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Chapter 15
Introduction
Should the government intervene in the market?
The framework presented might be called the invisible hand framework. Invisible hand framework perfectly competitive lead individuals to make voluntary choices that are in societys interest.
Market Failures
A market failure occurs when the invisible hand pushes in such a way that individual decisions do not lead to socially desirable outcomes.
Market Failures
Any time a market failure exists, there is a reason for possible government intervention into markets to improve the outcome.
Market Failures
Because the politics of implementing the solution often leads to further problems, government intervention may not necessarily improve the situation.
Externalities
Externalities are the effect of a decision on a third party that is not taken into account by the decisionmaker. Externalities can be both positive and negative.
Externalities
Negative externalities occur when the effect of a decision on others that is not taken into account by the decisionmaker is detrimental to the third party. Examples include second-hand smoke, water pollution, and congestion.
Externalities
Positive externalities occur when the effect of a decision on others that is not taken into account by the decisionmaker is beneficial to others. Examples include innovation, education, and new business formation.
Negative Externalities
When negative externalities ensue third parties are hurt. Marginal social cost is greater than marginal private cost.
Negative Externalities
Marginal social cost includes all the marginal costs borne by society.
Negative Externalities
Marginal social cost is calculated by adding the negative externalities associated with production to the marginal private costs of that production.
P1
P0
Marginal social benefit 0 Q1 Q0 Quantity
Positive Externalities
Private trades can benefit third parties not involved in the trade. Marginal social benefit equals the marginal private benefit of consuming a good or service plus the positive externalities resulting from consuming that good or service.
A Positive Externality
Cost P1 P0 S = Marginal private and social cost
Direct Regulation
A program of direct regulation is where the amount of a good people are allowed to use is directly limited by the government.
Direct Regulation
Economists do not like this solution since it does not achieve the desired end as efficiently (at the lowest cost possible in total resources without consideration as to who pays those costs) and fairly as possible.
Direct Regulation
Direct regulation is inefficient because it achieves a goal in a more costly manner than necessary.
Incentive Policies
Incentive programs are more efficient than direct regulatory policies. The two types of incentive policies are either taxes or market incentives.
P1
P0
Q1 Q0
Quantity
Voluntary Reductions
Voluntary reductions leave individuals free to choose whether to follow what is socially optimal or what is privately optimal. Economists are dubious of voluntary solutions.
Voluntary Reductions
A persons social conscience and willingness to do things for the good of society generally depend on his or her belief that others will also be helping.
Voluntary Reductions
If a socially conscious person comes to believe a large number of other people will not contribute, he or she will often lose their social conscience. This is another example of a free rider problem individuals unwillingness to share in the cost of a public good.
Some environmentalists say yes. Economists would answer that doing so is costly so marginal costs should be balanced against marginal benefits.
Public Goods
A public good is one that is nonexclusive (no one can be excluded from its benefits) and nonrival (consumption by one does not preclude consumption by others.
Public Goods
There are no pure examples of a public good.
The closest example is national defense.
Public Goods
Once a pure public good is supplied to one individual, it is simultaneously supplied to all. A private good is only supplied to the individual who bought it.
Public Goods
With public goods, the focus is on groups. With private goods, the focus is on the individual.
Public Goods
In the case of a public good, the social benefit of a public good is the sum of the individual benefits.
Public Goods
Adding demand curves vertically is easy to do in textbooks, but not in practice. This is because individuals do not buy public goods directly so that their demand is not revealed in their actions.
0.50
2
0.40
Informational Problems
Perfectly competitive markets assume perfect information. Real-world markets often involve deception, cheating, and inaccurate information.
Informational Problems
When there is a lack of information, buyers and sellers do not have equal information, markets may not work properly.
Informational Problems
Economists call such market failures adverse selection problems. Adverse selection problems problems that occur when a buyer or a seller have different amounts of information about the good for sale.
A Market in Information
A market in information is one solution to the information problem. Information is valuable, and is an economic product in its own right.
A Market in Information
Left on their own, markets will develop to provide information that people need and are willing to pay for it.
A Market in Information
Economists who do not like government interference point out that informational problems are not a problem of the market; it is a problem of government regulation.
Licensing of Doctors
Licensing of doctors is a debate that is motivated by information problems. Currently all doctors practicing medicine are required to be licensed this was not always so. Licensing of doctors is justified by informational problems.
Licensing of Doctors
Some economists argue that licensing is as much a problem of restricting supply as it is to help the consumer.
Licensing of Doctors
Why, if licensed medical training is so great, do we even need formal restrictions to keep other types of medicine from being practiced?
Licensing of Doctors
Whom do these restrictions benefit: the general public or the doctors who practice mainstream medicine? What have the long-term effects of licensure been?
This would give rise to consumer sovereignty the right of the individual to make choices about what is consumed and produced.