1. 1 Stigler : The Economists’ Traditional Theory of the Economic Functions of the State 1. Schizophrenic view 2. 19th C. economists had developed theory of maximum satisfication. ignore distribution. competition benign. 3. If true state (1) eneme competition (2) alter distribution egalitarianism care for poor

2. 2 (3) preserve order and enforce contract army counts Tend to be monopoly 4. Modern theorists find new flaws : externalities public goods enoneous decisions 5. Externalities (1912 A.C. Pigon) An effect of an economic decision (harmful or beneficial) upon a person who was not a party to the decision, for which compensation (+-) was not made.

3. 3 But no attempt to illuminate where externalities are important. R. Coase 1961 Why doesn’t the decision get internalize through private negotiation. The failure to consult all affected parties to an economic decision by the cost of transaction. We can study which transaction where feasible or not. If T-costs were zero the theory of max. satisfaction would hold no matter how rights and duties were assigned by law.

4. 4 6. Public goods (1954) P. Samuelson) A pure public good is defluence as any commodity or service which can be used by one person without interfering with the use of the very same service by other persons. Competition cannot supply the proper amounts of a public good. (1) monopoly inefficiencies of public goods inevitable if provided privately. But monopoly element is of limited importance because of entry. (2) Free rider problem - incentive to understate desire for the public good. (3) exclusive use possible but policing costs could be very expensive.

5. 5 7. Erroneous Decisions (1) individuals choose inappropriate means to fulfill desires, clearly not max. satisfaction. It is not merely imperfect knowledge, since all knowledge is imperfect. But that individual would not acquire a proper amount of information even though one can buy information at its cost of production. Under- investment in information - irrationality. (2) Non-fulfillment of desires, not censorship of desires (heroism is to thwart market fulfillment of undesirable desires, this is non- economic source of satisfactory).

6. 6 1. Failures can be improved by an intelligent and efficient government. 2. Theory does not tell us what classes of economic activity market failures occur. e.g. * economists has no knowledge of when the consumer is incompetent, * no study of the average error in consumer decisions in different types of decisions, * in public goods does not indicate what to do but merely explain why the state undertakes what it happens to undertake, * externalities experts are reformers not economists. Market failures as a basis for policy Economists can have only a limited role in detecting market failure.