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ECON 208 (210)
Lecture 20

ECON 208 Lecture 20: ECON 208 - 004 Lecture 20
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Department
Economics (Arts)
Course
ECON 208
Professor
Paul Dickinson
Semester
Winter

Description
Private sector: rivalrous and excludable Common Property Resources: Non-excludable but rivalrous • Overuse causes excessive depletion o Ex fisheries, buffalo, elephants • Private users go to MBpriv (=Pd) = MCpriv o Marginal benefit (private) is the same as the Pd = Marginal cost (private) • If MCpriv < Mcsocial, Pd < MCsocial (overuse) o One consumer has no effect o BUT same for us all (we all think we will have no effect), so nobody has the incentive to restrict their own use • If externality on future generations, then current generations pay P < true MCsoc • Example: use in excess of regeneration rate o Fisheries • Government has tried to introduce policies to fix this --> mixed results o Results of global warming • True cost will affect future generations (ex half of Manhattan will disappear) o Tragedy of commons • Ex Put more sheep on the lands then land dried up --> overuse and stocks went down Potential Policies? 1. Direct controls by government o Ex Canada closed Atlantic cod fishery in 1992 & Pacific salmon in 1998 2. Private property rights (ie market excludable) o Ex elephants and ivory and tourism: Kenya gave villages where elephants live private property rights. It made the elephants valuable to the people will those property rights bc animals bring in tourism --> these people have incentive to protecting the animals so they drove out ivory-hunters Why/how do property rights work? • Current market price reflects future values o Property right gives incentive and ability to preserve future value o Incentive to increase market value o Ability to do this because of laws • Overuse reduces future values, so o Reduces current market price of property rights, but owners do not want this capital loss so they protect Excludable, but non-rivalrous (club goods) • If non-rivalrous, MC = $0 o Not reducing amount for anybody else - no opportunity cost • If excludable, firms can sell at P > $0 o Can sell at a positive price --> allocatively inefficient bc MC = 0 • So P > MC = allocative inefficiency • Government ownership is often better o Art galleries, museums, etc at P = $0 o Not consuming anything that nobody else can consume (no MC) and many of these are government-owned What if non-rivalrous only up to a point? • MC is 0 up to a certain point of consumption, then MC becomes positive • Example: congested highways o Extra users slow traffic which increases (time) costs to many other users • Solution: tolls o Low or zero in normal period o Higher in peak periods (set MC curve - some people will avoid the highways if they don't really need to use them at peak hour) • Eg electronic cameras - Toronto, London, DC ▪ EZpass Public Goods: Non-rivalrous and non-excludable (sometimes called collective-consumption goods) • Non-rivalrous: P = $0 for allocative efficiency (bc MC = 0) • Non-excludable: can't make user pay • Most people will not voluntarily pay • Private firms won't produce it (won't make money off of it) • Government does it (ex national defence) o People aren't excluded and no matter how many people come in, they are still protected by national defence • Since public goods are not excludable, it is impossible to prevent anyone from using them once they are provided. • This is known as the free-rider problem. • If the provider charged a price, non-payers would take a free ride at the expense of those individuals with a social conscience who do pay. • Because of the free-rider problem, private markets will usually not provide public goods. • In such situations, public goods must be provided by government. • Since public goods are not excludable, it is impossible to prevent anyone from using them once they are provided. • 4. Asymmetric Information (4th thing that will cause market failure) • Information is a valuable commodity. • Markets for expertise are prone to market failure. • The reason is that one party to a transaction can often take advantage of special knowledge in ways that change the nature of the transaction itself. • Asymmetric information is a situation in which one party to a transaction has more or better information about the transaction than the other party. • Asymmetric information --> market failure via o Moral hazard o Adverse selection Moral Hazard: • Moral hazard exists when one party to a transaction has both the incentive and the ability to behave in a way that shifts costs onto the other party. • Moral hazard problems often arise from insurance contracts. • Examples: o Insured drivers drive less carefully, raising premiums for others • More accidents = higher premiums o Will dentist say you need more work than necessary? (or honour professional ethics codes?) • They know more than you - will they take advantage of this? o TV investigation loosened an electrical connection on an auto - found a lot of moral hazard by mechanics • Loosened electrical connection so it made a sound then they took it to various mechanics. Some addressed the problem properly and some recommended a new engine (thousands of dollars to repair, when there was nothing wrong with the car) o CBC's 'marketplace' found same for garage doors Adverse Selection: • Adverse selection refers to the tendency for people who are more at risk than average to purchase insurance, and for those who are less at risk to reject insurance Example: • Higher-risk people more likely to buy health insurance o Not as much of a problem in Canada and Europe o TrumpCare vs ObamaCare: will people with pre-existing conditions allowed to get and keep health insurance? • High-risk people push up premiums for all and lower-risk groups starts to reject which push up premiums even more • In limit only those at greatest risk would buy it - at very high premiums. No longer 'spreading the risk' over many people • Different level of risk on average within the group ("statistical discrimination") o Ex young people pay higher automobile insurance rates o Can't tell who will have more accidents individually, but as group they know young people have more accidents. So they raise the premium for this group to protect other groups from high premiums Other examples: • Used cars and market for 'lemons' (see box in text) o Probability of 'problem autos' on used lots reduces P of all used cars (including no-problem ones) • Note ads for private sales: ▪ "Owner been transferred overseas" ▪ "Previous owner just died" *Implies nothing is wrong with the car, protect from adverse selection • TV ad: Life insurance for 55+ without medical check-up o No mention of premium in ads… wonder why not? o Ad attracts high-risk people bc if they had a check-up, they would find problems (which would raise premiums). No health check-up attracts high-risk people Summary • To summarize, the following four situations result in market failures and, at least in principle, provide a rationale for government intervention: 1. Firms with market power 2. Externalities 3. Common-property resources and public goods 4. Asymmetric information 16.4 Broader Social Goals • Even in the absence of market failures, the government may choose to intervene in markets to achieve broader social goals. o Read in text book Income Distribution • The tax-and-transfer system redistributes income, as do many policies such as employment insurance and child benefits. • Policies designed to redistribute income often reduce economic efficiency. Preferences for Public Provision • Some things—like justice and police services—are viewed by most people as being better provided by government than by the private sector. Protecting Indiv
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