1. 1 Chapter 5 Difficult Cases for the Market and the Role of Government

2. 2 Overview Economic efficiency Economic efficiency The role of government within the market The role of government within the market The four types of market failure The four types of market failure

3. 3 Economic Efficiency To be economically efficient: 1. All actions generating more benefits then costs should be undertaken 2. No actions generating more costs then benefits should be undertaken

4. 4 Economic Efficiency

5. 5 Role for Government The government should… 1. Protect individuals and their property rights 2. Provide goods that cannot be easily provided by the market (overcome market failure)

6. 6 The Role of Government

7. 7 Market Failure 1. Lack of Competition 2. Externalities 3. Public goods 4. Lack of information

8. 8 1. Lack of Competition With no competition, a firm can hold back production and raise price

9. 9 1. Lack of Competition Role for Government? 1. Refrain from activities that reduce competition: licenses, price controls, etc. 2. Antitrust legislation: Sherman Antitrust Act (1890) Sherman Antitrust Act (1890) Clayton Act (1914) Clayton Act (1914)

10. 10 2. Externalities Externalities: The effects of an activity that influence the well-being of non- consenting third parties

11. 11 2. Externalities Negative externality: Producer gains the benefit, everybody bears the cost ex. pollution, loud music ex. pollution, loud music Producer will produce more than society wants (too much). Producer will produce more than society wants (too much). Role for government: tax or regulate negative externalities Role for government: tax or regulate negative externalities

12. 12 2. Externalities Positive externality: producer bears the cost, everybody gains the benefit. ex. education, vaccinations ex. education, vaccinations Producer will produce less than society wants (too little) Producer will produce less than society wants (too little) Role for government: subsidizes positive externalities Role for government: subsidizes positive externalities

13. 13 3. Public Goods Public goods have two characteristics: 1. Non-rival in consumption: making the good available to one consumer does not reduce its availability to others. 2. Non-excludable: it is impossible (or incredibly costly) to exclude nonpaying customers from receiving the good.

14. 14 3. Public Goods Free-rider: A person who receives the benefit of a good without paying for it This will cause the good to become under- supplied

15. 15 3. Public Good Role for the Government? The government forces people to pay through taxes. The government forces people to pay through taxes. Private market can provide a public good by tying it to a private good: radio broadcasts and advertising. Private market can provide a public good by tying it to a private good: radio broadcasts and advertising.

16. 16 4. Lack of Information When purchasing a good, consumers may not have the information necessary to make an informed choice. Role for government? Help provide information through regulations Help provide information through regulations However, the market may be able to provide information as well However, the market may be able to provide information as well

17. 17 Review 1. What do we mean by economic efficiency 2. What are the two roles that the government should play in the market 3. Know the 4 types of market failure 4. Understand the concept of externalities 5. Understand the characteristics of public goods