Unit 6 - Market Failure and the Role of Government

6.1 - Socially Efficient Market Outcomes

  • Allocative Efficiency: MB=MC

  • Public goods - provided by the government 

MSB=Marginal social benefit

MSC= Marginal social cost

MSB=MSC

Private vs. Social

Information Failures: inefficient outcome

  • Asymmetric (unequal) information

    • about sellers

      • licensing

      • weights and measures

    • about buyers

      • moral hazard problem

        • acting recklessly with insurance

      • adverse selection

        • insuring more risky than safe people

  • Deadweight loss - market failure

    • per unit taxes

    • binding price controls

    • imperfect competition

    • externalities

    • asymmetric information

    • insufficient public goods (lack of parks or police)

6.2 - Externalities

Think of Domino’s car crash

  • Market Failure

    • requires government action

  • Negative Externality

    • external (spillover) cost

    • overproduction

  • Positive Externality

    • External (spillover) benefit

    • Underproduction

  • Production vs Consumption

    • production has 2 supply lines

    • consumption has 2 demand lines

Correcting Externalities

  • Individual Bargaining - Coase Theorem

    • resolving externality on your own

  • Liability Rules and Lawsuits

  • Government intervention

    • direct control

    • taxes and subsidies

    • environmental regulation

    • assigned property rights

Per unit taxes and subsidies

  • Negative externalities

    • production=tax product

    • consumption=tax product

  • Positive externalities

    • Production=subsidize producer

    • consumption=subsidize consumer

6.3 - Public and Private Goods

  • Private Goods

    • Rivalrous - someone can’t use it bc it has already been used up

    • Excludable - someone can’t afford it

    • Demand Curve is Horizontal Summation

  • Public Goods

    • nonrivalrous

    • not excludable

    • demand curve is vertical summation

    • Supplied by the government

    • Government estimates demand via the census

    • Compare marginal social benefit (MSB) to marginal social cost (MSC)

    • Tragedy of the commons

      • communally owned things/places will not be cared for as much privately owned things/places

  • Free Rider - people who don’t pay but receive benefits

Other Types of Goods

  • Excludable but non-rivalrous - anyone who pays gets access

    • toll or club good

      • toll roads

      • pay per view TV

  • Not excludable but rivalrous - once one pays less can use

    • Common Pool

      • fish in the ocean (no one else can catch that fish)

6.4 - The Effects of Government Intervention in Different Market Structures

  • Taxes and elasticity (Ed and Es)

    • more elastic curves (S and D) create more DWL

    • more inelastic curve (S or D) has the higher Tax Incidence

  • Government Regulation of Monopolies

    • Antitrust Action

      • Sherman Act

      • Clayton Act

      • Ignore Monopolies if they will be short lived

      • Regulate Natural Monopolies

  • Government Set Prices

    • Socially Optimal Price

      • P=MC

    • Fair-Return Price

      • P=ATC

6.5 - Inequality

  • big banana bad! = most amount of inequality

  • Gini Ratio

    • Numerical measure of overall dispersion of income

    • Gini Ratio= Area Between Lorenz Curve and Diagonal / Total area below the diagonal

  • Effect of government redistribution of cash and noncash transfers

    • taxing the rich and helping the poor to make banana smaller

  • U.S. Gini Coefficients

    • Income after taxes are collecetd and benefits paid: 2024 U.S. Gini Ratio=0.49

  • Causes of Inequality

    • Greater demand for skilled workers

    • Globalization

    • Higher tuition costs

    • Decline in unions

    • Tax cuts for the wealthy

    • Unequal distribution of wealth

    • Discrimination

  • Tax Structures

    • Tax as a percentage of income:

      • Progressive tax - a tax system in which the tax rate increases as the taxable income or wealth of an individual or entity increases

      • Regressive tax - a tax where the tax rate decreases as the taxpayer's income increases

      • Proportional tax - everyone pays the same rate

    • analyze the percentage of income, not absolute dollars

  • Poverty

    • poverty line

      • can afford food, clothing, shelter, and adequate transportation - ABOVE the poverty line (bare neccessities)

      • 2024:

        • Single person < $15,060

        • Family of 4 < $31,200

        • 37.9 million Americans

        • Poverty rate 12.1%