UNIT 6.3-6.5

Market Failure #1: PUBLIC GOODS

Public Sector- The part of the economy that is primarily controlled by the government

Private Sector- The part of the economy that  is run by private individuals and companies that seek profit.

Public Goods:

Why must the government provide public goods and services?

• It is impractical for the free-market to provide these goods because there is little opportunity to earn profit - this is due to the Free-Rider Problem   (Free Riders are individuals that benefit without paying)

The Free Rider Problem

Examples: 

1. People who download music illegally

2. People who watch a street performer and don’t pay 

3. Teenagers that live at home and don’t have a job

What’s wrong with Free Riders?

• Free-Riders keep firms from making profits.

• If left to the free market, essential services would be under produced.

To solve the problem, the government can: 

1. Find new ways to punish free-riders.

2. Use tax dollars to provide the service to everyone.

Definition of Public Goods

Public goods have two criteria:

1. Non-exclusionary

• Everyone can use the good

• Cannot exclude people from enjoying the benefits (even if they don’t pay). 

• Ex: National Defense

2. Shared Consumption (Non-rival)

• One person’s consumption of a good does not reduce the usefulness to others.

• Ex: City Park

How does the government determine what quantity of public goods to produce? 

They use Supply and Demand 

Demand for Public Goods-

The Marginal Social Benefit of the good determined by citizens willingness to pay.

Supply of Public Goods- 

The Marginal Social Cost of providing each additional quantity.

Government Intervention to correct market failures depends of the Different Market Structures behind the market failures

Market Failure #3: Monopolies

Monopoly Review

Why are monopolies a Market Failure?

• Monopolies destroy the key ingredient of the free market system- Competition.

• Price Makers

• Inefficient (productively and allocatively)

• To fix this MARKET FAILURE the government must get involved.

Regulating Monopolies/…

Antitrust Laws

Antitrust Laws- Laws designed to prevent monopolies and promote competition.

• After the Civil War, advances in technology and transportation lead to national markets.

• Eventually only a few firms began to dominate industries: Railroads, Steel, meatpacking, coal, etc.

Legislative Branch

• Passed laws designed to stop monopolies

• Sherman Act of 1890- “Every person who shall monopolize …or conspire to monopolize…shall be deemed guilty of a felony.”

Executive Branch 

• The Federal Trade Commission must approve all corporate mergers. (Like AT&T and…) 

• When firms use anti-competitive tactics the Department of Justice files suit against them.

Judicial Branch

• Supreme Court finds the firm guilty or not guilty and assigns a punishment.

Why Regulate?

Why would the government regulate a monopoly? 

1. To keep prices low 

2. To make monopolies efficient

How do they regulate?

• Use Price controls: Price Ceilings NOT Taxes

• Why don’t taxes work?

  • Taxes limit supply and that’s the problem

Where should the government place the price ceiling?  :

1.Socially Optimal Price

P = MC=D (Allocative Efficiency)

OR

2. Fair-Return Price (Break–Even)

P = D = ATC (Normal Profit)

Socially Optimal = Allocative Efficiency=(d=mc)

Fair Return means no economic profit