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Failures
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 decision-
maker.
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 decision-
maker 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 decision-
maker is beneficial to others.
Marginal cost
P1 from externality
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
0 Q0 Q1 Quantity
Alternative Methods of Dealing with
Externalities
Externalities can be dealt with via
direct regulation, incentive policies,
and voluntary solutions.
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.
Tax Incentive Policies
A tax incentive program uses a tax to
create incentives for individuals to
structure their activities in a way that
is consistent with the desired ends.
Often the tax yields the desired end
more efficiently than straight
regulation.
Tax Incentive Policies
This solution embodies a measure of
fairness about it the person who
conserves the most pays the least tax.
Tax Incentive Policies
Another way to handle a negative
externality is through a pollution tax
or effluent fees.
P1
Efficient tax
P0
Marginal social
benefit
0 Q1 Q0 Quantity
Market Incentive Policies
An alternative to direct regulation is
some type of market incentive
program.
Market incentive program a plan
requiring market participants to
certify total consumption their own
or others has been reduced by a
specified amount.
Market Incentive Policies
A market incentive program is similar
to the regulatory solution in that the
amount of the good used is reduced.
Market Incentive Policies
A market incentive program differs
from a regulatory solution in that
individuals who reduce consumption by
more than the required amount are
given a marketable certificate that can
be sold to someone else.
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.
1.00
0.50
.80
.60 0.10 Market demand
.40 DB
0.60 0.40
0.50
.20
DA
0.10
1 2 3 Quantity
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.
Grades in college.
Grades in medical school.
Success rate for various procedures.
References.
Medical philosophy.
Charges and fees.
An Informational Alternative to
Licensure
This information alternative would
provide much more useful information
to the public than the present licensing
procedure.
An Informational Alternative to
Licensure
Here are some words of caution about
the informational alternative.