Chapter 16 Government and Market Failure

 Private goods are rivalous and excludable  Both features must be present  Rivalry means when someone buys and consumes a good, they prevent anyone else from buying and consuming that good  Excludability means the seller can exclude non-payers from enjoying the product  These characteristics are not found for public goods— their absence makes it impossible for private providers to profit from offering these products

 Public goods are nonrivalous and nonexcludable  Nonrivalry means that more than one person can consume the same good at the same time  Watching a ballgame is a nonrivalrous good, though particular seats in a ballbark are rivalous. Ballgames are provided privately because they are excludable.  Nonexcludability means that the good’s benefits cannot be limited to those who pay for it

 If consumers can enjoy satisfaction from a nonrivalous good, and cannot be excluded from using it even when they don’t pay….  There’s no incentive to pay for the good if it is offered on the market,  And there’s no incentive for private agents to offer it for sale….  So it must be provided by the government or not at all.

 The optimal amount is determined by the collective willingness to pay, the vertical sum of the prices for a given quantity (marginal social benefit)  And the intersection with the marginal cost

 Net benefit = marginal benefit – marginal cost  NB = MB – MC  Determines the socially optimal quantity

 aka “spillover” costs and benefits  Negative externalities (external costs) result in a lower production cost being borne by the producer and being passed onto consumers  Creates an overallocation of resources—producers produce too much  Positive externalities (external benefits) result in more satisfaction being received by consumers than producers can charge for  Results in underallocation of resources—producers produce too little

 Market processes can internalize all costs and benefits, provided ◦ A. Property rights are well understood, enforced, and mutually agreed on, ◦ B. The number of independent negotiating agents is small, and ◦ C. Transaction costs, including costs of bargaining, are small enough to be negligible.  Too many participants or too high transaction costs make a private solution unworkable.

 Only producers know their marginal costs, and only consumers know their own marginal benefits  Used car dealers know whether the car is a lemon  Buyers find out later  Results in a market solution that all used cars are worth significantly less than new cars

 Lojack and other car antitheft devices lower car theft, even of cars without them  Local crackdowns on chopshops reduce theft  Crackdowns on traffickers in stolen car audio equipment yield even better benefits