1. Role of Government and Market Failures

2. Marginal Social Benefit and Marginal Social Cost
Externalities: the costs and benefits of production that are not paid by the producer or the consumer
These are imposed on someone not part of the market exchange of goods and so are ignored by the producers and consumers

3. Externalities can be positive or negative
Externalities are external costs or benefits
Negative externalities are created when a person or firm’s actions impose a cost – an adverse side effect – on others
Positive externalities are benefits for people who are not directly involved with the good that created the benefit

4. Marginal Private Benefit (MPB): benefit that belongs to the producer or consumer of the good
Marginal External Benefit (MEB): is the spillover benefit
Together MPB and MEB make up Marginal Social Benefit (MSB)

5. Marginal Social Cost (MSC) is equal to the sum of the two costs
Marginal Private Cost (MPC) is the cost incurred by the producer or consumer while Marginal External Cost (MEC) is the spillover or externality.
Marginal Social Cost (MSC) is equal to the sum of the two costs
MSC = MPC + MEC
Marginal costs are rising as output rises
(dimishing marginal returns)
Marginal benefits are decreasing
(diminishing marginal utility)

6. S=MPC P Pe
D=MPB Q Qe

7. Positive Externalities
If you add together the MPB and the MEB you will see the demand curve move to the right as an increase

8. Negative Externalities
Supply will be too large if you don’t account for negative externalities
If you take negative externalities into account, you will see the supply curve move to the left as a decrease

9. Remedies Government intervention to fix the market failures
Sometimes the failure can be fixed without government intervention
According to the Coase Theorem there needs to be 3 conditions that would allow people to negotiate to fix market failures without the government’s help
Property rights are clear
The number of people in the negotiating must be small
Bargaining costs are negligible

10. Other remedies Lawsuits Government regulation Taxes Externality rights
Subsidies
Direct Controls
Government provides the goods themselves

11. Public Goods
Public goods are items that anyone can have regardless of their ability to pay for it
Can not be able to exclude people from having the good or service
One person using it can not prevent another person from using it
Government provides public goods because they are considered necessities and there is now way to make enough profit from them

12. Public goods are items that produce positive externalities
Creates the free rider problem – people want the good but do not want to pay for it
Funded with tax money

13. What & How much to provide?
How does a government decide what to provide and how much?
Public surveys
Research
Elections
Supply and Demand tells how much to provide

14. Taxation How do governments decide what, who and how much to tax?
Benefits Received principle: tax individuals according to the amount of benefits they receive, regardless of income
Ability to pay principle: tax individuals according to their income or wealth regardless of what benefit they get from the government.
Higher incomes receive less benefits but pay higher taxes
Low incomes receive more benefits but pay lower taxes

15. Classifications Progressive: tax rates increase as income increases
Regressive: tax rate declines as income increases
Proportional: tax rates stay the same regardless of income changes

16. Public Policies Policies to promote competition Antitrust Policy
Limit monopoly power
Sherman Antitrust Act: made restricting trade illegal (price fixing, separation of markets)
Clayton Act: strengthen gov’t powers to promote competition – outlawing tying contracts, interlocking directorates and price discrimination)
Federal Trade Commission – share power with Justice Department to enforce policies

17. Income Distribution Equity
Incomes differ between people for lots of reasons.
Incomes are generally set by the value of what a resource can produce.
Governments will seek to balance incomes to a certain extent to lower poverty levels.
Minimum wage
Welfare
Social security
These programs are called transfer payments: payments to individuals who do not give a good or service in return

18. Sources of Income Inequality
Productivity – the more productive a resource, the higher the income
Compensating differentials – differences in income due to non-monetary characteristics
Risk of job (difficulty & danger)
Human Capital (skills and abilities of labor) – training and education
Age
Gender
Union affiliation
Special abilities

19. Quintile
Percent of Total Income
Mean Annual Household Income
Lowest
3.6
$10,190
Second
8.9
$25,334
Third
14.9
$42,361
Fourth
23.0
$65,729
Fifth
49.6
$141,620

20. Lorenz Curve Used to measure income inequality
Relationship between cumulative percentage of households and cumulative percentage of income
The more bowed out the curve, the more unequal the distribution of income

21. 100 50.4 27.4 12.5 3.6 40 60 80 100 20 Cumulative % of Personal Income
Cumulative % of Households