● OFFICE HOURS: THURSDAYS FROM 1 - 3 PM GE351
The Role Of Government
● “Market Failures”
● We don’t get the outcome that we want.
● 1) Monopoly: not allocatively efficient
○ Government needs to to regulate monopoly
○ Natural Monopoly: Declining ATC, constant MC curve, as Output Expands,
○ Regulate so that P = ATC,
● 2) Externalities
○ Deodorant: positive consumption externality
○ Negative production externality: the price will be too low and the output too
○ When cost/benefits are external to the market
● Public Goods - things that individuals will never buy there own.
2. Public and Private Goods
● Characteristics of goods:
○ 1. Excludability: a person can be excluded from using a good
○ 2. Rivalness: one person’s use of a good diminishes with other people’s use
● Pure Private Good: excludable, rival (ice-cream sundae)
● Pure Public Good: Non-excludable, Non-rival (fireworks, national defense)
● Key result: private market cannot produce public goods
3. The Provision of Public Goods
● Non-excludable and non-rival
Value to Each Ship Owner $5,000
# of Ship Owners 2,000
Total Value (Total Benefit) $10 Million
Total Cost $1 Million
● Should the lighthouse be built?
○ Yes, Total Value > Total Cost => Efficient to build
● Marginal benefit versus cost to the town
● Private Market:
○ An entrepreneur requires $500 from each owner to build
○ Yet no owner will pay since he cannot be excluded from the benefit of the
lighthouse once it is built
○ Private market fails because of the free rider problem. ● Government Intervention
○ Government has the power to get beyond the non-excludability of the public
○ The government requires $500 from each owner to build
○ The government can force each owner to pay using taxes.
■ tax each owner $500 => lighthouse is built
■ each owner gets a surplus of $4500 ($500 - $500)
○ There is a need for government intervention when there is a public good.
● How do we determine the allocatively efficient output of a public good?
○ Produce output where the sum of the marginal benefit to each individual =
■ where the MB = MC for the whole “town” combined
■ Q* is the allocatively efficient quantity of lighthouses.
4. Excise Taxes and Allocative Efficiency. Taxes and
Transfers - Income Inequality
● 2nd role of government: Redistribution of income
● Allocative efficiency isn’t the only kind of efficiency, looking from a social standpoint.
○ For example: perfect price discrimination
■ The quantity is allocatively efficient but the producer/consumer surplus
isn’t distributed evenly.
● Altering the distribution of income
● Taking from the “rich” to give to the “poor
○ Employment Insurance Premiums pa