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Market Failure and the Role of Government

Market Failure and the Role of Government. Chapter Five. What is Economic Efficiency ?. Economists use the concept of efficiency to judge actions because efficient use of resources implies the maximum value of output from the resource base. 2 conditions necessary for ideal efficiency :

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Market Failure and the Role of Government

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  1. Market Failure and the Role of Government Chapter Five

  2. What is Economic Efficiency? • Economists use the concept of efficiency to judge actions because efficient use of resources implies the maximum value of output from the resource base. • 2 conditions necessary for ideal efficiency: • All activities that provide individuals with more benefits than costs must be undertaken. • No activities that provide benefits less than costs should be undertaken. • In order for economic efficiency to be achieved, both conditions must be present.

  3. Inefficient All quantities other than Q2 are inefficient Q1 Q3 Economic Efficiency Marginal Cost and Marginal Benefit • As more resources are used to expand the level of an activity, the marginal benefits (MB) of the activity generally decline and marginal costs (MC) rise. Marginal Cost • From the viewpoint of efficiency, the activity should be expanded as long as the MB > MC. Marginal Benefit Quantity Q2

  4. Two Major Functions of Government • Protective function:protection of individuals and their property against invasions by others. • Productive function:the production of goods and services that cannot easily be provided through private markets.

  5. Protective Function of Government • The most fundamental function of government is the protection of individuals and their property against acts of aggression. • Involves the maintenance of a legal structure (rules) for the enforcement of contracts and a mechanism for the settlement of disputes.

  6. Productive Function of Government • Involves the provision of a limited set of goods difficult to supply through the market.

  7. Four Reasons Why the Invisible Hand May Fail • Externalities • Public Goods • Poor Information • Lack of Competition

  8. S2(restricted supply) Lack of Competition Price S1(competitive supply) P2 P1 D Quantity/time Q1 Q2

  9. Externalities exist … … when costs (or benefits) are external to the market, and spill-over effects are present.

  10. Example: pollution http://www.youtube.com/watch?v=-1DNjJd2YfA

  11. S2(including external costs) Actual price and output Ideal price and output External Costs Failure to register fully external costs. Price S1 P2 P1 D Quantity/time Q1 Q2

  12. Actual price and output Ideal price and output D2(including external benefits) External Benefits Failure to register external benefits. Price S1 P2 P1 D1 Quantity/time Q1 Q2

  13. Public goods are … … non-rival and non-excludable.

  14. Rival? Excludable? Both? Neither? • A cup of coffee. • Your subscription to Aplia. • A sunset. • Public television. • Vaccinations. • The college quadrangle.

  15. Free Rider Problem Receiving the benefit of a good without paying for it; e.g., a viewer of public television who doesn’t subscribe.

  16. Information Problems • Information as a public good. • Solution 1: government funding of research & public awareness campaigns. • Solution 2: franchises, trademarkts, seals of approval, accreditation.

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