1. Mixed Economies & Market Failure

2. All economies must answer 3 questions.
What goods & services should be produced?
How should the goods & services be produced?
Who gets the goods & services that are produced?

3. Two extreme types of economies
communism or socialism
capitalism

4. Who owns & controls the physical capital?
In communism & socialism: the government
In capitalism: private parties

5. How are resources allocated?
In communism & socialism: through central planning & government administration.
In capitalism: through contractual agreements between private parties.

6. In the real world, there are no purely communist or socialist economies and no purely capitalist economies.
All economies are mixtures.

7. Some sectors of all economies are privately owned and controlled and some sectors are owned and controlled by the government.
The extent of the mix differs from economy to economy.

8. Mixed Economies capitalistic or market economies
communistic/socialistic or centrally-planned economies
U.S., Canada, Australia, Japan, most of western Europe
Sweden, India, Israel
Russia, China, N. Korea, most of eastern Europe

9. Reasons Markets May Fail to Attain an Ideal Allocation of Resources
Lack of competition
Externalities
Public goods

10. Lack of Competition
Firms may collude to limit output and keep prices high.

11. Externalities Externalities are spillover effects.
Good externalities are external benefits.
Bad externalities are external costs.

12. External Benefits
benefits generated by the action of an individual or group that favorably influences the welfare of non-paying parties
example: gardens

13. External Costs
costs that result from an action of an individual or group that harms the welfare of non-consenting parties.
examples: litterbugs, drunk drivers, polluters

14. Social Benefits
social benefits = private benefits received by the decision-maker + any external benefits.
When there are no external benefits, private and social benefits are equal.

15. Social Costs
social costs = private costs incurred by the decision-maker + any external costs.
When there are no external costs, private and social costs are equal.

16. Example project cost to a firm : $1500
amount of aggravation to neighbors: $500
What is the social cost?
social cost = private cost + external cost = = $2000.

17. project cost to a firm : $1500 project revenues to firm: $1800
Example continued
project cost to a firm : $1500
project revenues to firm: $1800
If the firm ignores the effects on the neighbors, will the firm undertake the project?
Yes, the firm will undertake the project, because
private benefits ($1800) exceed private costs (1500).

18. From the viewpoint of society, however,
the project should not be undertaken.
recall: social cost = $ project revenues to firm = $1800
social benefits = private benefits + external benefits = $ $0 = $1800
Since social costs > social benefits, the project should not be undertaken.

19. Coase Theorem
An acceptable solution to an externality will be found if
ownership of property is clearly defined,
the number of people involved is small,
the costs of bargaining are negligible.

20. In many situations, many people are affected and the costs of bargaining are substantial.
These types of problems are unlikely to be resolved appropriately without government intervention.

21. External Costs Supply - taking externality into consideration price
Supply - ignoring externality P2 P1
Demand
quantity Q2 Q1

22. Effects of External Costs
When an external cost is ignored,
the price is too low, and
the quantity is too high.

23. External Benefits price Supply
Demand-taking externality into consideration P2 P1
Demand - ignoring externality
quantity Q1 Q2

24. Effects of External Benefits
When an external benefit is ignored,
the price is too low, and
the quantity is too low.

25. Public goods also create a problem for a market economy.
To see why, let’s first look at how public goods are different from typical private goods.

26. Typical private goods have the characteristics of rivalry and excludability.
Rivalry: If someone consumes or uses a good, there is one less unit for someone else to consume or use. Excludability: Individuals can easily be prevented from consuming or using a good.

27. Consider a cookie as an example of a typical private good.
If someone eats a cookie, there is one fewer cookie for other people to consume (rivalry). A person cannot consume a cookie if they do not purchase cookies (excludability).

28. Characteristics of Public Goods
Non-rivalry: One person’s consumption of the good does not diminish the amount available for others to consume.
Non-excludability: Once a public good has been provided to one person, there is no easy way to prevent others from consuming it as well.

29. Examples of Public Goods
national defense system
flood prevention by a dam

30. Notice that for both the national defense system and flood prevention by a dam,
one person’s consumption of the good does not diminish the amount available for others to consume (non-rivalry); and
once the good has been provided to one person, there is no easy way to prevent others from consuming it as well (non-excludability).

31. How do you get people to reveal what a good is worth to them and then pay for the good?
In the case of private goods, it’s fairly simple.
Suppose a package of cookies costs $2.
If a person buys the good, it must be worth at least $2 to them. If it is worth less than $2, they don’t buy it.
It’s not so simple for public goods.
You don’t just walk into a store and buy $100 worth of national defense.

32. For public goods, there is an incentive to not reveal your true valuation, since if the good is provided, you are going to get the use of it anyway.
A person who uses a good without paying his/her share is called a free rider and the problem of people doing this is called the free rider problem.
If everyone refuses to reveal their true value of the good and so refused to voluntarily pay what it is worth, the good will not be provided.
This is a situation in which the government is useful. The government tells everybody what to pay and everybody has to do it. Then the government has the money to produce the good.

33. So far, we have discussed two major sectors of the economy.
The first consists of for-profit businesses, and is the largest sector in the U.S. economy.
The second sector is the government.
The third sector consists of nonprofit organizations.

34. The Nonprofit Sector
The term “nonprofit sector” describes institutions and organizations that are neither government nor for-profit businesses.
It is also sometimes called the third sector, the independent sector, the philanthropic sector, or the voluntary sector.
Outside the United States, nonprofits are often called nongovernmental organizations (NGOs).
From BoardSource, formerly the National Center for Nonprofit Boards.

35. What does nonprofit mean?
Nonprofit organizations are not forbidden to generate a profit, but if they make profits, these profits may not be distributed to owners or other private persons.
This nondistribution constraint is imposed on the organizations by the charter under which they are organized under state law.
The Nonprofit Sector: A Research Handbook (1987). Walter W. Powell (ed.) Chapter 5.

36. We have established that while the market system works well, it is far from perfect.
The nonprofit sector represents one of the ways that the U.S. economy attempts to adjust for the imperfections.

37. In a perfect world, no one would be hungry, cold, or homeless.
In the real world, that is not the case.
That brings us to the subject of Poverty & Income Inequality

38. One way of examining income inequality is by looking at the shares of different quintiles of the population.
For example, what percent of all the income in the U.S. is in the hands of the poorest 20% of the population, and what percent is in the hands of the wealthiest 20%?

39. Perfect Equality Income Distribution
Percent of Population
Percent of Income
“Poorest” 20% 20
Second 20%
Third 20%
Fourth 20%
“Richest” 20%

40. Perfect Equality Cumulative Income Distribution
Percent of Population
Percent of Income
Bottom 20% 20
Bottom 40% 40
Bottom 60% 60
Bottom 80% 80
All 100%
100

41. A graph of the cumulative income distribution is called the Lorenz Curve.

42. Graphing Income Distributions
1.00
0.80
0.60
0.40
0.20
Proportion of Income
Proportion of Population

43. Proportion of Population
Perfect Equality Line
1.00
0.80
0.60
0.40
0.20
Perfect Equality Line
Proportion of Income
Proportion of Population

44. In the hypothetical situation of perfect inequality, one person has all the income, and everyone else has nothing.

45. Proportion of Population
Perfect Inequality
1.00
0.80
0.60
0.40
0.20
Proportion of Income
Perfect Inequality
Proportion of Population

46. U.S. Household Income Distribution in 2014
Percent of Population
Percent of Income
Poorest 20%
3.1
Second 20%
8.2
Third 20%
14.3
Fourth 20%
23.2
Richest 20%
51.2
Source:

47. U.S. Cumulative Household Income Distribution in 2014
Percent of Population
Percent of Income
Bottom 20%
3.1
Bottom 40%
11.3
Bottom 60%
25.6
Bottom 80%
48.8
All 100%
100
Source:

48. Lorenz Curve for the U.S. in 2014
1.00
0.80
0.60
0.40
0.20
Proportion of Income
Lorenz Curve
Proportion of Population

49. Proportion of Population
The greater the extent of income inequality, the further the Lorenz Curve sags from the perfect equality line and the larger is area A.
1.00
0.80
0.60
0.40
0.20
Proportion of Income A
Lorenz Curve
Proportion of Population

50. We can capture the extent of inequality using a single number called the Gini Coefficient or Gini Index.

51. The Gini coefficient is the ratio of two areas.
Numerator: area between perfect equality line & Lorenz curve.
Denominator: area of the triangle below the perfect equality line.

52. A B Gini Coefficient = A / (A+B) 1.00 0.80 0.60 0.40
0.20
Proportion of Income A B
Proportion of Population

53. The greater the extent of income inequality (and the further the Lorenz Curve sags from the perfect equality line), the larger is the Gini Coefficient A/(A+B).

54. The Gini Coefficient is a number between 0 & 1.
0 means perfect equality
1 means perfect inequality

55. Percent of Income by Year
How has the U.S. income distribution changed in the past few decades?
Percent of Population
Percent of Income by Year
1970
1990
2014
Poorest 20%
4.1
3.8
3.1
Second 20%
10.8
9.6
8.2
Third 20%
17.4
15.9
14.3
Fourth 20%
24.5
24.0
23.2
Richest 20%
43.3
46.6
51.2
Sources: ;
The share of the wealthiest group has increased, while the shares of all the other groups have decreased.

56. Gini Coefficient in the U.S
These figures reflect an increase in income inequality.

57. Gini Coefficients for Distribution of Family Income
Rank
Country
Gini Coefficient
Date 1
Lesotho
63.2
1995 2
South Africa
63.1
2005 14
Chile
52.1
2009 24
Mexico
48.3
2008 26
China
47.3
2013 41
United States
45.0
2007 50
Russia
42.0
2012 74
Israel
37.6 75
Japan 95
Poland
34.1 96
Spain
34.0
2011 98
Ireland
33.9
2010
106
United Kingdom
32.3
108
Canada
32.1
114
France
30.9
119
Australia
30.3
129
Germany
27.0
2006
130
Finland
26.8
135
Norway
25.0
141
Sweden
23.0
Notice that countries with the most inequitable income distributions have Gini coefficients in the 60’s while those with the most equitable distributions are in the 20’s.
The countries that we tend to consider our peers are generally in the 30’s, which indicates greater equality than the US at 45.0.
From: .

58. Closely related to the concept of income distribution is the notion of poverty.

59. Poverty Thresholds
Poverty thresholds are the dollar amounts used to determine poverty status.
If total family income is less than the threshold appropriate for that family, the family is in poverty.
Each person or family is assigned one out of 48 possible poverty thresholds, which vary according to Size of the family Ages of the members 
The same thresholds are used throughout the U.S.
The thresholds are updated annually for inflation using the Consumer Price Index.
Source:

60. Poverty threshold for a family of four
$3,100
$24,300

61. Poverty Patterns
Poverty rates among Blacks, American Indians, and Hispanics are much higher than among Whites and Asians.
Poverty among the under-18 population is higher than for other age groups.
Poverty rates are lower for married-couple households and higher for female householder families.

62. Area Poverty Rates 2015 (%) U.S. 15.5 Pennsylvania 13.5
Delaware County 10.6
Chester

63. Other Statistics Comparing Chester to the U.S. as a Whole
Unemployment (%)
5.2
10.8
Median family income
$66,011
$32,608
Population over 25 that has not completed h.s. (%)
13.3
20.6
Child poverty rate (%)
21.7
47.4
Median value of owner-occupied housing
$178,600
$67,900
From: factfinder2.census.gov

64. Income vs. Wealth We have talked about income inequality.
Income refers to the flow of money.
When you look at the stock of money that you have accumulated, that is wealth.

65. People who have very little income are unable to save anything
People who have very little income are unable to save anything. So they have no accumulated money, no wealth.
People who have more income are more able to save and invest their money.
So while income in the U.S. is distributed very unequally, wealth is distributed even more unequally.

66. Video: Wealth Inequality in America (about 6 mins)
Based on: Norton, M.I. & Ariely, D. (2011). Building a Better America - One Wealth Quintile at a Time. Perspectives on Psychological Science, 6, 9–12.