10.0 The Microeconomy and the Government

Milton Friedman – Capitalism and Freedom Potential roles for government Ensuring commutative justice – making sure there are fair rules for the game Dealing with market power Dealing with market failure Plus, what about equity?

Two underlying questions about policy debates Does economy need help from the gov ’ t? Is government intervention part of the solution or a bigger problem unto itself?

Solving externality problems All you have to do is figure out the marginal external cost, and impose that cost on the private actor This is called internalizing the externality

Government might choose to Tax equal to MEC Limit ouput – no more beyond L s Require firms to install scrubbers – reducing MEC

Much easier said than done Tough to measure MEC Have to make an educated guess – a proxy Plus, if there are strict rules, firms may move elsewhere

Market power in labor disputes Adam Smith – owner may have an advantage over workers There are fewer, and it is easier for them to collude

Every government has an economic policy Even if it chooses to not get involved at all, That is a choice Sometimes the policies are not the most thoughtful ones

Assume your objectives are Pareto optimality and equity Questions to ask: How well do you think the market system works? How realistic are the nice assumptions? How much do you trust government to effectively carry out policy?

Further, Does gov ’ t simply become a tool to create or enhance market power? Can it be a source of constructive solutions, or Is it a rent-seeking/rent-maintenance structure that must be constrained?

If the web of connections is so complicated, is wise policy even possible? Decent, intelligent people disagree on the answers to these questions

Two extreme positions Laissez-faire – leave markets alone – non-intervention People who believe in the nice assumptions often espouse this Intervention – governments can and should get involved to fix problems that arise with the market system

10.4 Distributive Justice

Problems of definition – tough to get people to agree on a definition of equity Gov ’ t can intervene through taxes, spending on various programs, etc.

Problems of implementation Even if you can reach a consensus on equity, the policy may have some unexpected effects Ex. Rent Control- Shortage becomes a long-term problem

Are equity and efficiency invariably a trade-off? Not if redistribution of endowments can occur Most often, interventions in the name of equity occur on an ad hoc (case by case) basis, and contain many efficiency issues

Do all these problems mean laissez-faire is the way to go? Not necessarily, but coherent, constructive policy is a challenge

Debate remains over How well the market economy works, How well the government works, and how fair the status quo is

Social and political competition revolves around these questions Sometimes it is peaceful, sometimes not, and sometimes played out both ways

10.5 Review Started with R.C. – individual choice in isolation Moved to complexity, division of labor, and exchange Then, markets under perfect competition and nice assumptions – Pareto optimality Relaxed assumptions - introduced market power and market failure Lastly, examined role of government – laissez- faire vs. intervention