lecture 3 - Government Intervention in the Economy

Flashcards about rationale for government intervention, market failure, and monopolies.

Name four ways governments intervene in the economy.

Provide a legal system, stabilization, allocation, and distribution.

According to the lecture, what can governments do to deal with monopolies?

Increase competition by enforcing the division of monopolies, reduce barriers to entry, regulate prices, take over production, or franchise.

What are the two welfare theorems?

The two Welfare Theorems tell us that the private market can achieve an efficient, equitable outcome, under ideal conditions; and that equity requires the redistributing of initial endowments.

List six reasons why governments should intervene in the economy.

To help create good institutions for trade; to promote equity by redistributing resources; to help consumers/firms learn what is most efficient; to smooth the transition to equilibrium; to spread risk in the economy; because of market failure.

What are examples of how governments matter in terms of creating institutions?

A legal system that enforces property rights, protection from exploitation at work, protection against abuse of power (corruption), regulation to avoid a positional arms race (e.g., safety at work legislation), making certain goods illegal, safeguarding personal bank deposits, pension rules to incentivize saving.

What are examples of market failures?

Imperfect competition, externalities, public goods, incomplete markets, imperfect information.

What are some examples of natural monopolies?

Water supply, electricity, gas, and railways where a large infrastructure has to be put in place to support the market and it is very costly to replicate.

Why might a private company not build a bridge that would increase social welfare?

The company cannot make a profit at any price. Even at the profit maximizing price ($4 in the example); Profit = (800-100p)p – 3000 = (800-1004)4 – 3000 = -1400.

What characterizes a natural monopoly?

Increasing returns to scale, which means decreasing average cost.

Why is monopoly considered Pareto inefficient?

If P > MC there is top level inefficiency.