Market Failure and Government

The Role of Government and Market Failure

Public v. Private Goods Excludability- Can producer keep benefits from those who do not pay? – Excludable – Non-Excludable Rivalry- Does use by one reduce usefulness to others? – Rival – Nonrival

Agenda Free Rider Problem Externality Basics and Practice Coase Theorem

Public v. Private Goods Pure Private – Excludable and Rival – Example: Chia Pets Pure Public – Nonexcludable and Nonrival – Example: National Defense – Government generally must provide – Free Rider Problem Solutions: taxes versus donations

Public v. Private Goods Toll Goods – Excludable and nonrival – Example: Cable TV, Toll Road (often natural monopolies) Common-pool Resources – Nonexcludable and rival – Example: fish in the public waters, congested roads – Government often regulates Quotas, licensing fees

Free Rider Problem People get benefit from good/service without paying for it. Market will underprovide Solutions – Government provides and taxes – Market provides and seeks donations

True or False (according to economists) The government should mandate that all cars produce zero emissions by 2020.

True or False (according to economists) The government should mandate that cars meet efficiency standards such that the marginal social cost of reducing emissions is equal to the marginal social benefit.

Externalities Consequences of production or consumption that affect an *uninvolved third party* *Someone other than the producers and consumers The Rule – MSC=MSB

Tax Incidence

Nominal (Statutory) versus Economic Incidence If “law” doesn’t matter, what does?

Agenda -I was a free rider today! -Externality -Review -Finding DWL -Tax Notes -Externality Free Responses

“The only thing we have to fear is fear itself” “It depends on what the meaning of the word is is” “Ask not what your country can do for you- ask what you can do for your country” “Half of anything is never as good as all of everything” “Read my lips- no new taxes” “Speak softly and carry a big stick”

Free Rider

Free Rider Solutions Government provides public goods using tax dollars Public shaming?

Externalities- simplified Negative – MPC < MSC – P is too low and Q is too high – Over allocation of resources – Per unit tax equal to MEC Positive – MPB<MSB – P is too low and Q is too low – Under allocation of resources – Per unit subsidy equal to MEB

Coase Theorum "if trade in an externality is possible and there are no transaction costs, bargaining will lead to an efficient outcome regardless of the initial allocation of property rights”

Agenda FRQ Tax Philosophies Wealth and Income Inequality Other Market Failures Set Up- On My Back Review

Types of Taxes *Based on % of income Progressive Proportional/Flat Regressive

Examples of Taxes *Based on % of income Progressive- Federal Income Tax Proportional/Flat- State Income Tax Regressive- Sales Tax

Income Tax Progressive Tax (Federal)

Income Tax Progressive Tax (Federal)

Income Tax Proportional Tax/Flat Tax PA = 3.07%

Sales Tax- Regressive or Proportional? 6%

Sales and Excise Taxes are Regressive

Paying for Public Goods- Tax Philosophies Benefits Received Principle – Closer to free market solution – Example- Gas tax to fund highways Ability to Pay Principle – Example- Progressive Income Tax - School Property Tax?

Income/Wealth Inequality Measures of the Distribution of Wealth/Income – Graphical: Lorenz Curve – Numeric: Gini Coefficient

Lorenz Curve Lorenz Curve (wealth OR income) Line of Equality

Lorenz Curve Line of Equality

Lorenz Curve Line of Equality

Gini Coefficient

Measuring Inequality Lorenz Curve – Farther from 45 = greater inequality Gini Coefficient – 0 = complete equality – 1 = complete inequality – A/A+B

Redistribution of Wealth Reduction of Inequality – Transfers WIC TANF SNAP Unemployment Comp Obamacare – Control Market Prices Minimum wage Rent control – Progressive Taxes Income Tax – largest federal revenue source

Asymmetric Information Adverse Selection -Before Transaction Examples -Used Cars -Health Insurance -Loans -Infomercials *I was watching QVC Moral Hazard -After Transaction Examples -Health Insurance -Car Insurance -Loans -Helmet Requirements

Government Failure Government Failure- government intervention decreases efficiency, leads to poor allocation of resources, and diminishes economic welfare. Public Choice Theory – economic self-interest motivates in the public sector as it does in the private sector – people vote for the candidate who promises the greatest economic gain for them Rent Seeking- $$ spent on lobbying for economic gain Lack of Profit Motive

Economic Rent- in other words Payment for/to any factor above the payment required by its owner

Quiz- Factor Market Stuff Cost-Min. and Profit Max. Combo of Resources Minimum Wage and Monopsony Economic Rent and Land Human Capital

Wage Determinant Productivity *American worker overseeing mechanized assembly line *Foreign worker hand painting a decoration

Wage Differential Skills/Knowledge – Limits supply MRP Risk Access More inelastic supply = More economic rent

Human Capital Investment to improve skills and productivity of labor Self or Firm High wage jobs OFTEN include large human capital investments *Profession/Unions often push for high human capital requirements.