Do Now: 1. Draw a monopoly making a profit. Label price, output, and profit. (Include D, MR, ATC, and MC) 2. Identify three specific reasons why monopolies.

Do Now: 1. Draw a monopoly making a profit. Label price, output, and profit. (Include D, MR, ATC, and MC) 2. Identify three specific reasons why monopolies are bad. 3. On your graph, identify the fair-return price. (P=ATC)

Market Failures and the Role of the Government
Unit 6: Market Failures and the Role of the Government

What is the Free Market? (Capitalism)

5 Characteristics of Free Markets
Little government involvement in the economy. (Laissez Faire = Let it be) Individuals OWN resources and determine what to produce, how to produce, and who gets it. The opportunity to make PROFIT gives people INCENTIVE to produce quality items efficiently. Wide variety of goods available to consumers. Competition and Self-Interest work together to regulate the economy. (Invisible hand) The government’s job is to enforce contracts, secure property rights, and defend the country.

Does the Free Market ever FAIL to meet society’s needs?

The government must step in to satisfy society’s wants.
What is a Market Failure? Market Failure- A situation in which the free-market system fails to satisfy society’s wants. (When the invisible hand doesn’t work.) Private markets do not efficiently bring about the allocation of resources. What’s the result… The government must step in to satisfy society’s wants.

The Four Market Failures
We will focus on four different market failures: Public Goods 2. Externalities (third person side effects) 3. Monopolies 4. Unfair distribution of income In each of the above situations, the government steps in to allocate resources efficiently.

Market Failure #1: PUBLIC GOODS

Would there be enough to meet our needs?
Public Goods If there was no government, how would schools, parks, and freeways be different? Would there be enough to meet our needs? Public Sector- The part of the economy that is primarily controlled by the government Private Sector- The part of the economy that is run by private individuals and companies that seek profit.

Free Riders are individuals that benefit without paying.
Public Goods Why are public goods a market failure? It is impractical for the free-market to provide these goods because there is little opportunity to earn profit. This is due to the Free-Rider Problem Free Riders are individuals that benefit without paying.

What’s wrong with this picture?
11

The Free Rider Problem Examples: People who download music illegally
People who watch a street performer and don’t pay Teenagers that live at home and don’t have a job

Does anyone free ride off you?
Canadian Military Spending: $21.8 Billion US Military Spending: $660 Billion Why doesn’t Canada spend more on their military? 13

What’s wrong with Free Riders?
Free-Riders keep firms from making profits. If left to the free market, essential services would be under produced. To solve the problem, the government can: 1. Find new ways to punish free-riders. 2. Use tax dollars to provide the service to everyone.

EVERYONE pays a mandatory tax and all receive the same benefits.
The Final Exam I am willing to give a 100% on the IA this Thursday to whichever class gives me $100. Everyone in the class will get 100% even if they don’t pay. Who is willing to pay? What about those that refuse to pay? Solution? EVERYONE pays a mandatory tax and all receive the same benefits.

Definition of Public Goods

Definition of Public Goods
Public goods have two criteria: 1. Nonexclusion Cannot exclude people from enjoying the benefits (even if they don’t pay). Ex: National Defense 2. Nonrivalry (shared consumption) One person’s consumption of a good does not reduce the usefulness to others. Ex: City Park

Identify which of the following are TRUE public goods
(have non-exclusion and non-rival consumption): 1. Hamburgers 2. Satellite TV 3. Free Public Education 4. Homes 5. Street lights 6. Highways 3 and 5

2008 Audit Exam 76% 15. E

Review List the characteristics of the Free Market.
Define Market Failure. What is the “invisible hand”? List the 4 Market Failures. Why must the government provide public goods? Define Free Rider. What is wrong with having free riders? List 10 movies that start with the letter “A”.

PUBLIC GOODS Why doesn’t the free market provide them?
Market Failure #1 PUBLIC GOODS Why doesn’t the free market provide them? There is little opportunity to earn profit. Why NOT? Individuals benefit without paying.

Can the government… Provide delicious food in the cafeteria?
Ensure that no one ever speeds on the freeway? Create a research station on Mars? Stop pollution from fossil fuels? Completely stop illegal immigration? Make sure everyone in the US has a job? YES! But the costs outweigh the benefits. How does the government decide how many public goods to provide?

They use Supply and Demand
How does the government determine what quantity of public goods to produce? They use Supply and Demand *Demand for Public Goods- The Marginal Social Benefit of the good is its usefulness to society and is determined by citizens’ willingness to pay. *Supply of Public Goods- The Marginal Social Cost of providing each additional quantity. Produce where MSB = MSC

Demand for a New Park Marginal willingness to pay higher taxes Assume:
There are only two people in society. Each additional park costs $5 How many parks should be made? Assume: There are only two people in society. Each additional park costs $5 How many parks should be made?

Demand for a New Park Marginal willingness to pay higher taxes
# of Parks Total Taxes for Adam Marginal Willingness to Pay Higher Taxes Total Taxes for Jill Society’s Demand (MSB) Marginal Social Cost (MSC) 1 $4 $5 2 $7 $9 3 $12 4 $10 $14 5 $15 Assume: There are only two people in society. Each additional park costs $5 How many parks should be made?

Demand for a New Park Marginal willingness to pay higher taxes - 1 $4
# of Parks Total Taxes for Adam Marginal Willingness to Pay Higher Taxes Total Taxes for Jill Society’s Demand (MSB) Marginal Social Cost (MSC) - - 1 $4 4 $5 2 $7 3 $9 3 2 $12 4 $10 1 $14 5 0 $15 Assume: There are only two people in society. Each additional park costs $5 How many parks should be made?

# of Parks Total Taxes for Adam Marginal Willingness to Pay Higher Taxes Total Taxes for Jill Society’s Demand (MSB) Marginal Social Cost (MSC) - - 1 $4 4 $5 5 2 $7 3 $9 3 2 $12 4 $10 1 $14 5 0 $15 Assume: There are only two people in society. Each additional park costs $5 How many parks should be made?

# of Parks Total Taxes for Adam Marginal Willingness to Pay Higher Taxes Total Taxes for Jill Society’s Demand (MSB) Marginal Social Cost (MSC) - - 1 $4 4 $5 5 9 2 $7 3 $9 7 3 2 $12 4 $10 1 $14 5 0 $15 Assume: There are only two people in society. Each additional park costs $5 How many parks should be made?

Supply and Demand for Public Parks
Price $ 9 7 5 3 1 The Demand is equal to the marginal benefit to society D=MSB Quantity of Parks

MSB = MSC Supply and Demand for Public Parks $ 9 7 5 3 1 0 1 2 3 4 5
What if the government made 1 park? What if the government made 4 parks? Price $ 9 7 5 3 1 MSB = MSC S=MSC The supply is the public good’s marginal cost to society D=MSB Quantity of Parks

Market Failure #2 Monopolies

What are Antitrust laws? Why are monopolies a Market Failure?
Antitrust Laws- Laws designed to prevent monopolies and promote competition. After the Civil War, advances in technology and transportation lead to national markets. Eventually only a few firms began to dominate industries: Railroads, Steel, meatpacking, coal, etc. Sherman Act of “Every person who shall monopolize …or conspire to monopolize…shall be deemed guilty of a felony.” Why are monopolies a Market Failure? Monopolies destroy the key ingredient of the free market system- Competition. To fix this MARKET FAILURE the government must get involved.

Practice Suppose Austin and ally are the only soccer enthusiast s in a village where any number of public soccer clinics could be put on by visiting experts for $80 each. There are no external costs involved. Austin’s marginal private benefit for soccer clinics is horizontal at $60. ally’s is a straight line starting at $100 on the vertical axis and ending at 10 clinics on the vertical axis. Draw a correctly labeled graph for soccer clinics showing the marginal social cost, the marginal social benefit,. Label the quantity of clinics that Austin would purchase if he were the only resident as Qaustin, label the quantity of clinics that ally would purchase if she were the only resident as Qally. Label the optimal quantity of clinics for society as Qoptimal.

Exit ticket

Regulating Monopolies

Why Regulate? How do they regulate?
Why would the government regulate an monopoly? To keep prices low To make monopolies efficient How do they regulate? Use Price controls: Price Ceilings Why don’t taxes work? Taxes limit supply and that’s the problem

Where should the government place the price ceiling?
1.Socially Optimal Price P = MC (Allocative Efficiency) OR 2. Fair-Return Price (Break–Even) P = ATC (Normal Profit)

Long Run AVERAGE Total Cost
Costs Economies of Scale Constant Returns to Scale Diseconomies of Scale Long Run Average Cost Curve , , ,000,0000 Quantity Cars 40

Natural Monopoly One firm can produce the socially optimal quantity at the lowest cost due to economies scale. P It is better to have only one firm because ATC is falling at socially optimal quantity MC ATC MR D Q Qsocially optimal 41

Natural Monopoly Unregulated Fair Return Socially Optimal P MC ATC MR
PFR ATC PSO MR D Q QM QFR Qsocially optimal 42

Regulating a Natural Monopoly
What happens if the government sets a price ceiling to get the socially optimal quantity? P The firm would make a loss and would require a subsidy MC ATC Pso MR D Q Qsocially optimal 43

Market Failure #2: EXTERNALITIES

Draw a perfectly competitive industry that has binding price ceiling
. Label the following: -Qd, Qs, Pceiling, P, Q, Pe,Qe -Shade in the deadweight loss -Consumer and producer surplus 2. Draw a perfectly competitive industry that has Binding price floor . Label the following: -Qd, Qs, Pfloor, P, Q, Pe,Qe

Negative Externalities
Smog Traffic

What are Externalities? Why are Externalities Market Failures?
An externality is a third-person side effect. There are EXTERNAL benefits or external costs to someone other than the original decision maker. Why are Externalities Market Failures? The free market fails to include external costs or external benefits. With no government involvement there would be too much of some goods and too little of others. Example: Smoking Cigarettes. The free market assumes that the cost of smoking is fully paid by people who smoke. The government recognizes external costs and makes policies to limit smoking.

Negative Externalities
(aka: Spillover Costs) Situation that results in a COST for a different person other than the original decision maker. The costs “spillover” to other people or society. Smog Traffic 48

Whistle Tips Smog Traffic I won’t. But that’s what they want. My business is to sell pipes so I have to sell whatever they want. So whatever people want, I will sell it.”- Marcello Carbrera 49

The marginal private cost doesn’t include the costs to society.
Market for Cigarettes The marginal private cost doesn’t include the costs to society. P Supply = Marginal Private Cost D=MSB Q QFree Market

What will the MC/Supply look like when EXTERNAL cost are factor in?
Market for Cigarettes What will the MC/Supply look like when EXTERNAL cost are factor in? Marginal Social Cost P Supply = Marginal Private Cost D=MSB Q QOptimal QFree Market 51

If the market produces QFM why is it a market failure?
Market for Cigarettes If the market produces QFM why is it a market failure? P MSC S=MPC At QFM the MSC is greater than the MSB. Too much is being produced so there is deadweight loss Overallocation D=MSB Q QOptimal QFree Market 52

Market for Cigarettes What should the government do to fix a negative externality? P MSC S=MPC Solution: Tax the amount of the externality (Per Unit Tax) D=MSB Q QOptimal QFree Market 53

Market for Cigarettes What should the government do to fix a negative externality? P MSC = MPC MSB = MSC S=MPC Solution: Per-unit tax the amount of the externality (No Deadweight loss) D=MSB Q QOptimal QFree Market 54

2012 Question 14 D 55

Positive Externalities

Positive Externalities
(aka: Spillover Benefits) Situations that result in a BENEFIT for someone other than the original decision maker. The benefits “spillover” to other people or society. (EX: Flu Vaccines, Education, Home Renovation) Example: A mom decides to get a flu vaccine for her child Mom only looks at the INTERNAL benefits. She ignores the social benefits of a healthier society. So, her private marginal benefit is her demand When you factor in EXTERNAL benefits the marginal benefit and demand would be greater. The government recognizes this and subsidizes flu shots.

D=Marginal Private Benefit
Market for Flu Shots The marginal private benefit doesn’t include the additional benefits to society. P S = MSC D=Marginal Private Benefit Q QFree Market 58

Market for Flu Shots What will the MB/D look like when EXTERNAL benefits are factor in? P S = MSC Marginal Social Benefit D=Marginal Private Benefit Q QFM QOptimal 59

Market for Flu Shots If the market produces QFM why is it a market failure? P S = MSC Marginal Social Benefit D=MSB Q QFM QOptimal 60

Market for Flu Shots At QFM the MSC is less than the MSB.
Too little is being produced P S = MSC Marginal Social Benefit Underallocation Q QFM QOptimal 61

Market for Flu Shots What should the government do to fix a negative externality? P Subsidize the amount of the externality (Per Unit Subsidy) S = MSC MSB =MPB D=MPB Q QFM QOptimal 62

2008 Audit Exam 30. B

2010 Practice FRQ 65

2010 Practice FRQ

Market Failures and the Role of the Government
Unit 6: Market Failures and the Role of the Government 69

Market Failure #4 Unfair Distribution of Wealth and Income
Net Worth over $2.3 billion

Distribution of Wealth in the US

(Based on 2003 Information)
Income Inequality In 2003, the average American family made $66,863. Everyone is obviously rich. What’s wrong with using the average? Averages reveal absolutely nothing about how income is distributed. How does the government measure distribution of income? (Based on 2003 Information)

Gap Between Rich and Super Rich

THE LORENZ CURVE

Measuring Income Distribution
Review the process: The government divides all income earning families into five equal groups (quintiles) from poorest to richest. Each groups represents 20% of the population. If there was perfect equality then 20% of the families should earn 20% of the income, 40% should earn 40% (and so on). The government compares how far the actual distribution is from perfect distribution then attempts to redistribute money fairly.

Measuring Income Distribution
Summary: Group #1 (Poorest 20%) Total of $5 (5% of total income) Group #2 Total of $10 (10% of total income) Group #3 Total of $15 (15% of total income) Group #4 Total of $25 (25% of total income) Group #5 (Richest 20%) Total of $45 (45% of total income)

The Lorenz Curve Perfect Equality Percent of Income
100 80 60 40 20 Perfect Equality Percent of Income Percent of Families

The Lorenz Curve Lorenz Curve (actual distribution) Perfect Equality
100 80 60 55 40 30 20 15 5 Lorenz Curve (actual distribution) Perfect Equality Percent of Income Percent of Families

The size of the banana shows
The Lorenz Curve 100 80 60 55 40 30 20 15 5 Lorenz Curve (actual distribution) Perfect Equality Percent of Income The size of the banana shows the degree of income inequality. Percent of Families 79

(the size of the banana)
The Lorenz Curve Lorenz Curve (actual distribution) Gini Coefficient- Statistical measurement of income distribution. Area A divided by the sum of areas A and B (the size of the banana) Perfect Equality Percent of Income Area A Area B Percent of Families 80

The Lorenz Curve Government transfer payments shift the Lorenz Curve toward more equality Is that good or bad? Perfect Equality Percent of Income Percent of Families 81

Where does the government get the money for welfare?
Welfare provides a safety net for citizens (retirement, unemployment, workers comp, health, etc.) BUT, what are some possible downsides? Where does the government get the money for welfare?

Types of Taxes

Why does the government tax?
What are Taxes? Taxes – mandatory payments made to the government to cover costs of governing. Why does the government tax? Two purposes: Finance government operations. Public goods-highways, defense, employee wages Fund Programs- welfare, social security 2. Influence economic behavior of firms and individuals. Ex: Excise taxes on tobacco raises tax revenue and discourages the use of cigarettes.

Three Types of Taxes 1. Progressive Taxes -takes a larger percent of income from high income groups (takes more from rich people). Ex: Current Federal Income Tax system 2. Proportional Taxes (flat rate) –takes the same percent of income from all income groups. Ex: 20% flat income tax on all income groups 3. Regressive Taxes –takes a larger percentage from low income groups (takes more from poor people). Ex: Sales tax; any consumption tax.

What kind of taxes are these? (THINK % of Income)
Three Types of Taxes What kind of taxes are these? (THINK % of Income) Toll road tax ($1 per day) State income tax where richer citizens pay higher % $.45 tax on cigarettes Medicare tax of 1% of every dollar earned 8.25% California sales tax Regressive Progressive Proportional

Federal Income Tax Debate
Equal Tax of $350 per week (Regressive Tax) Income Amount of Tax % Amount to live on $200 $ % -$150)[crime?] $350 $ % $0 $500 $ % $150 $1,000 $ % $650 $5,000 $ % $4,650 Tax tax of 20% per week (Proportional Tax) Income Amount of Tax Amount to live on $200 $40 $160 $350 $70 $280 $500 $100 $400 $1,000 $200 $800 $5,000 $1,000 $4,000

Federal Income Tax Debate This is our current system. Is it fair?
The Progressive tax system is the most effective way to fight this market failure

Review Define Market Failure.
Identify the four market failures we have learned in this unit. Explain why are public goods a market failure. Explain why are externalities a market failure. Explain why are monopolies a market failure. By yourself, draw a positive externality. By yourself, draw a negative externality. Use graph to explain the remedy for positive externalities. Use graph to explain the remedy for negative externalities. Name 10 different super heroes.

GREAT NEWS… YOU ARE DONE WITH MICRO!!!!

Do Now: 1. Draw a monopoly making a profit. Label price, output, and profit. (Include D, MR, ATC, and MC) 2. Identify three specific reasons why monopolies.

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Do Now: 1. Draw a monopoly making a profit. Label price, output, and profit. (Include D, MR, ATC, and MC) 2. Identify three specific reasons why monopolies.

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Presentation on theme: "Do Now: 1. Draw a monopoly making a profit. Label price, output, and profit. (Include D, MR, ATC, and MC) 2. Identify three specific reasons why monopolies."— Presentation transcript:

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