1. Difficult Cases for the Market, and the Role of Government
Micro Chapter 5
Difficult Cases for the Market, and the Role of Government

2. 3 Learning Goals Explore the details of efficiency
Identify factors that reduce the efficiency of markets
Explain how those factors reduce efficiency

3. A Closer Look at Economic Efficiency

4. What does efficiency mean?
The largest net benefit is achieved
Rule: Engage in an activity so long as the expected marginal benefit is greater than the expected marginal cost

5. Graph:

6. Have you ever said to yourself “that’s good enough”?
When cleaning something
When studying for an exam
When completing a task
Perfection is not usually a desirable result

7. Potential Shortcomings of the Market

8. Markets will usually generate an efficient outcome
Markets will usually generate an efficient outcome. Sometimes they may not.
Four reasons why the market may produce an inefficient outcome:
(1) A lack of competition
(2) Poor information
(3) Public goods
(4) Externalities

9. (1) A lack of competition
If there are only a few firms, then supply may be restricted which will lower the quantity available and raise price
(2) Poor (or no) information
Poor information results in poor decision making

10. (3) Existence of public goods
A public good has two distinguishing characteristics:
(1) Many people can consume the good simultaneously; referred to as joint consumption or non-rival
(2) People who don’t pay for the good can still consume it; referred to as non-excludable
Note: public goods are not necessarily provided by the gov’t (i.e. paid with public money)

11. Why does a public good pose a problem?
Because of its characteristics, it will be hard to generate funds to pay for its production
Individuals have a strong incentive to free ride – not pay, wait for someone else to pay, then consume the good
This typically leads to underproduction of public goods; i.e. an inefficient amount being produced

12. (4) Presence of externalities
Not all costs and benefits will be used in decision making (external costs and benefits are typically ignored)
With an external cost, too many units are produced and price is too low
With an external benefit, too few units are produced and price is too low

13. Another way to think of externalities:
Negative externality – a cost imposed on you for an activity you’re not directly involved in and you would like to see less of the activity
Positive externality – a benefit accrued to you for an activity you’re not directly involved in and you would like to see more of the activity

14. Graph of external cost:
See handouts on BB: “externality graphs.pdf” and “externality comments.pdf”

15. Graph of external benefit:
See handouts on BB: “externality graphs.pdf” and “externality comments.pdf”

16. Why do externalities produce inefficient outcomes?
With an external cost, too many units are produced and price is too low
With an external benefit, too few units are produced and price is too low
External costs and benefits are ignored, difficult to measure, or hard to distribute to affected parties

17. What causes externalities?
The primary source is lack of property rights