POL 321 Lecture Notes - Lecture 4: Market Failure, Transaction Cost, Externality

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Lecture 4: Economics in Policymaking
Economic Policymaking
3 justifications for policymaking: moral, political, & economic
o Moraladdressing this problem is the right thing to do
o Politicalit is what voters want, it will improve reelection chances
o Economicfree-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 Failuremarket fails to achieve efficiency; inefficient distribution of goods &
services, due to:
o Public goods
o Externalities
o Information Asymmetry
o Monopoly
Public Goods
Public Gooda non-excludable & non-rival good
Excludable Goodthere is a meaningful way to prevent people from getting it
Rival Goodone person getting the good means less of it for others
Other Types of Goods:
o Private Goodsrival & excludable
o Common Pool Resourcesrival & non-excludable
o Club Goodsnon-rival & excludable
A public-good is a market failure because of the free-rider problem
o Free-Rider Problempeople have no incentive to pay since they benefit anyway
We use taxes to pay for a public good
Externalities
Externalitya 3rd party to the transaction either gets a benefit (positive externality) or
accrues a cost (negative externality), despite not being involved
Negative Externality3rd party accrues a cost
o Ex: pollution
o Regulations/Direct Controlsgovernment puts forth a regulation
Ex: a limit on pollution
o Taxesde-centivize behavior by making it more expensive
o Market for Externality Rates/Cap & Tradegovernment wants to reduce amount
of behavior, so they create a market to purchase permits to do something
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