2. The Market Economy Process of voluntary exchange Specialization
Gains from trade

3. Economic Efficiency and the Competitive Market
Demand Curve – value of output produced
Supply Curve – opportunity cost of producing output
Intersection of supply and demand curves determine level of output maximizing value of economy’s resources

4. Economic Efficiency and the Competitive Market

5. Role of Government Private Sector – voluntary exchanges
Public Sector – government activity
typically financed by mandatory taxes
monopoly on legitimate coercion and force

6. Why is the Public Sector Necessary?
Failure of market system
Government may be more efficient than market
Equity

7. Market System and Individual Rights
Right to freedom of exchange
Rights protected by:
police
national defense
court system
Protection of rights creates incentives to produce goods

8. Government as Protector of Rights
Primary function of government is protection of individual rights
Proper level of protection is debatable
Many rights can be protected through private provision

9. The Government as Violator of Rights
Any government powerful enough to protect rights is strong enough to violate rights
Public sector institutions should be designed so as to act in public interest

10. The Public Interest What does it mean to act in the public interest?
Greatest good for the greatest number
Utilitarianism – public interest measured by total utility of society
Contemporary Utilitarianism – weigh benefits and costs

11. Pareto Criteria
Pareto superiority – change makes at least one person better off; no one worse off
compares two possible situations
Pareto optimality – no one can be made better off without making one person worse off
applied to a single situation

12. The Pareto Criteria

13. The Pareto Criteria Market Exchange and Pareto Criteria
Satisfies utilitarian criterion
Satisfies Pareto superiority (in absence of negative externalities)
Political Exchange and Pareto Criteria
Political process – if all agree to a change, change is Pareto superior

14. Limitations of Pareto Criteria
Not possible to adhere strictly to Pareto criteria
Lends legitimacy to status quo
Does not rank all possible states of the world

15. Other Measures of the Public Interest
Potential compensation – gainers value gains more than losers value losses
Cost-benefit analysis – dollar value placed on costs/benefits of a project
Social welfare function – indifference curves depicting welfare of entire society

16. Other Measures of the Public Interest

17. Positive and Normative Economics
Positive economics – what is
conclusions will be either right or wrong
Normative economics – what should be
involves value judgments

18. Normative Analysis and Public Interest
Positive analysis evaluates effects of policy
Pareto criteria useful to evaluate public interest
Public sector involves normative analysis

19. Goals of Public Policy
Reallocate resources efficiently – positive analysis
Equity – normative analysis