Holding the Invisible Hand Government Intervention in the Microeconomy

Central Questions of Government Intervention Under what circumstances do markets fail? How can government intervention help? How much government intervention is desirable?

Market Failure Optimal Mix of Output Nature of Market Failure Definition: Nature of Market Failure Definition of market failure: Market Failure implies that the forces of supply and demand have not led us to the optimal mix of output Sources of Market Failure Public Goods Externalities Market Power Inequity

Public Goods Definition of Public Good: Definition of Private Good: Market Mechanism only works efficiently if the benefits of consuming a good or service are available only to those who purchase the product Joint Consumption One person consuming a public good does not preclude another person consuming the same good “Free-Rider” Dilemma Definition of “free-rider”: Exclusion In many cases, the technical capability to exclude “free-riders” from consuming a public good does not exist Underproduction The market tends to overproduce private goods and under produce public goods

Externalities Definition: The market will underproduce goods that yield external benefits and overproduce goods that generate external costs External Costs vs. External Benefits Social Costs vs. Private Costs

Market Power & Inequity Definition of market power: The market mechanism functions through communications between producers and consumers by way of prices and purchases The more market power a firm has, the greater its ability to ignore the desires of consumers and pursue profit maximization Inequity Market mechanism involves inherently unequal outcomes Society generally expresses a desire for less unequal (but still unequal) distributions of wealth Definition of income transfer Table 9.1, pg. 205