1. Topic 8: Market v. State Agenda, Friday 3 rd December 2010 A: Alternative Mechanisms for Allocation of (Society’s) Resources B: Market and Market Failures C: Private Solutions v. Public Solutions D: State Failures E: Market (Failures) v. State (Failures)

2. A: Alternative Mechanisms for Allocation of (Society’s) Resources

3. Alternative Mechanisms u Market (or more realistically Regulated Market), e.g. restaurant meals, mobile phone, … u Command System, e.g. North Korea, within organisations, … u Majority Rule, e.g. voting on alternative tax-and-spend menus, committees, … u Contest, e.g. CAO points, Oscars, mobile telephony licence, beauty contest, …

4. Alternative Mechanisms u First-Come, First-Served, e.g. tickets (Take That, All-Ireland, Rugby v. NZ, … u Sharing (Equally?), e.g. votes, air, water, household waste collection?, health?, education?, … u Lottery, e.g. raffle, Medicine TCD = 575*, selling a house?, … u Personal Characteristics, e.g. beauty contest, finding partner(s), discrimination, … u Force, e.g. theft, “taxation Is theft”?, …

5. B: Market and Market Failures

6. Market: Welfare Theorems u First Fundamental Theorem of Welfare Economics u Second Fundamental Theorem of Welfare Economics

7. First Welfare Theorem (Efficiency) u Perfect Competition u D = SMB (= P) & S = SMC (= PMC = MC) u P = MC (Allocative Efficiency) u Perfect Competition + Market → Pareto Efficiency

8. Market Equilibrium: Consumer Surplus and Producer Surplus Price Equilibrium price 0Quantity Equilibrium quantity A Supply C B Demand D Producer surplus Consumer surplus E

9. Second Welfare Theorem (Equity) u Perfect Competition + Lump-Sum Taxes and Subsidies + Market → Any Specific Pareto Efficiency u Perfect Competition + Lump-Sum Taxes and Subsidies + Market → Pareto Optimality

10. Second Welfare Theorem (Equity) u Existence of Lump Sum Taxes and/or Subsidies? u Lump-Sum → No Distortion (e.g. no distortionary wedges between buying and selling price introduced) u Poll Tax? Window Tax? … (State Pension, Invalidity Pension) u Second Welfare Theorem?

11. First Welfare Theorem (Efficiency) u Perfect Competition? u D = SMB = P? & S = SMC = MC? u P = MC? u Second Best Theorem! u Specific Market Failures: Externalities, Public Goods, Informational Problems, Market Power, Equity? Distribution?

12. Externalities u Non-priced by-products u Negative Production (e.g. pollution) u Positive Production (e.g. orchards and honey-producing bees) u Negative Consumption (e.g. passive smoking) u Positive Consumption (e.g. vaccines such as flu, MMR?)

13. Public Goods u Non-rivalry in consumption u Non-exclusion in consumption u Examples: defence, lighthouse?, … u Pure v. Impure Public Goods u Public Goods ≈ Positive Externalities

14. Informational Problems u Adverse Selection (“hidden information”, e.g. second-hand car market is incomplete) u Moral Hazard (“hidden action”, e.g. insurance markets are incomplete) u Principal Agency (different interests → conflict of interests, e.g. shareholders v. board v. managers v. workers, “life”!)

15. Market Power u Seller: Monopoly, Oligopoly u Buyer: Monopsony (→ buy too little)

16. C: Private Solutions v Public Solutions

17. Private Solutions u Coase Theorem u Property Rights (State = “Night Watchman” role) u Transactions Costs u Negotiations u Efficiency! (Distributional considerations remain)

18. Public Solutions u State Provision u Nationalisation u Command & Control u Regulation (“exercise of control by a public agency over economic and social activities”)

19. Public & Private Solutions u State & Market-Based Solutions (e.g. Tax, Subsidy, Pollution Permits) u State Ownership/Provision facilitated by market mechanisms (e.g. road building, hospital building, … ) u Public-Private Partnerships (PPPs)

20. D: State Failures

21. Role of State: Public Interest/Finance Perspective u Benevolent Social Planner/Dictator Examples u Stabilization Policy u Optimal Taxation

22. Role of State: Private Interest Perspective u Public Choice (Economic Theory of Regulation) u Politicians (& Self Interest) u Bureaucrats (& Self Interest) u Regulators, e.g. regulatory capture u Interest Group Perspective u Force of Ideas Perspective

23. E: Market (& Failures) v. State (& Failures)

24. Examples u Efficiency-Equity Trade-Off Arthur Okun’s Leaky-Bucket? u Equity: Equality of Opportunity v. Equality of Outcome