1. Market Failure And Government Policy Market Failure And Government Policy A’lam Asadov aasadov@mdis.uz

2. Markets and the Role of Government Government intervention and social objectives The objective of social efficiency –marginal social benefits and costs MSB > MSC  produce (or consume) more MSC > MSB  produce (or consume) less –socially efficient output where MSB = MSC Equity –concepts of fairness Trade-offs between equity and efficiency Government intervention and social objectives The objective of social efficiency –marginal social benefits and costs MSB > MSC  produce (or consume) more MSC > MSB  produce (or consume) less –socially efficient output where MSB = MSC Equity –concepts of fairness Trade-offs between equity and efficiency

3. Types of Market Failure Externalities –An externality refers to the uncompensated impact of one person’s actions on the well- being of a bystander. –Externalities cause markets to be inefficient, and thus fail to maximize total surplus. –There are two types of externalities: Negative and Positive externalities Externalities –An externality refers to the uncompensated impact of one person’s actions on the well- being of a bystander. –Externalities cause markets to be inefficient, and thus fail to maximize total surplus. –There are two types of externalities: Negative and Positive externalities

4. Externalities and Market Failure Negative Externalities –Automobile exhaust –Cigarette smoking –Barking dogs (loud pets) –Loud stereos in an apartment building Negative Externalities –Automobile exhaust –Cigarette smoking –Barking dogs (loud pets) –Loud stereos in an apartment building

5. Externalities and Market Failure Positive Externalities –Education –Restored historic buildings –Research into new technologies Positive Externalities –Education –Restored historic buildings –Research into new technologies

6. Types of Market Failure Externalities in production –External costs of production MSC > MC –External benefits of production MSC < MC Externalities in production –External costs of production MSC > MC –External benefits of production MSC < MC

7. Q1Q1 External costs in production O MC = S D P Costs and benefits Quantity

8. O MC = S D P MSC Costs and benefits Quantity External cost Q1Q1 Q2Q2 Social optimum External costs in production

9. External benefits in production O D P MC = S Q1Q1 Costs and benefits Quantity

10. O MSC D P Q1Q1 External benefit Costs and benefits Quantity MC = S Q2Q2 Social optimum External benefits in production

11. O MC = S D P Q 1 Q 2 Costs and benefits (£) Quantity MSC External cost (a ) External costs O D P Q 2 Q 1 Costs and benefits (£) Quantity MSC MC = S External benefit (b) External benefits External costs and benefits in production

12. Types of Market Failure Externalities in consumption –External costs of consumption MSB < MB –External benefits of consumption MSB > MB Externalities in consumption –External costs of consumption MSB < MB –External benefits of consumption MSB > MB

13. O MB P P Costs and benefits (£) Car miles MSB External cost O MB P P Q 1 Costs and benefits (£) Rail miles Q 2 MSB External benefit (a ) External costs (b) External benefits External costs and benefits in consumption Q 1 Q 2

14. Types of Market Failure Public goods –non-rivalry –non-excludability and the free-rider problem Public goods –non-rivalry –non-excludability and the free-rider problem

15. Public vs. Private goods Goods can be classified according to two attributes:  whether they are excludable and  whether they are rival in consumption A good is excludable if the supplier of that good can prevent people who do not pay from consuming it. A good is rival in consumption if the same unit of the good cannot be consumed by more than one person at the same time.

16. Characteristics of Goods There are four types of goods:  Private goods, which are excludable and rival in consumption, like bread or personal computer  Public goods, which are non-excludable and non- rival in consumption, like a public sewer system  Common resources, which are non-excludable but rival in consumption, like clean water in a river  Artificially scarce goods, which are excludable but non-rival in consumption, like pay-per-channel Satellite broadcasting.

17. There are four types of goods. The type of a good depends on (1) whether or not it is excludable— whether a producer can prevent someone from consuming it; and (2) whether or not it is rival in consumption—whether it is impossible for the same unit of a good to be consumed by more than one person at the same time.

18. Types of Market Failure Market power –lack of social efficiency –deadweight welfare loss under monopoly Market power –lack of social efficiency –deadweight welfare loss under monopoly

19. O £ Q P pc Q pc AR = D Consumer surplus Producer surplus MC (= S under perfect competition) (a) Industry equilibrium under perfect competition a Perfect competition Deadweight loss under monopoly

20. MR O £ Q P pc Q pc AR = D a Q pc PmPm b Consumer surplus Producer surplus Deadweight welfare loss MC (= S under perfect competition) (b) Industry equilibrium under monopoly Monopoly Deadweight loss under monopoly

21. Types of Market Failure Ignorance and uncertainty –by consumers –by firms Immobility of factors and time lags Protecting people’s interests –dependants –merit goods Ignorance and uncertainty –by consumers –by firms Immobility of factors and time lags Protecting people’s interests –dependants –merit goods

22. Government Intervention in the Market Taxes and subsidies –to correct externalities Taxes and subsidies –to correct externalities

23. Q1Q1 O MC = S D P Costs and benefits Quantity Using taxes to correct a market distortion

24. O MC = S D P MSC Costs and benefits Quantity External cost Q1Q1 Q2Q2 Social optimum Using taxes to correct a market distortion

25. Q2Q2 MC Q1Q1 O P Costs and benefits Quantity Optimum tax = MSC – MC MC = S MSC D Using taxes to correct a market distortion

26. O D P MC = S Q1Q1 Costs and benefits Quantity Using subsidies to correct a market distortion

27. O MSC D P Q1Q1 External benefit Costs and benefits Quantity MC = S Q2Q2 Social optimum Using subsidies to correct a market distortion

28. MC O P Q2Q2 Q1Q1 Costs and benefits Quantity Optimum subsidy = MC – MSC MSC MC = S D Using subsidies to correct a market distortion

29. Government Intervention in the Market Taxes and subsidies (cont.) –to correct for monopoly use of lump-sum taxes plus subsidies –advantages of taxes and subsidies can vary the rate according to the size of the market distortion –disadvantages of taxes and subsidies infeasible to use different tax and subsidy rates lack of knowledge Taxes and subsidies (cont.) –to correct for monopoly use of lump-sum taxes plus subsidies –advantages of taxes and subsidies can vary the rate according to the size of the market distortion –disadvantages of taxes and subsidies infeasible to use different tax and subsidy rates lack of knowledge

30. Government Intervention in the Market Other forms of government intervention Changes in property rights –the problem of limited property rights –extending property rights –limitations of this solution Laws prohibiting behaviour that imposes external costs –advantages of legal restrictions –disadvantages of legal restrictions Regulatory bodies Other forms of government intervention Changes in property rights –the problem of limited property rights –extending property rights –limitations of this solution Laws prohibiting behaviour that imposes external costs –advantages of legal restrictions –disadvantages of legal restrictions Regulatory bodies

31. Government Intervention in the Market Other forms of government intervention (continued) Price controls –high minimum prices –low maximum prices Provision of information Direct provision of goods and services –justification social justice large positive externalities dependants ignorance Other forms of government intervention (continued) Price controls –high minimum prices –low maximum prices Provision of information Direct provision of goods and services –justification social justice large positive externalities dependants ignorance

32. More or less intervention? Drawbacks of government intervention –shortages and surpluses –poor information –bureaucracy and inefficiency –lack of market incentives –shifts in government policy –voters’ ignorance –unrepresentative government –lack of freedom for the individual Drawbacks of government intervention –shortages and surpluses –poor information –bureaucracy and inefficiency –lack of market incentives –shifts in government policy –voters’ ignorance –unrepresentative government –lack of freedom for the individual

33. Private Solutions to Externalities Government action is not always needed to solve the problem of externalities. There might be some private solutions to externalities such as: Moral codes and social sanctions Charitable organizations Integrating different types of businesses Contracting between parties Government action is not always needed to solve the problem of externalities. There might be some private solutions to externalities such as: Moral codes and social sanctions Charitable organizations Integrating different types of businesses Contracting between parties

34. Question ???