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. Example of efficient decision:
Watch video: Sandlot-marginal benefit of kissing lifeguard (optional, just for fun)

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

6. Graph: Watch content video: Efficiency
Watch Video: Along Came Polly-efficiency

7. Q5.1 When economists say that an activity meets the criterion for economic efficiency, they mean
a majority of citizens favor the activity.
the benefits that result from the activity exceed the costs.
the number of people who gain from the activity exceeds the number on whom costs are imposed.
the costs that result from the activity exceed the benefits.

8. 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

9. Watch video of violating efficiency (viewer discretion advised): Sandlot-big chew on Yoyo (optional, just for fun)

10. Potential Shortcomings of the Market

11. 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

12. (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

13. A tradition at the University of Michigan and a few Ivy League schools is the annual “Naked Mile,” in which students run through campus naked to welcome the arrival of spring. At Michigan (where “spring” arrives late in April), participation in the Naked Mile has decreased sharply over the last few years. This is partly because the university has tried to discourage potential participants with warnings and also by arrests of some participants for indecent exposure. The real problem for the low turnout, however, is that the Naked Mile is a public good. Everyone can enjoy watching it without bearing the cost of participating- consumption is nonrival and the good is nonexcludable. It is not surprising that the event creates a serious free-rider problem.
Q: What could the organizers of the Naked Mile do to encourage more people to participate?

14. (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)

15. 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

16. One of the teaching assistants pointed out a neat free-rider problem
One of the teaching assistants pointed out a neat free-rider problem. A friend of hers was getting married. That was one of a number of weddings that took place in the church over a weekend. There was no time to put in new flowers before each wedding, so the brides were asked to chip in for the flowers. Several brides said no; those who said yes paid for the flowers (presumably the private benefit to each was large enough to exceed the flowers’ cost), and the flowers were installed. The other brides paid nothing but had the free-rider benefit of the flowers.
Q: What could the individual brides have done to get the others to pay a “fair share” of the costs of the flowers? Is there any way the free-rider brides could have been compelled to pay?

17. Q5.2 Which of the following is true?
Consumption of a public good by one individual reduces the availability of the good for others.
It is extremely difficult to limit the benefits of a public good to only the people who pay for it.
Public goods are free to a society when they are produced by the government.
From an efficiency standpoint, a market economy will generally supply too much of a public good.

18. Q5.3 A competitive market economy is unlikely to provide an efficient quantity of some public goods because
only the government has the vast resources necessary to produce public goods.
the nature of public goods makes it difficult for producers to withhold them from nonpaying consumers.
the technology involved in the production of public goods makes it difficult for private firms to produce them even though, once produced, they could be marketed efficiently.
private production of public goods generally results in a large amount of profit, which is difficult for a firm to effectively pay out to shareholders.

19. (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

20. Watch video of Negative Externality: Jonah-negative externality

21. 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

22. Watch video example of negative externality: Car whistle news report-externalities

23. Graph of external cost:
See handouts “externality graphs.pdf” and “externality comments.pdf”

24. Q5.4 Suppose the actions of the producers of a good impose an external cost which results in the actual market price of $25 and market output of 1,000 units. How does this outcome compare to the efficient, ideal equilibrium?
The efficient price would be higher than $25 while the efficient output would be less than 1,000 units.
The efficient price would be higher than $25 while the efficient output would be greater than 1,000 units.
The efficient price would be lower than $25 while the efficient output would be less than 1,000 units.
The efficient price would be lower than $25 while the efficient output would be greater than 1,000 units.

25. A recent news story showed how complex the interactions that involve externalities can be. The overfishing of Pollock in Alaskan waters has, so scientists claim, reduced the population of seals, which eat Pollock. With fewer seals, orca whales have lost their favorite prey and have had to move closer to shore to prey on sea otters. The sea otter population is down, allowing their prey- sea urchins- to multiply rapidly and chew up the underwater kelp forests near the shore. Since the kelp forests aren’t there, the shorelines are more exposed to waves that generate beach erosion and have caused an increasing loss of shoreline housing. This six-step externality is the most complex I’ve heard of. It illustrates how something seemingly harmless- overfishing just one species- can generate serious negative effects in an area that to a layperson would seem very far removed from the action that originally produced the externality.
Q: List one remedy that the government could introduce to reduce the problem of beach erosion presented in this story. Are there any potential secondary effects of your solution?

26. Graph of external benefit:
See handouts “externality graphs.pdf” and “externality comments.pdf”

27. One of my colleagues just returned from vacation in the Florida Keys
One of my colleagues just returned from vacation in the Florida Keys. He was all excited that, at age forty-eight, he had gone scuba diving for the first time. He remarked that, unfortunately, the water was quite rough and made him somewhat seasick. He felt worse and worse, had to return to the boat, and eventually was so ill that he “fed his lunch to the fishes.” He noted, however, that he had at least created a positive externality: His activity attracted a large number of exotic fish, allowing other divers standing on the boat much better viewing than they otherwise would have had.
Q: If you were a tour-boat operator and read this what might you do to make the fish-viewing trip better for all of the people taking the trip?

28. Q5.5 Suppose the actions of the producers of a good generate an external benefit which results in the actual market price of $15 and market output of 614 units. How does this outcome compare to the efficient, ideal equilibrium?
The efficient price would higher than $15 while the efficient output would be less than 614 units.
The efficient price would be higher than $15 while the efficient output would be greater than 614 units.
The efficient price would be lower than $15 while the efficient output would be less than 614 units.
The efficient price would be lower than $15 while the efficient output would be greater than 614 units.

29. Q5.6 When the consumption of a good generates an external benefit,
the private benefit consumers receive from the good will be higher than the true social benefit.
too much of the good will tend to be produced from the viewpoint of economic efficiency.
the community generally suffers an exactly offsetting external cost from the production of the good.
the market demand curve will understate the total benefits derived from consumption of the good, and as a result, too little of it will be produced and consumed.

30. 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

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

32. Question Answers:
5.1 = 2
5.2 = 2
5.3 = 2
5.4 = 1
5.5 = 2
5.6 = 4