POL 321 Lecture Notes - Lecture 4: Market Failure, Transaction Cost, Externality
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28 Sep 2019
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Lecture 4: Economics in Policymaking
Economic Policymaking
• 3 justifications for policymaking: moral, political, & economic
o Moral—addressing this problem is the right thing to do
o Political—it is what voters want, it will improve reelection chances
o Economic—free-market failed to work as expected/needed, didn’t achieve efficiency;
market failure
• In free-market, business people provide goods to meet needs of consumers
• Market Failure—market fails to achieve efficiency; inefficient distribution of goods &
services, due to:
o Public goods
o Externalities
o Information Asymmetry
o Monopoly
Public Goods
• Public Good—a non-excludable & non-rival good
• Excludable Good—there is a meaningful way to prevent people from getting it
• Rival Good—one person getting the good means less of it for others
• Other Types of Goods:
o Private Goods—rival & excludable
o Common Pool Resources—rival & non-excludable
o Club Goods—non-rival & excludable
• A public-good is a market failure because of the free-rider problem
o Free-Rider Problem—people have no incentive to pay since they benefit anyway
• We use taxes to pay for a public good
Externalities
• Externality—a 3rd party to the transaction either gets a benefit (positive externality) or
accrues a cost (negative externality), despite not being involved
• Negative Externality—3rd party accrues a cost
o Ex: pollution
o Regulations/Direct Controls—government puts forth a regulation
• Ex: a limit on pollution
o Taxes—de-centivize behavior by making it more expensive
o Market for Externality Rates/Cap & Trade—government wants to reduce amount
of behavior, so they create a market to purchase permits to do something