Chapter 3 Government Intervention.docx
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Chapter 3 Government Intervention.docx
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Chapter3GovernmentIntervention
Chapter3GovernmentIntervention
MarketFailure
•Definition:
♦‘marketfailureoccurswhenmarketimperfectionsleadstoanallocationofresourcesthatislessefficientthanitmightbe’
♦‘Themarketfailstodelivereconomicefficiency(Productiveorallocative)
♦‘whentheinteractionofsupplyanddemandinamarketdoesnotleadtoproductiveand/orallocativeefficiency
•Marketsfailformanyreasons:
♦Externalities
♦Meritanddemeritgoods
♦Publicgoods
♦Informationfailureorimperfectinformation
♦Adverseselectionormoralhazard
♦Lackofcompetitioninamarket/MonopolyPower
♦Inequality/Unfairdistributionofincomeandwealth
•Whenamarketfailsthegovernmentmaydecidetointervenebutnotalwayssuccessfully!
♦Wewillalsolookatgovernmentfailure!
!
Governmentintervention
•Whenthegovernmentintervenesittakesadecisiononwhethersomethingisharmfulorbeneficialtosociety.
•Thegovernmentmakesavaluejudgement.
•Governmentsgetinvolvedinthemarketwhereifitwaslefttothemarkettherewouldbemarketfailure.
•Thereareanumberofwaysgovernmentsintervene.
•Theywilltryandminimisenegativeexternalitiesandmaximisepositiveexternalities.
Externalities
•Themarketworkswellwhenonlythebuyer/consumerandproducer/supplierareinvolvedinandaffectedbyatransactionoreconomicdecision.
•Ifsomeonewhoisnotapartytotheeconomicdecisionbutisaffectedbythedecisionisaneconomicconceptknownasanexternality
•Canbepositiveornegative
Negativeexternalities
•Howdogovernmentsgetinvolvedtopreventthefollowingnegativeexternalitiesoccurring?
-pollution,
-trafficcongestion,
-environmentaldegradation,
-chewinggum,
-illegaldumpingofwaste?
•Decisionmakersdonottakeintoaccountthecostimposedonsocietyandothersasaresultoftheirdecision
♦e.g.pollution,trafficcongestion,environmentaldegradation,depletionoftheozonelayer,misuseofalcohol,tobacco,anti-socialbehaviour,drugabuse,poorhousing
Postiveexternalities
•Howdogovernmentsgetinvolvedtopromotethefollowingpositiveexternalities:
-educationandtraining,
-publictransport,
-healtheducation,
-inoculations,
-refusecollection?
•Inthiscasetoolittleofsomething(agoodorservice)isbeingproducedbythemarket
•Onlytheprivatebenefitsarebeingconsideredbytheproducersandconsumersandexternalbenefitstosocietyarenotconsideredorpaidforthusnotenoughofthegoodorserviceisproduced
UnderproductionCausedbyapositiveexternality
CostsandBenefits
•Economistsareveryinterestedinexternalitiesbecauseofthevariouscostsandbenefitsthatariseoutoftheactionsofothers
♦Forexamplewhoshouldpaythecosttoclearupotherpeopleschewinggum?
♦Whoshouldpaythehospitalcostsofpeoplesufferingfromcancerdueto‘passivesmoking’
♦Inoculations.Forfluetc.Bypeoplebeinginoculatedpreventsotherpeoplecatchingavirusandhavingtimeoffworkorhavingtopaymedicalfees
♦Whoshouldpayforthese?
♦Howwouldthemoneybecollected?
♦Whowouldpayforaninoculationtostopsomeonetheydidn’tknowfromcatchingflu?
Therearethreetypesofcostsandthreetypesofbenefits
PrivatecostsandPrivatebenefits
•Thesearethecostsandbenefitsexperiencedbythepeoplewhoaredirectlyinvolvedinthedecisiontotakeaparticularaction
•Privatecostsarethecostsincurredbyfirmsorconsumerscarryingouttheaction,eitherasproducersorconsumers
•Theprivatebenefitsaredirectlyreceivedbythosewhoproduceorconsumetheproductoftheaction
ExternalCostsandexternalbenefits
•Thesearetheconsequenceofexternalitiesthatariseoutofaparticularprivateaction
•Theyarenotpaidfornoraretheyaccruedtothoseresponsiblefortheaction
•Thefallon‘thirdparties’
SocialcostsandSocialbenefits
•Thetotalcostsandbenefitsincurredbyoraccruedbysocietyasaresultofaparticularaction
SC=PC+EC
SB=PB+EB
Paternalism
•thepolicyorpracticeonthepartofpeopleinpositionsofauthorityofrestrictingthefreedomandresponsibilitiesofthosesubordinatetotheminthesubordinates'supposedbestinterest:
thearroganceandpaternalismthatunderliescradle-to-graveemploymentcontracts.
Informationfailure
•Asymmetricinformation
–Onesidedinformation
–Eitherthebuyerorsellerhasmoreinformationthantheotherparty
–Oftenthebuyerisnotfullyawareoftheconsequencesoftheirdecision
–Agoodexamplesisillegaldrugconsumption
–Thereislittlethoughtorknowledgeofthelongtermconsequences!
•Externalities
•Meritanddemeritgoods
•MoralHazard
–Seeingadoctor!
–Hemightbewrong!
•Adverseselection
–Buyinginsurance!
–Ionlysmoke5cigarettesaday’!
Publicgoods
•Definition:
Goodsconsumedcollectivelybysociety.Itisusuallyimpossibletochargedirectlyfortheirprovision.Theywouldnotbeprovidedbythemarketatall.Theyarecharacterisedbynon-excludabilityandnon-rivalry.
Publicgoodsandmarketfailure
•Businessesintheprivatesectoroftheeconomymaynotprovidepublicgoodsleadingtomarketfailure.
•Itisimportanttodistinguishbetweenprivateandpublicgoodsandtounderstandwhythefreemarketmaynotofferpublicgoods!
!
!
!
Characteristicsofprivategoods
1)Privategoodsareexcludable
---consumersofprivategoodscanbeexcludedfromconsumingtheproductiftheyarenotwillingorabletopayforit
---Example:
-atheatreticket,asportsevent,amealinahoteletc.
---Ifonedoesnotpay-onedoesnotconsumeandbenefitfromgood/service
•Characteristicsofprivategoods
2)Privategoodsarerival.
---oneperson’sconsumptionreducestheamountleftforotherstoconsume.
---Scarceresourcesareusedupinproducingandsupplyingthegoodorservice
---Thereisanopportunitycostinvolved.
•Characteristicsofprivategoods
3)Privategoodsarerejectable
---Privategoodscanberejected.
---Examples-Digital”payperview”-anexcludableprivategood!
!
Movies,sportingevents,news,internetservices,onlinelibrariesetc
Purepublicgoodscharacteristics
1)Non-excludability
--Thebenefitsofpublicgoodscannotbeconfinedtothosewhohavepaidforit.
--Nonpayerscanenjoythebenefitsofconsumptionatzerofinancialcosttothem
Afireworkdisplay!
Howcanyoustopsomeoneenjoyingit
2)Nonrivalryinconsumption
--Consumptionofapublicgoodbyonepersondoesnotreducethaeavailabilityofgoodtoothers.
--Inotherwords,ifthegoodisprovidedforoneperson,itmustbeprovidedforothers.
Example:
Defense.Thearmydefendseveryone.Bymebeingdefendeddoestn’tstopanyoneelsebeingdefended
3)Nonrejectable
--Ifapublicgoodisprovided,wecannotavoidit.
•Example.Icannotdecidetonotbedefendedbythearmy!
Purepublicgoodsarealsoknownascollectiveconsumptiongoods
•NationalDefenseSystems
•SewageandWasteDisposalSystems
•LighthouseProtection
•NationalRailSafetySystems
•Streetlighting
•FireworksDisplays
Semi-public/Quasipublicgoods
•Theseareproductsthatarepublicinnature,butdonotfullyexhibitthefeaturesofnon-excludabilityandnonrivalry
Someexamplesare:
-
•Motorwaysandmajorroads
•Parks
•GalleriesandMuseums
•Publicgoodsandmarketfailure
•Freemarketeconomywillfailtodelivertheefficientquantityofpublicgoods
-Aproblemarisingfrompublicgoodsisthe“free-rider”issue.
-Peopletakeafreeridewhentheybenefitfromconsumingagoodorservicewithoutpayingforthecostsofprovision.
TheFreeRiderProblem
•Consumershaveanincentivenottorevealtheirwillingnessandabilitytopayforpublicgoodsiftheybelievethattheywillbeexpectedtocontributetofinancingthepublicgood.
•Example:
-
Agroupofresidentsinablockofflatswhoallstandtobenefitfrombetterlightingandsecuritysystems,butwhoindividuallymightavoidpaymentandbenefitoncetheimprovedamenitiesareinplace.
•Giventhenatureofthefreeriderproblem,publicgoodsareoftenfinancedthroughsomeformofenforcement.
•NeedforStateIntervention
Thestateprovidespublicgoods:
-
•Ongroundsofequity-sothatpeopleonalllevelsofincomecanhaveanaccesstothem
---Provisionongroundsofneedratherthanabilitytopay
•Ongroundsofefficiency,asiteasiertoprovidethemcollectively.
•Toovercomethe“free-rider”problemTocorrectthemarketfailure
---thefailureofthemarkettoprovidesufficientpublicgoods
•Payingforpublicgoods
•Marketscannotprovidetheincentivesneededtosupplyessentialservicessuchaspoliceanddefenseetc,causingallocativeinefficiency.
•Hence,publicgoodsareprovidedcollectivelybygovernmentandfinancedthroughgeneraltaxation.
•PublicBads
•Environmentaldamageandglobalwarmingaffectseveryone-nooneisexcludedfromthedis-benefitsofothers’pollutingeconomicactivity.
•Incidencesofthisarecalled‘publicbads”
•Asummary–publicgoods
–Marketswouldnotprovidesuchgoodsandservicesatall!
•Non-excludability–Personpayingforthebenefitcannotpreventanyoneelsefromalsobenefiting-the‘freerider’problem
•Non-rivalry–Largeexternalbenefitsrelativetocost–sociallydesirablebutnotprofitabletosupply!
Meritgoods
●Definition:
Somethingthatisgoodandbetterforapersonthantheymightrealise.Wouldbeunderconsumediflefttothemarket.
●Examplesofgovernmentintervention:
-Education–governmentorstateprovides
-Health–governmentprovidesinformation
Marketfailure:
Caseofmeritgoods
•An
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