Market Failures and the Role of the Government Unit 6: Market Failures and the Role of the Government Copyright ACDC Leadership 2015 1

2011 Practice FRQ Copyright ACDC Leadership 2015 2

Market Failure #3 Monopolies

Antitrust Laws

What are Antitrust laws? Why are monopolies a Market Failure? Antitrust Laws- Laws designed to prevent monopolies and promote competition. After the Civil War, advances in technology and transportation lead to national markets. Eventually only a few firms began to dominate industries: Railroads, Steel, meatpacking, coal, etc. Sherman Act of 1890- “Every person who shall monopolize …or conspire to monopolize…shall be deemed guilty of a felony.” Why are monopolies a Market Failure? Monopolies destroy the key ingredient of the free market system- Competition. To fix this MARKET FAILURE the government must get involved.

Regulating Monopolies Copyright ACDC Leadership 2015

Why Regulate? How do they regulate? Why would the government regulate an monopoly? To keep prices low To make monopolies efficient How do they regulate? Use Price controls: Price Ceilings Why don’t taxes work? Taxes limit supply and that’s the problem Copyright ACDC Leadership 2015

Where should the government place the price ceiling? 1.Socially Optimal Price P = MC (Allocative Efficiency) OR 2. Fair-Return Price (Break–Even) P = ATC (Normal Profit) Copyright ACDC Leadership 2015

Natural Monopoly One firm can produce the socially optimal quantity at the lowest cost due to economies scale. P It is better to have only one firm because ATC is falling at socially optimal quantity MC ATC MR D Q Qsocially optimal 9 Copyright ACDC Leadership 2015

Natural Monopoly Unregulated Fair Return Socially Optimal P PM MC PFR ATC QSO MR D Q QM QFR Qsocially optimal

Regulating a Natural Monopoly What happens if the government sets a price ceiling to get the socially optimal quantity? P The firm would make a loss and would require a subsidy MC ATC Pso MR D Q Qsocially optimal

Review Activity: Name that Concept Copyright ACDC Leadership 2015

Round 1 Public Good Tax Positive Externality Free Rider Marginal Social Cost Round 1 Copyright ACDC Leadership 2015

Round 2 Negative Externality Nonexclusion Market Failure Invisible Hand Common Pool Problem Round 2 Copyright ACDC Leadership 2015

Review Define Market Failure. Identify the four market failures we have learned in this unit. Explain why are public goods a market failure. Explain why are externalities a market failure. Explain why are monopolies a market failure. By yourself, draw a positive externality. By yourself, draw a negative externality. Use graph to explain the remedy for positive externalities. Use graph to explain the remedy for negative externalities. Name 10 different super heroes.

Market Failure #4 Unfair Distribution of Wealth and Income Net Worth over $2.3 billion Copyright ACDC Leadership 2015

Distribution of Wealth in the US Copyright ACDC Leadership 2015

(Based on 2003 Information) Income Inequality In 2003, the average American family made $66,863. What’s wrong with using the average? Averages reveal absolutely nothing about how income is distributed. How does the government measure distribution of income? (Based on 2003 Information) Copyright ACDC Leadership 2015

Gap Between Rich and Super Rich Copyright ACDC Leadership 2015

THE LORENZ CURVE Copyright ACDC Leadership 2015

Measuring Income Distribution Review the process: The government divides all income earning families into five equal groups (quintiles) from poorest to richest. Each groups represents 20% of the population. If there was perfect equality then 20% of the families should earn 20% of the income, 40% should earn 40% (and so on). The government compares how far the actual distribution is from perfect distribution then attempts to redistribute money fairly. Copyright ACDC Leadership 2015

Measuring Income Distribution Summary: Group #1 (Poorest 20%) Total of $5 (5% of total income) Group #2 Total of $10 (10% of total income) Group #3 Total of $15 (15% of total income) Group #4 Total of $25 (25% of total income) Group #5 (Richest 20%) Total of $45 (45% of total income)

The Lorenz Curve Perfect Equality Percent of Income 100 80 60 40 20 Perfect Equality Percent of Income 20 40 60 80 100 Percent of Families

The Lorenz Curve Lorenz Curve (actual distribution) Perfect Equality 100 80 60 55 40 30 20 15 5 Lorenz Curve (actual distribution) Perfect Equality Percent of Income 20 40 60 80 100 Percent of Families

The Lorenz Curve Lorenz Curve (actual distribution) Perfect Equality 100 80 60 55 40 30 20 15 5 Lorenz Curve (actual distribution) Perfect Equality Percent of Income 20 40 60 80 100 Percent of Families 25

(the size of the banana) The Lorenz Curve Lorenz Curve (actual distribution) Gini Coefficient- Statistical measurement of income distribution. Area A divided by the sum of areas A and B (the size of the banana) Perfect Equality Percent of Income Area A Area B Percent of Families 26

The Lorenz Curve Government transfer payments shift the Lorenz Curve toward more equality Is that good or bad? Perfect Equality Percent of Income Percent of Families Copyright ACDC Leadership 2015 27

Where does the government get the money for welfare? Welfare provides a safety net for citizens (retirement, unemployment, workers comp, health, etc.) BUT, what are some possible downsides? Where does the government get the money for welfare?

Types of Taxes Copyright ACDC Leadership 2015

Why does the government tax? What are Taxes? Taxes – mandatory payments made to the government to cover costs of governing. Why does the government tax? Two purposes: Finance government operations. Public goods-highways, defense, employee wages Fund Programs- welfare, social security 2. Influence economic behavior of firms and individuals. Ex: Excise taxes on tobacco raises tax revenue and discourages the use of cigarettes.

Three Types of Taxes 1. Progressive Taxes -takes a larger percent of income from high income groups (takes more from rich people). Ex: Current Federal Income Tax system 2. Proportional Taxes (flat rate) –takes the same percent of income from all income groups. Ex: 20% flat income tax on all income groups 3. Regressive Taxes –takes a larger percentage from low income groups (takes more from poor people). Ex: Sales tax; any consumption tax.

What kind of taxes are these? (THINK % of Income) Three Types of Taxes What kind of taxes are these? (THINK % of Income) Toll road tax ($1 per day) State income tax where richer citizens pay higher % $.45 tax on cigarettes Medicare tax of 1% of every dollar earned 8.25% California sales tax Regressive Progressive Proportional

Federal Income Tax Debate Equal Tax of $350 per week (Regressive Tax) Income Amount of Tax % Amount to live on $200 $350 175% -$150)[crime?] $350 $350 100% $0 $500 $350 70% $150 $1,000 $350 35% $650 $5,000 $350 7% $4,650 Tax tax of 20% per week (Proportional Tax) Income Amount of Tax Amount to live on $200 $40 $160 $350 $70 $280 $500 $100 $400 $1,000 $200 $800 $5,000 $1,000 $4,000

Federal Income Tax Debate This is our current system. Is it fair? The Progressive tax system is the most effective way to fight this market failure

Practice

2008 Audit Exam 44. B

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