Textbook Notes (367,974)
Canada (161,538)
Economics (326)
ECON 110 (199)
Chapter 16

Chapter 16.docx

8 Pages
79 Views
Unlock Document

Department
Economics
Course
ECON 110
Professor
Ian James Cromb
Semester
Winter

Description
Chapter 16: Market Failures and Government Intervention Basic Functions of the Government  From the creation of gov’t, one function that has been maintained throughout is to provide what is called monopoly of violence o Violent acts can be conducted by the military, police, and through the judicial system (incarcerating or executing them)  These monopolies are easily abused which is why good societies have system checks and balances designed to keep the gov’t directed to the general public’s good  Gov’t are also supposed to provide security of property – through property rights o The rights include clear definition and enforcement of the rights and obligations of institutions such as corporations, religious organizations, and not-for-profit’s The Case for Free Markets  Formal Defence: Allocative efficiency – resources used such that total surplus is captured  The “informal” defence is based on three central arguments o Free markets provide automatic coordination of the actions of decentralized decision makers. o The pursuit of profits in free markets provides a stimulus for innovation and rising material standards of living o Free markets permit a decentralization of economic power Automatic Coordination  Argue that a free market system is more flexible and adjusts more quickly to changes o If the price of gas went up – people could change how much they use o If centralized, the same pattern would be forced on everyone – by price fixing, rationing the gas, regulating temperature, etc.  As market conditions continue to change, prices in a market economy will also change, and decentralized decision makers can react continually o In contrast, gov’t quotas, allocations, and rationing schemes are much more difficult to adjust – more likely to be constant shortages or surpluses Innovation and Growth  Individuals risk their time and money in the hope of earning profits – not many succeed o The market system works by trial and error to sort them out and then allocates resources to those who prove to be as successful innovations  In contrast, planners in more centralized systems have to guess which innovations will be productive and which goods will be strongly demanded – they may guess wrong o One of the biggest failures was their inability to encourage experimentation and innovation that have proven to be the driving forces of long-run growth Decentralization of Power  Free market economies tend to decentralize power, thus requiring less coercion of individuals than any other type of economy – although power is not distributed evenly  Though the market power of a large corporation is not negligible, tends to be constrained both by competition and by the emergence of new products & firms – creative destruction o Supporters say that this private power is less substantial than the gov’t power  Gov’ts must coerce if markets are not allowed to allocate people to jobs and gods to consumers – such coercion creates opportunities for bribery, corruption, etc. Market Failures  Market failure: The failure of the market economy to achieve allocative efficiency  Market failure happens when firms in the industry have negatively sloped demand curves and can set price higher than marginal cost o These market failures provide gov’t opportunities to improve allocative efficiency  There are four situations in which free market fails to reach allocative efficiency o Market power, externalities, non-rivalrous, and non-excludable Market Power  Market power is inevitable in any market economy for three reason o In many industries, economies of scale are such that only a few firms operate efficiently, each having some ability to influence market conditions o Firms sell differentiated products & therefore have some ability to set their prices o Firms that innovate with new products or production processes gain a temporary monopoly until other firms learn what the innovator knows  As we already know, firms with market power will maximize profits by operating where price exceeds marginal cost – allocatively inefficient  When gov’ts intervene, all they do is prevent monopolistic practices that would permit firms to avoid behaving competitively with respect to one another – active competition Externalities  An externality occurs whenever actions taken by firms or consumers directly impose costs or confer benefits on others – also called third-party effects  Private Cost measures the cost faced by the private decision maker including production costs, advertising costs, and so on – similar distinction of private benefit  Social Cost includes the private cost (since they are a part of society) but also includes any other costs imposed on third parties – similar distinction to social benefit  Negative Externalities: When externalities are harmful to third-parties  Positive Externalities: When externalities are beneficial to third-parties  When there is an externality, either too little (+) or too much (-) of a good is produced Non-Rivalrous and Non-Excludable Goods  Economists classify goods/services based on the rivalry & the excludability of the good  A good/service is said to be rivalrous if one person’s consumption of one unit of the good means no one else can consume that same unit  A good/service is said to be excludable if people can be prevented from consuming it Private Goods  These are goods and services that are both rivalrous and excludable  Most goods that we consumer fall into this category – no problem for public policy Common-Property Resources  This is a product that is rivalrous but not excludable – challenge for public policy o Fisheries, wildlife, clean air – no way to make someone pay for it; zero price  In the absence of gov’t intervention, private users overuse common-property resources o Faced with a zero price, private users will use resource until marg benefit = zero o Will be some positive marginal cost to society – society would be better off if less resources were used these social costs are referred to as tragedy of the commons Excludable but Non-Rivalrous Goods  Examples include art galleries, roads, and bridges  Non-rivalry means that the marg cost of providing these goods to one extra person is zero  If marginal cost to society of providing one more unit of the good is zero, then allocative efficiency requires that the price be zero - any price could prevent people from using it o As long as their marginal benefit exceeds the social marginal cost of providing this good, it is efficient for these people to use the good Public Goods  These are goods/services that can simultaneously provide benefits to a large group of people – also called collective consumption goods  ex. National defence  Public goods cause rise to what is called the Free-Rider Problem o Since public goods can be used by anyone, non-payers of a good can free-ride its use at the expense of the individuals with the social conscience who do pay o Because of free-riders the private market won’t produce efficient amounts of the public goods because once produced, it’s impossible to get people to pay to use it Asymmetric Information  This is a situation in which one party to a transaction has more or better relevant information about the transaction than the other party Moral Hazard  This is a situation in which an individual or a firm takes advantage of special knowledge while engaging in socially inefficient behaviour  This would happen if the individual does not bear all of the marginal cost imposed by the risk – raises total cost for society  Ex. You get people to do/not do something for your benefit by not telling them the truth Adverse Selection  Refers to the tendency for people more at risk to purchase insurance and those who are less at risk, to reject insurance – if you have a heart condition, you seek life insurance  People getting the insurance know more about themselves than the company selling the insurance – although they can do tests/credit checks o Therefore different people are charged different prices for insurance  Resources get allocated inefficiently because the marginal private benefit of the action is not equal to the marginal social cost Broader Social Goals  Even if markets were completely competitive and allocatively efficient and there were no problems of externalities, market power, public goods, or asymmetric information, the gov’t would still have to intervene  The following are broader social goals that would still require gov’t intervention Income Distribution  People whose services are in large demand relative to supply have large incomes, whereas those not in heavy demand earn much less  As discussed in ch. 13, these can be temporary or equilibrium differentials  Free-market systems reward certain groups and penalize others o Is it fair that people starve if they lose their job? – there are many charities and gov’t policies concerned with modifying the distribution of income Preferences for Public Provision  Police protection and justice could, in principle, be provided by a private-market mechanism (security guards,
More Less

Related notes for ECON 110

Log In


OR

Join OneClass

Access over 10 million pages of study
documents for 1.3 million courses.

Sign up

Join to view


OR

By registering, I agree to the Terms and Privacy Policies
Already have an account?
Just a few more details

So we can recommend you notes for your school.

Reset Password

Please enter below the email address you registered with and we will send you a link to reset your password.

Add your courses

Get notes from the top students in your class.


Submit