4 - 1 Unit 4 Market Failure and the Role of the Government Honors Economics

4 - 2 Karl Marx Market Failures

4 - 3 The world praises the individual who makes the most people happy. Wealth is Utility, not the accumulation of Material Wealth -Das Kapital 1867 Karl Marx

4 - 4 All wealth is a direct result of combining Labor with the other Tools of Production LABOR THEORY OF VALUE The concept of Private Property has separated the worker from access to the other Means of Production ALIENATION Scientific SocialismEXPLOITATION Private Ownership allows the Capitalist to seize the Surplus Labor Value of the worker as Profit by paying Subsistence Wages

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4 - 6 Disney World was completed in 1973 the final cost of construction, land, material, display and other expenses is estimated at $ 331,000, The daily cost for running Walt Disney World is about $ 259,000 a day; that’s $ 94,534,000 a year. In the final year before he was fired as CEO of the Disney Corporation, Michael Eisner was given a bonus of $202,000,000.

4 - 7 QUESTION: If Michael Eisner didn’t show up for work this Saturday, could you still go to Disney World? If all the employees didn’t show up for work this Saturday, could you still go to Disney World ?

4 - 8 BUSINESS CYCLES IMPERFECT COMPETITION PUBLIC GOODS ASYMMETRIC INFORMATION Marx’s Market Failures INEQUITY EXTERNALITIES

4 - 9 Marx’s Market Failures BUSINESS CYCLES Fluctuations in the level of economic activity as measured by the general levels of unemployment and inflation

Marx’s Theory of the Business Cycle Level of Real Output Time Peak Recession Expansion Trough Growth Trend  Twin Problems of the Business Cycle Unemployment Inflation

Business Cycles SEASONAL CYCLES 36 MONTH CYCLES 10 YEAR CYCLES 50 YEAR CYCLES STRUCTURAL CHANGES IN TECHNOLOGY

Marx’s Market Failures INEQUITY economic disparity in income and wealth between people or groups of people resulting from lack of equal treatment, unequal opportunity and causing inefficient market outcomes

US Family Income Shares before Taxes and Transfers: –Lowest 5 th = 1% –Second 5 th = 7% –Middle 5 th = 14% –Second highest 5 th = 23% –Highest 5 th = 55%

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Marx’s Market Failures INEQUITY

Marx’s Market Failures IMPERFECT COMPETITION exists when an business has sufficient control over a particular market to determine the terms on which other individuals shall have access to it’s product; a market in which the seller determines the price and quantity rather than the consumer.

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Marx’s Market Failures ASYMETRIC INFORMATION A situation where access to information in a transaction is better for one person than another. Asymmetric information gives advantage to one while the other may have to suffer.

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Marx’s Market Failures EXTERNALITIES An externality or spillover is an impact on a party that is not directly involved in a market production or transaction. In such a case, prices do not reflect the full costs or benefits in production or consumption of a product or service.

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BUSINESS CYCLES IMPERFECT COMPETITION PUBLIC GOODS ASYMMETRIC INFORMATION Marx’s Market Failures INEQUITY EXTERNALITIES

Marx’s Solutions

Alternatives Considered #1 REVOLUTION

Alternatives Considered #2 Unions

Alternatives Considered #3 government

SOCIALISM GOVERNMENT BY DIRECT POPULAR VOTE PUBLIC OWNERSHIP OF THE MEANS OF PRODUCTION –COMMUNICATION –TRANSPORTATION –FINANCE –EDUCATION –HEALTH CARE PROGRESSIVE INCOME TAX REDISTRIBUTION OF INCOME THROUGH TRANSFER PAYMENTS CREATION OF A SOCIAL WELFARE SAFETY NET ELIMINATION OF DISCRIMINATION

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Modern Economist and the Debate Over the Free Market

Friedman and Galbraith

“ The proper guardians of the public interests are governments, which are accountable to all citizens. It is the job of elected politicians to set goals for regulators, to deal with externalities, to mediate among different interests, to attend to the demands of social justice, to provide the public goods, and to organize resources for the greater good. ” John Kenneth Galbraith The Economist Magazine January 2005

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John Kenneth Galbraith All truly important economic activity takes place within giant corporations. Large dominant firms are immune to competitive pressure. Wages and prices are artificial creations of large corporations. Consumers are manipulated by advertising. The United States is a planned economy run by large corporations. The government in a liberal society is the ‘public conscience’ which must –enforce law and order and protect property rights –serve as a balance to the power of large corporations. –protect human rights: resolve inequity, prevent discrimination and exploitation –promote full employment and a stable economy through taxing and spending –model social responsibility: correct externalities, promote culture, and eliminate pollution –Provide community investment in public goods such as schools, transportation, communication, and healthcare. Taxation is the price paid for membership in civilized society

John Kenneth Galbraith Role of government in mixed economy -protective function -corrective function -Distributive function -productive function

SOLUTION TO MARKET FAILURE: DIRECT GOVERNMENT INTERVENTION GOVERNMENT AS REFEREE John Kenneth Galbraith

The Capitalist Rebuttal

“ There is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits in open and free competition without deception or fraud. Businessmen who talk about corporate social responsibility are unwitting puppets of the intellectual forces that have been undermining the basis of a free society for decades; in fact, they are preaching pure and unadulterated socialism. ” Milton Friedman New York Times 13th September 1970

Friedman on Capitalism

Milton Friedman Economic freedom promotes political freedom. The only role of the government is to provide order and protect property rights. Government intervention in the market is ineffective because of –the rational ignorance of voters, –the special interest effect from lobbyists, –the short-sightedness of politicians. Taxation and spending by the government make the economy less stable. A uniform flat ax with no deductions is more fair than a progressive income tax. Social welfare programs don't help the poor; they reward poverty and prevent investment in human capital. Free public education is foolish. Anything that is perceived as free is undervalued and abused. There is no justification for licensing or regulation; government regulations inhibit the freedom of individuals to produce and consume as they choose. The only true solution to the problem of global conflict and poverty is the end of all trade barriers.

CROWDING OUT RENT-SEEKING AND SPECIAL INTERESTS BUREAUCRATIC CAPTURE DEADWEIGHT LOSS Friedman’s Government Failures SHORT-TERM THINKING RATIONAL IGNORANCE

Friedman’s Government Failures RATIONAL IGNORANCE The rational voter has little incentive to gain more knowledge about politics because his or her vote is unlikely to affect the outcome and political decisions have little impact on the voter’s everyday life. Since gaining more knowledge offers few benefits and substantial costs, it is thus rational to remain ignorant.

Friedman’s Government Failures RENT-SEEKING AND SPECIAL INTERESTS The idea that politicians are rational in seeking to maximize their potential for re-election by giving something for nothing; or taking a small amount from a large group of people and giving a large amount to a small group of people. This encourages the formation of small groups which lobby politicians and the government for larger shares of spending and favorable regulation.

Consequences of Rent-Seeking: The Special Interest Effect Pork Barrel Legislation or “Earmarks” The term usually refers to spending that is intended to benefit constituents of a single politician in return for their political support, either in the form of campaign contributions or votes. “Logrolling” act of exchanging favors for mutual gain; especially trading of influence or votes among legislators to gain passage of certain projects.

In 2006, Rep. Don Young (R-AK) and Sen. Ted Stevens (R- AK) amended the National Appropriation bill to use federal funding for a bridge in Ketchikan, Alaska. Dubbed the “Bridge to Nowhere,” it became a national symbol of “pork-barrel” spending. The bridge would connect the town of Ketchikan (population 8,900) with the island of Gravina (population 50) at a cost to federal taxpayers of $320 million, by way of three separate earmarks in the 2006 highway funding bill.

Friedman’s Government Failures SHORT-TERM THINKING The idea that politicians are rational in seeking to maximize their potential for re-election by giving something for nothing; and do not think further than the next election. This may result in actions having short-term benefits, but higher costs in the long run.

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Friedman’s Government Failures CROWDING OUT A reduction in private consumption or investment from increased governments spending. If the increase in spending is financed by a tax increase, the tax increase would tend to reduce private consumption. If the increase in spending is not accompanied by a tax increase, government borrowing to finance the increased government spending would increase interest rates, leading to a reduction in private investment.

Friedman’s Government Failures DEADWEIGHT LOSS The term "deadweight loss" can be applied to any inefficient allocation of resources caused by government interference. Lost production and investment due to government taxation and crowding out are primary examples.

Friedman’s Government Failures BUREAUCRATIC CAPTURE Regulatory or bureaucratic capture is a term used to refer to situations in which a government regulatory agency created to act in the public interest instead acts in favor of the industry it is charged with regulating. Regulatory capture is a form of government failure, as it can act as an encouragement for large firms to produce negative externalities.

SOLUTION TO MARKET FAILURE: inDIRECT GOVERNMENT INTERVENTION GOVERNMENT AS REpairman Milton Friedman

Reagan’s First Inaugural Address 1980

Bill Gates and Creative Capitalism

Friedman and Galbraith