Market Failure and the Role of Government

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
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
  gt MC.

Marginal Benefit
Quantity
Q2
4
Two Major Functions of Government

• Protective functionprotection of individuals
  and their property against invasions by others.
• Productive functionthe 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.

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Productive Function of Government

• Involves the provision of a limited set of goods
  difficult to supply through the market.

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Four Reasons Why the Invisible Hand May Fail

• Lack of Competition

• Externalities
• Public Goods
• Poor Information

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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.

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Example pollution

• http//www.youtube.com/watch?v-1DNjJd2YfA

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External Costs Failure to register fully
external costs.
Price
S1
P2
P1
D
Quantity/time
Q1
Q2

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External Benefits Failure to register external
benefits.
Price
S1
P2
P1
D1
Quantity/time
Q1
Q2

14
Public goods are

• non-rival
• and
• non-excludable.

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Rival? Excludable? Both? Neither?

1. A cup of coffee.
2. Your subscription to Aplia.
3. A sunset.
4. Public television.
5. Vaccinations.
6. The college quadrangle.

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Free Rider Problem

• Receiving the benefit of a good without paying
  for it
• e.g., a viewer of public television who doesnt
  subscribe.

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Information Problems

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