Macro - Public Goods, Externalities, and Price Controls
Chapter 1: Introduction
Public Goods and Market Failure
Definition of Public Goods: These are goods characterized by "external consumption effects." This means that once a good is provided, it becomes easily accessible to many people who did not contribute to its provision. They get full use of it without paying a penny.
Free-Rider Syndrome: Because individuals can consume public goods without paying, no single individual or private entity would be incentivized to supply them. Why would one person purchase something if everyone else gets to use it for free?
Market Failure: As a result of the free-rider problem, essential goods, no matter how vital to society's best interest, would never come into existence through the system of markets and prices.
Examples of Public Goods: Roadways, national defense, police and fire protection, public schools, public libraries, and public parks. These are all beneficial for society, but would not be provided by a purely free market.
Government's Role: The government has a responsibility to identify these situations and provide these public goods to meet the best interests of society.
Capitalism, Socialism, and Mixed Capitalism
Mutually Exclusive Concepts: Capitalism and socialism represent opposing ways societies allocate their scarce productive resources.
America's System: While the United States often identifies as capitalistic, the necessity of government involvement in providing public goods demonstrates that it is not purely capitalistic. It incorporates elements of government impact on the market to produce essential public goods that pure capitalism would not.
Mixed Capitalism: The US economic system is best described as "mixed capitalism." It is primarily capitalistic but requires government intervention where necessary, indicating a blend of capitalistic and socialistic methodologies.
Real-World Example: Obamacare: Explored the debate around the Affordable Care Act (Obamacare) to illustrate government intervention in a market.
Problem: Existing insurance markets had unaffordable pricing, leaving many people uninsured (due to cost, lack of employer benefits, or pre-existing conditions).
Obamacare's Goal: To guarantee healthcare for every citizen, regardless of condition or situation.
Criticism: Opponents argued that government intervention in the healthcare market was turning the US into a "socialistic state." The argument focused on the principle of government involvement, rather than the benefits or detriments of the policy itself.
Significance: This example highlights how government intervention, even when intended to ensure a better environment for society, can be perceived as moving towards a socialistic model, sparking significant debate.
Externalities
Second Example of Government Intervention: Externalities are another reason government intervention may be desirable and beneficial.
Distinction from Public Goods: While public goods involve "external consumption effects," externalities are different. It is preferred to keep them separate for clarity.
Definition of Externalities: Byproducts generated during the production of some primary good.
Negative Externalities (Spillover Costs): These occur when the byproduct adversely influences society.
Example: Tire Production: Tires are a beneficial product. However, their production process creates significant exhaust and poor air quality as a natural byproduct. This negative influence, or spillover cost, impacts society.
Chapter 2: In Government
Addressing Negative Externalities
Producer's Dilemma: Individual producers (e.g., BF Goodrich) in a competitive market would not voluntarily incur extra costs to control exhaust and make production safer. Doing so would increase their prices, making them uncompetitive and leading to business failure.
Government Intervention: The government steps in to dictate how products must be produced (e.g., environmental regulations) to eliminate harmful byproducts and make the environment safe for all.
Example: Printing Inks: The industry shifted from solvent-based inks to water-based inks due to government intervention and research, resulting in a safer and better outcome for society.
Example: Los Angeles Air Quality Standards: In certain regions of Los Angeles, new companies were denied operation if their exhaust levels exceeded city-determined standards. This drastic measure, though potentially impacting tax revenues and causing punitive actions, was taken to protect society from severe air quality issues, as the business sector alone would not address the problem.
Positive Externalities (Spillover Benefits)
Definition: An additional benefit realized over and above the primary product, which spills over to others.
Example: Oscar Mayer Slaughterhouse Tour: Many decades ago, a manager at Oscar Mayer learned about a byproduct from slaughtered cows.
Observation: A tiny gland (e.g., pituitary gland) extracted from slaughtered cows.
Value: This gland sold for an ounce (equivalent to approximately in today's market), used in pharmaceutical products.
Concept: While the primary purpose of killing the cow was for meat, this gland was a valuable "spillover benefit" or positive externality that would not be taken advantage of if not for its discovery.
Hypothetical Policy Application (Chemical Warfare Antidote):
Scenario: Imagine this gland is a key component for pills countering chemical warfare, and the government wants every household to have them.
Government Intervention: To stimulate the production of these pills, the government might inspire increased beef consumption. This could involve:
Giving tax benefits or subsidies to beef producers.
Providing coupons to buyers to encourage more beef purchases.
Outcome: These actions would lead to a higher level of gland harvesting, allowing more pills to be made for societal benefit.
Summary of Byproduct Intervention: Government addresses byproducts in two ways:
Negative Byproduct: Regulates and may deny primary good production to eliminate the byproduct.
Positive Byproduct: Stimulates primary good production to increase the realization of beneficial byproducts.
Chapter 3: Imposed Price Floor
Government Intervention in Market Fairness
Market Equilibrium: Free markets naturally gravitate towards an equilibrium price and quantity, where supply and demand balance.
Government's Perception of Unfairness: In certain situations, the government may view this equilibrium price and quantity as "unfair." Critics argue that the government should not deem what is or is not fair, but nonetheless, this is a basis for intervention.
Government Response: To address perceived unfairness, the government may impose a price ceiling or a price floor.
Government-Imposed Price: A price ceiling or price floor is a government-defined and government-imposed price set to deny the market-determined equilibrium price from existing.
Price Floors
Definition: A government-imposed price set above the equilibrium price.
Note: Although "floor" implies something beneath, a price floor is a minimum legal price set above what the market would naturally establish.
Purpose: To prevent the market price from falling below a certain level that the government deems unfair.
Example: Agricultural Support Programs (Price Supports):
Scenario: Consider the market for wheat. The government observes that the natural equilibrium price, without intervention, would be a bushel.
Government's View: This price is deemed unfair because small farmers would likely be unable to make a profit, leading to business failures and loss of livelihood for families with generations in farming.
Intervention: The government stipulates a minimum price, such as a bushel, ensuring the price cannot drop any lower.
Consequence: Creation of a Surplus: By setting the price floor above equilibrium, the quantity willingly supplied at a bushel will be greater than the quantity willingly demanded at that price. This creates a surplus.
Chapter 4: Imposed Price Floor
Managing Surpluses from Price Floors
Government Purchase of Surplus: To manage the surplus created by a price support program, the government commits to purchasing any excess goods that are not bought in the market at the imposed price floor.
Real-World Evidence: This leads to sights like overflowing grain elevators in the Midwest, where government-owned wheat or barley is stored. Often, these surpluses are shipped to third-world countries as aid.
Criticisms of Price Support Programs:
Higher Consumer Prices: Consumers end up paying more for goods like bread, cakes, pizza, and cookies (all made from wheat), as their prices are artificially inflated by the higher wheat cost.
Higher Taxes: Taxpayers foot the bill for the government to purchase and manage these surpluses.
Inefficiency: Opponents argue that these programs support inefficient farmers who would not be competitive at the natural market equilibrium price of a bushel. They advocate for market forces to drive out inefficiency and reallocate resources more effectively.
Historical Context and Political Reality: These programs have existed for centuries due to the US economy being highly agrarian in its early days. Their continuation is often due to the political process, where politicians engage in "logrolling"—supporting agricultural support programs in exchange for votes on other bills (e.g., anti-terrorism bills from non-agrarian states).
Crop Restriction Programs (Alternative Agricultural Support)
Premise: Similar to price support, the government sets a price for a protected item above equilibrium.
Deviation: Instead of managing surpluses, the government recognizes its inefficiency in managing excess goods.
Method: The government pays large, "mega farmers" not to grow a certain product. This restricts the quantity of supply to be consistent with the market demand at the protected price, thereby avoiding the creation of a surplus.
Chapter 5: Example Of Price
Price Ceilings
Definition: A government-imposed price set below the equilibrium price.
Purpose: To prohibit the market price from rising above a level that the government deems too high (and unfair).
Theoretical Example: Gasoline Market:
Unregulated Equilibrium: Imagine the price of gasoline rising to a gallon in an unregulated market. While some might adapt by walking or using public transport, it would be devastating for businesses heavily reliant on travel (e.g., roofers, physical therapists).
Government Intervention: The government might impose a price ceiling of a gallon to protect these businesses and mitigate negative economic impacts.
Consequence: Creation of a Shortage: At the imposed ceiling price, the quantity demanded will exceed the quantity supplied, leading to a shortage.
Addressing Shortages: Rationing: When a shortage occurs due to a price ceiling, the government must implement a means of rationing the limited supply.
Example: Gasoline Rationing: The government might issue special classifications or stickers for businesses that qualify, allowing them priority access to gasoline to conduct essential operations.
Example: Milk Price Ceiling for Children's Health: If a price ceiling of per half-gallon is placed on milk to support children's mental and physical development (requiring daily consumption), a shortage would occur.
Rationing Method: Milk producers might be directed to send milk primarily to schools for children at the set price. Any leftover milk would then be sent to supermarkets. This ensures the intended beneficiaries (children) receive the product, even if it means some people (e.g., a wealthy individual with many cats) cannot get their desired quantity.
Chapter 6: Imposed Price Floor
Price Floor Example in the Resource Market: Minimum Wage
Applicability: The concepts of supply and demand, and thus price floors, apply to both product markets and resource markets (e.g., labor).
Scenario: Unskilled Labor Market:
Unregulated Equilibrium: The market for unskilled labor might naturally lead to a wage rate of an hour.
Government's View of Unfairness: The government deems this wage unfair, believing it impossible for a person working, say, hours a week ( gross, approximately after taxes) to support themselves or a family, cover rent, food, and clothing.
Government Intervention: Minimum Wage: The government establishes a minimum wage, which is an example of a price floor in the labor market. A common contemporary figure, for instance, is an hour.
Purpose: To ensure workers earn a more livable wage (e.g., hours at an hour would yield gross, approximately after taxes), allowing for minimal sustenance.
Consequence: Restricted Quantity Demanded and Unemployment:
Benefit for Hired Workers: Those who secure jobs at the minimum wage are better off, earning significantly more than the equilibrium wage.
Cost for Unemployed Workers: However, imposing a minimum wage at an hour, much higher than the equilibrium of an hour, drastically restricts the quantity of labor demanded by businesses, leading to unemployment or difficulties in finding jobs for many.
Real-World Impact Example: High School Prom Costs:
Before Minimum Wage (4$/hr): A high school senior could easily find a part-time job (e.g., at McDonald's) to earn enough for prom expenses, with the quantity of labor hired being Q_115$/hr):
Employer Response: Facing higher labor costs, businesses like McDonald's change their operating methods. They automate (e.g., kiosks replace cashiers), reduce staffing, and promote self-service.
Reduced Job Opportunities: The total staffing at local McDonald's outlets might drop from people to . This technological innovation and reduction in labor demand mean that while the wage is high, the chances of getting hired are slim to none.
Outcome: The student, unable to secure employment, cannot afford prom, despite the higher potential wage if they could find a job.
Chapter 7: Conclusion
Unintended Consequences of Minimum Wage: The example of the high school senior illustrates that while the minimum wage aims to provide a fairer living wage, it can lead to unintended consequences such as reduced employment opportunities due to businesses responding to increased labor costs through automation and reduced staffing. This means that some individuals, who might have earned a lower wage but still had a job, are now completely without employment.