to assume
Epidemic on eggs…
Oil embargo and Iranian revolution…

24. Macroeconomic Dynamics
Business cycle
Fiscal v. monetary policies