MARKET GOVERNMENT GOVERNMENT FAILURE INTERVENTION FAILURE EXTERNALITY -PUBLIC GOODS MARKET POWER INEQUITIES DYNAMIC MKT. FAIL. INDIVISIBILITY INFORMATION ASYMMETRY FAILURE TO RATION

EXTERNALITIES: impacts on third parties besides the buyer and seller. CONSUMPTION EXTERNALITIES: impacts on third parties as a result of the consumption of a good. =>Divergence of social and private demand PRODUCTION EXTERNALITIES: impacts on third parties as a result of the production of a good. =>Divergenece of social and private supply

Smoking Private DemandPrivate Supply # of packs $10/ Pack Price Market equilibrium Price

The Consumption Externality of Smoking: Suppose everyone who smokes a pack costs $5 in costs on everyone else who breathes the fumes. Private demand (the hooked) is in black. Social demand is in RED (deduct health cost). Private DemandPrivate Supply $5 per pack # of packs $10/ Pack Price

The Consumption Externality of Smoking: Suppose everyone who smokes a pack costs $5 in costs on everyone else who breathes the fumes. Private demand (the hooked) is in black. Social demand is in RED (deduct health cost). Private DemandPrivate Supply $5 per pack # of packs

The Consumption Externality of Smoking: Suppose everyone who smokes a pack costs $5 in costs on everyone else who breathes the fumes. Private demand (the hooked) is in black. Social demand is in RED (deduct health cost). Private DemandPrivate Supply $5 per pack # of packs Socially Desirable Price= $8.46 per pack

Tobacco Production: Production Externality Private DemandPrivate Supply Pounds of tobacco $2 per pound Price Market equilibrium Price

Tobacco Production: Every pound sold builds sound community of the U.S.A.: value of moral fiber= $1 per $2 sold (50% ad valorem) Private DemandPrivate Supply Pounds of tobacco $3 per pound Price 50% above private market price: Ad valorem sales subsidy

Contradictory policy on production and consumption: other examples: -Car production ($50 billion for GM, emission controls and clunker taxes) -Electric Power (subsidize production, tax consumption (carbon tax)) -Oil (subsidize production (depletion allowance, foreign tax exemption), tax consumption at pump) -Steel (tax pollution, subsidize production (tariff)) -Medical education (subsidize doctor education, tax physician incomes & malpractice insurance requirement)

MARKET POWER: a downward sloping demand curve from the point of view of the seller; the power over the market price. includes: MONOPOLY, OLIGOPOLY, MONOPOLISTIC COMPETITION, MONOPSONY, OLIGOPSONY, BILATERAL OLIGOPOLY, AND BILATERAL MONOPOLY.

DEAD WEIGHT WELFARE LOSS OF MONOPOLY DEMAND MARGINAL COST Monopoly Case Competitive Case transferred to producer A Loss to Consumers +Gain to Producers =Increased profit to producers Railroad Rates ($/ton mile) Price Due to higher prices Due to lower costs Deadweight loss: due to lower output neither gains

DYNAMIC MARKET FAILURE: the failure through time to achieve technological change and the failure of the market to achieve stable, equilibrium outcomes. examples: - Stagnation - Lack of technological change. -The cobweb problem - Instability

COBWEB MODEL Ao B3 CHEMICALS (millions of pounds/year) Price Suppose a shock knocks the price on the Market higher to Ao.

COBWEB MODEL Ao A1 B3 CHEMICALS (millions of pounds/year) Price Because of higher prices, more firms enter The market to produce more quanity supplied

COBWEB MODEL Ao A1 A2 B3 CHEMICALS (millions of pounds/year) Price With so much production, there is a surplus On the market and prices fall.

COBWEB MODEL Ao A1 A2 A3 B3 CHEMICALS (millions of pounds/year) Price With such low prices firms get out of the Market and there is very little supplied.

COBWEB MODEL Ao A1 A2 A3 Bo B3 CHEMICALS (millions of pounds/year) Price With so little production, people pay a lot For what is available

COBWEB MODEL Ao A1 A2 A3 Bo B1 B3 CHEMICALS (millions of pounds/year) Price High prices induce firms to enter… with A lag

COBWEB MODEL Ao A1 A2 A3 Bo B1 B2B3 CHEMICALS (millions of pounds/year) Price Overexpansion causes the price to drop

COBWEB MODEL Ao A1 A2 A3 Bo B1 B2B3 CHEMICALS (millions of pounds/year) Price Such a low price provides no incentive to produce any product at all.

WHAT PREVENTS THE UNSTABLE CYCLE? - MORE INELASTIC SUPPLY - A LONG TIME HORIZON - INSTANTANTANEOUS FEEDBACK ABOUT PRICES - IMMEDIATE ADJUSTMENT OF PRODUCTION - COUNTERCYCLICAL INVENTORY POLICY (requiring storable goods) - EXTRA CAPACITY - MARKET POWER - COMMUNICATION, PLANNING OF MEMBERS IN MARKET. INFORMATION ON MARKET - MARKETS THAT ALLOW SPECULATION AGAINST UNSTABLE BEHAVIOR Government intervention: BUFFER STOCKS

Quintiles Based on Per Capita Income

Cumulative % of: Coun- GNP tries WORLD INCOME DISTRIBUTION

LINE OF EQUALITY USA WORLD

FOUR FAILURES TO RATION QUANTITY PRICEPRICE PRICEPRICE PRICEPRICE PRICEPRICE DemandSupply Glut Se- vere Shor- tage Not a Problem Infeasibility

PRIVATE (for profit) STUDIES

MARKET GOVERNMENT GOVERNMENT FAILURE INTERVENTION FAILURE EXTERNALITY PUBLIC ENTERPRISE ADMINISTRATIVE -PUBLIC GOODS-NATIONALIZATION COST MARKET -PRIVATIZATION COMPLIANCE POWER REGULATION COST INEQUITIES - OUTPUT EFFICIENCY COST DYNAMIC - PRICE - NEGATIVE EXTER. MKT. FAIL. - STANDARDS -PUBLIC BADS INDIVISIBILITY ANTITRUST - MKT POWER INFORMATION -STRUCTURE - INEQUITIES ASYMMETRY -CONDUCT - DYNAMIC FAILURE TO TAXES (SUBSIDIES) - INDIVISIBILITY RATION PROVISION OF - INFORMATION INFORMATION RATIONING (MONEY)