Market and Government Failures BUSINESS, GOVERNMENT AND SOCIETY SPRING 2000

MARKET AND GOVERNMENT FAILURES (1) MARKET FAILURES -EFFICIENCY JUSTIFICATIONS FOR GOVERNMENT “INTERVENTION” (2) GOVERNMENT FAILURES - MARKET FAILURES AS NECESSARY, BUT NOT SUFFICIENT CONDITION FOR GOVERNMENT INTERVENTION (3) GROUP CASE EXERCISES (4) REGULATION OF THE INTERNET DEBATE (5) THE INTERNET AS A BG&S RESOURCE

MARKET FAILURES (EFFICIENCY ARGUMENTS FOR GOVERNMENT INTERVENTION) A) PRISONERS’ DILEMMA B) FREE RIDER PROBLEMS C) INFORMATION ASYMMETRY D) AGENCY PROBLEMS E) EXTERNALITIES F) PUBLIC GOODS G) NATURAL MONOPOLY

PRISONERS’ DILEMMA n TWO PARTIES, A & B, WOULD BOTH BE BETTER OF IF THEY COOPERATED n HOWEVER, INDIVIDUALLY THEY HAVE INCENTIVE NOT TO n THUS PRIVATE INCENTIVES (PRIVATE MARKET) FAILS TO ENSURE OPTIMAL OUTCOME

PRISONERS’ DILEMMA

PRISONERS’ DILEMMA SOLUTION n GOVERNMENT CAN MANDATE COOPERATION THROUGH LAWS AND REGULATIONS WHICH ARE MUTUALLY BENEFICIAL n THUS GOVERNMENT CAN IMPROVE EFFICIENCY AND EFFECTIVENESS OF PRIVATE MARKET

FREE RIDER PROBLEM n MORE GENERAL FORM OF PRISONERS’ DILEMMA n WHEN THE BENEFITS FROM COLLECTIVE ACTION GO TO THOSE WHO DO NOT CONTRIBUTE FREE RIDER PROBLEMS ARISE n EXAMPLES, CONSERVATION OF NATURAL RESOURCES --e.g., North Atlantic Salmon

FREE RIDER PROBLEMS SOLUTIONS n AS WITH PRISONERS’ DILEMMA ONE SOLUTION IS GOVERNMENT LAWS/REGULATIONS n FREE RIDER PROBLEMS ARE MOST PREVALENT WHEN THE # OF PEOPLE INVOLVED IS HIGH (HARDER TO SELF-ENFORCE) AND THE BENEFITS ARE EVENLY DISTRIBUTED

INFORMATION ASYMMETRY n WHEN TWO PARTIES (buyers and sellers) HAVE ACCESS TO DIFFERENT INFORMATION n MARKET FOR “LEMONS” OCCURS, e.g., used car market n GOVERNMENT AND PRIVATE GROUPS CAN INTERVENE TO CORRECT INFO ASYMMETRY, e.g., state “lemon laws”, FDA, DOA, AMA

AGENCY PROBLEMS n AGENTS ACT FOR PRINCIPALS n SOME AGENTS (e.g., stock broker) CAN ACT IN OWN, NOT PRINCIPAL’S (e.g., client/shareholder) BEST INTEREST AND THE MARKET FAILS n THIS IS PREVALENT WHEN THERE IS INFO ASYMMETRY (e.g., securities industry, doctor-HMO-patient relationships)

AGENCY PROBLEM SOLUTION n GOVERNMENT AND/OR INDUSTRY CAN REGULATE THE ACTIONS OF AGENTS n CAN CORRECT INFO ASYMMETRY BETWEEN PRINCIPALS AND THEIR AGENTS n EXAMPLES, SECURITIES AND EXCHANGE COMMISSION, REAL ESTATE INDUSTRY STANDARDS

MARKET EFFICIENCY: DEFINITION AND GRAPHICAL REPRESENTATION n MARKET EFFICIENCY: u SUPPLY CURVE INTERSECTS DEMAND u MC=P u MAX (PRODUCER SURPLUS + CONSUMER SURPLUS) u THE DISTRIBUTION OF SURPLUS IS UNIMPORTANT FOR EFFICIENCY CONSIDERATIONS

EXTERNALITIES n EXTERNALITIES ARE WHEN THIRD PARTIES (I.E., THOSE NOT DIRECTLY INVOLVED IN THE MARKET TRANSACTION) ARE AFFECTED BY MARKET ACTIVITIES n THERE ARE BOTH NEGATIVE (e.g., pollution) AND POSITIVE (e.g., education) EXTERNALITIES WITH PRIVATE MARKET ACTIVITIES

EXTERNALITIES, cont. n FOR EFFICIENCY PURPOSES DESIRE u LESS THAN PRIVATE MARKET PRODUCTION OF GOOD/SERVICE WITH NEGATIVE EXTERNALITIES AND HIGHER PRIVATE COSTS OF THAT GOOD/SERVICE u MORE OF GOODS/SERVICES WITH POSITIVE EXTERNALITIES AND LOWER PRIVATE COSTS

EXTERNALITIES SOLUTIONS n GOVERNMENT REGULATIONS, e.g. emission charges, pollution taxes n GOVERNMENT SUPPORT AND SUBSIDY, e.g., grants to educational institutions and student loan guarantees

PUBLIC GOODS n “LARGE” FREE RIDER PROBLEM n NONEXCLUDABLE GOODS n ALSO NON-RIVAL -- ONE PERSON’S USE DOES NOT TAKE AWAY FROM OTHER'S (THIS MAKES IT DIFFERENT FROM SOME COMMON RESOURCES LIKE FISH STOCK)

PUBLIC GOODS, cont. n EXAMPLES -- NATIONAL SECURITY, PARKS n SOLUTION IS GOVERNMENT OWNERSHIP/MANAGEMENT AND TAXATION OF CITIZENS TO OVERCOME FREE RIDER PROBLEM

NATURAL MONOPOLY -- A MARKET FAILURE n INDUSTRY WITH DECLINING COSTS, I.E., MARGINAL COSTS (UNIT COSTS) GO DOWN AS THE NUMBERS PRODUCED/SERVED GO UP n EXAMPLES -- PHONE, GAS AND UTILITY DISTRIBUTION LINES SERVING CUSTOMERS IN A LARGE SERVICE AREA

NATURAL MONOPOLY continued n EFFICIENCY BEST ACHIEVED WITH SINGLE PROVIDER n HOWEVER, WITH SINGLE PROVIDER WOULD GET MONOPOLY PRICING AND PRICE HIGHER AND SALES/PRODUCTION BELOW EFFICIENT LEVEL

NATURAL MONOPOLY SOLUTIONS AND ISSUES n GOVT REGULATION CAN SET PRICE & OUTPUT TO ENSURE EFFICIENCY AND “FAIR” MARKET RETURN n THIS IS A HIGHLY CONTESTED AREA, e.g., NH PUC & PSNH n ECONOMICS OF “NATURAL MONOPOLY” INDUSTRIES ARE CHANGING WITH NEW TECHNOLOGY

NON-EFFICIENCY BASED ARGUMENTS FOR GOVT. INTERVENTION IN MARKET II. SOCIAL AND EQUITY A) SOCIAL GOAL ACHIEVEMENT -- e.g., economic opportunity, equality, fairness B) ECONOMIC & SOCIAL STABILITY -- e.g., temper negative effects of business cycles and economic dislocation caused by global competition

GOVERNMENT FAILURE (REASONS WHY MARKET FAILURE IS NOT A SUFFICIENT CONDITION FOR GOVERNMENT INTERVENTION) A) LACK OF DIRECT CUSTOMER FEEDBACK -- ineffective political process (to be discussed next week) B) SELF INTEREST “DRIVEN” PUBLIC OFFICIALS -- a principal-agent problem C) NATURE OF POLITICS (affected by the distribution of benefits from support and opposition)

THE NATURE OF POLITICS

GOVERNMENT FAILURE continued D) CAPTURE THEORY (agencies dominated by private industry interests, e.g., DOT, DOA) E) INFORMATION FAILURES (e.g., DOJ anti-trust division) F) BUREAUCRATIC/ ORGANIZATIONAL COSTS

CASE DISCUSSION n Overfishing

GROUP ASSIGNMENT n (1) IDENTIFY THE MARKET FAILURE AND/OR GOVT FAILURE ASPECT OF THE CASE n (2) HOW IS GOVT OR PRIVATE COLLECTIVE ACTION GROUP TRYING TO OVERCOME THE MARKET FAILURE? n (3) IS IT DOING IT EFFECTIVELY? n (4) ARE THERE ALTERNATIVES?

DEBATE: SHOULD THE INTERNET BE REGULATED BY THE GOVERNMENT? n OPENING STATEMENTS u AGAINST REGULATION (GROUP 2) u IN FAVOR OF REGULATION (1) u QUESTIONS: F GROUP 1 TO GROUP 2 F GROUP 2 TO GROUP 1 F FROM CLASS F FROM INSTRUCTOR

THE INTERNET AS A BG&S RESOURCE n THE INTERNET IS A RESOURCE FOR INDUSTRY AND COLLECTIVE ACTION GROUPS n VALUABLE TOOL FOR: u INFO ON THE NONMARKET u SCANNING THE NONMARKET ENVIRON. u DETECTING EMERGING ISSUES u STAYING AHEAD OF COMPETITION u STAYING IN TOUCH WITH ALLIES

KEYS TO EFFECTIVE USE OF THE INTERNET n IDENTIFY THE MOST USEFUL SITES FOR YOUR INDUSTRY, FIRM & PARTICULAR INTERESTS n JUDGE SITES BASED ON QUALITY AND TIMELINESS OF INFORMATION n SCAN DIVERSITY OF SITES --E.G., WITH INFO ON “BOTH SIDES” OF ISSUES n BROWSE WITH SEARCH ENGINES n EVALUATE CREDIBILITY OF INFO --DO NOT TAKE “INFO” AS FACTS!!

INTERNET DEMO n HOMEPAGE: pubpages.unh.edu\ ~rgittell\BGSSITES.html n “HOT” LINKS --media, government, collective action groups n BG&S HOMEPAGE IS JUST A START -- ADD YOUR OWN WITH BOOKMARKS n USE THE INTERNET FOR SCRAPBOOKS AND EXERCISES