1 Announcements: THURSDAY Read: DeBeers case for next weeks breakout session For half of you, DeBeers writeups are due in section. it to your TA as an attachment (or give him a disk) too. Online Quiz 1: You can take it starting next Monday 4pm.

2 Announcements: TUESDAY Read: Blumenthal, Greasy Pole Online Quiz 1: You can take it starting next Monday 4pm.

3 Week 4 Government Failure

4 What you will learn today Why having a government helps the economy Why governments fail to perform efficiently

5 Government-owned Eternal deficits Huge subsidies

6 Why have a government? Maintain property rights Fix market failure Provide public goods Anything else? But even when it does these things, beware of ____________________ THE VISIBLE FOOT government failure

7 Public Goods Public goods have two key features. They are: Non-excludable ___________________________________ Non-rivalrous ___________________________________ They suffer from ____________, like communal property. (Cant exclude people who dont pay) (Your use doesnt prevent my use) free riding

8 Examples of Public Goods National defense The legal system Public television Basic science Monitoring politicians to check that they serve the public interest

9 Free Riding As a Prisoners Dilemma Game Suppose low effort costs $0 and adds $0 to output; high effort costs $5 and yields $8; Smith and Jones split output equally. The net payoffs are shown above. Jones Smith 3,3 High effort Low effort High effort Low effort 4,-1 -1,4 0,0

10 I Samuel 8: And Samuel told all the words of Jehovah unto the people that asked of him a king. And he said, This will be the manner of the king that shall reign over you: he will take your sons, and appoint them unto him, for his chariots, and to be his horsemen; and they shall run before his chariots; and he will appoint them unto him for captains of thousands, and captains of fifties; and he will set some to plow his ground, and to reap his harvest, and to make his instruments of war, and the instruments of his chariots. And he will take your daughters to be perfumers, and to be cooks, and to be bakers. And he will take your fields, and your vineyards, and your olive yards, even the best of them, and give them to his servants. And he will take the tenth of your seed, and of your vineyards, and give to his officers, and to his servants. And he will take your men-servants, and your maid- servants, and your goodliest young men, and your asses, and put them to his work. He will take the tenth of your flocks: and ye shall be his servants. And ye shall cry out in that day because of your king whom ye shall have chosen you; and Jehovah will not answer you in that day. But the people refused to hearken unto the voice of Samuel; and they said, Nay: but we will have a king over us, that we also may be like all the nations, and that our king may judge us, and go out before us, and fight our battles. (I Samuel 8:10-20

11 Public goods require taxes, which discourages trade Reading: Figure 9.21 amount of tax=.20 P P Q Q supply with no tax supply with a tax demand quantity price

12 Taxes reduce surplus CS (no tax) = A +B+D PS (no tax) = C+E+F CS (tax) = A PS (tax) = F Tax revenue= B+C DWLoss = D+E P P Q Q supply with no tax demand quantity price A B C D E F

13 What is the ratio of DWL to tax revenue? supply with no tax demand quantity price A B C D E F 10 0 D+E =.5(12-10)(100-80) = 20 B+C= (12-10) (80-0) = 160 ratio = 1/8. (a) 0%-4% (b) 5%-10% (c) 11%-20% (d) 21%-80% (e) None of the above Did the sign-in sheet get around? If you answered a question, bring up a notecard for me.

14 What motivates government? _____________________________ _______________________ from some people to other people __________________________, both elected (politicians) and unelected (bureaucrats) Maximizing societys overall wealth Redistributing wealth Benefiting government officials

15 Causes of Government Failure Rational ignorance: ______________ ______________________________ Rent seeking: ____________________ _______________________________ voters do not bother to follow politics closely special interests do follow politics closely

16 The Principal-Agent Problem In a business, ____________________ ________________________________ In government, the principal is the _________; the agent is the _________ One level deeper, the principal is the politician and the agent is the bureaucrat the principal is the boss; the agent is the worker voter politician

17 Voters and Shareholders Individual voters, like individual shareholders in a corporation, have little incentive to monitor their representatives So why are corporations any better managed than government? The threats of _________ and __________ takeover bankruptcy

18 Rent Seeking: Pushing for Regulation or Subsidy Government policies can create _______________________ by eliminating competition, providing subsidies, etc. ______________ are people or companies who use government to obtain rents rents (windfall gains) Rentseekers

19 An Example of Rent Seeking: Exemption from Antitrust Law P Q MC D Q* P* Monopoly profits threatened by regulation $100M Triangle of deadweight loss $40M The potential social cost of the regulation is __________ $140 million

20 When is Regulation Justified? 1. If there is _______________ AND there would not be too much ____________________ if we tried to fix the market failure market failure government failure