When Should Government Intervene?:

Definitions n Politics is the authoritative allocation of values in society n Free market: the distribution of goods and services in society through voluntary exchange

Justifications for Governmental Intervention: n Equity concerns override Efficiency concerns. n The Market is not Efficient (Market Failure) n A necessary but not sufficient justification (Note: government failure)

Efficient Markets n Were the marginal benefit to society exceeds the marginal cost to society. n Value of a good or service exceeds the value of the goods or services used to produce it.

Market failure caused by: n Lack of Competition n Lack of Information n Transaction costs n Presence of Externalities u Positive u Negative n Public Goods (positive externality)

Markets and prices n If a good or service is produced in an efficient free market: Price of good or service equals its value to society.

Lack of competition: n Insufficient number of buyers or sellers: u Natural Monopolies (utilities) Market Fixing and collusion. Effect: artificially high prices, goods tend to be under produced. Correction: price and service regulation

Lack of information: n Buyers and Sellers must know the value of the good they are buying and selling. Effect: under or over production Correction: labeling laws; licenses of doctors, plumbers; building codes, some product standards

Negative Externality: n A third party bears the cost of a transaction between a buyer and seller. Effect: good is over-produced (e.g.: pollution, health insurance) correction: taxes or regulation

Positive Externality (Public Goods): n A third party (or Free-rider) benefits without paying the cost. Effect: good is underproduced: (light houses, national defense, fire protection, education) Correction: subsidies or government service