JP

4_RationalesGovtIntervention

Rationale for Government Involvement

  • Welfare Economics: Describes assumptions for Pareto efficiency in market allocations.

  • Common market failures include:

    • Public Goods

    • Externalities

    • Natural Monopolies

    • Information Asymmetries

  • Understanding these failures assists in framing and modeling policy issues.

Perfect Competition

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Characteristics

  • Perfect and Free Information: All participants access accurate data on prices and quality.

  • Price Taking: Market participants cannot influence prices; they accept market prices as given.

  • Private Decisions: Individual choices do not affect others' welfare.

  • Private Goods: Goods are not public; market failures arise when these conditions are violated.

Market Failures Identification

  1. Public Goods

  2. Information Asymmetries

  3. Market Power

  4. Externalities

Public Goods

Key Features

  • Nonrival: Consumption by one does not reduce availability to others.

  • Nonexcludable: Impossible to exclude anyone from benefits.

  • Property Rights Issues: Differentiates pure from impure public goods and considers congestion impacts.

Free-Rider Problem

  • Definition: Consumers can benefit from public goods without bearing costs, leading to underinvestment and inefficiency.

Classification of Public Goods

  • Assign examples to quadrants, assessing their potential for inefficiency.

  • Toll Goods: Nonrival but excludable; congestion creates deadweight loss.

Externalities

Definition

  • Impact (positive or negative) from a transaction affecting non-participants:

    • Consumption Examples: Secondhand smoke

    • Production Examples: Pollution

  • Recognizing externalities is crucial for policy formulations.

Government Responses to Externalities

Coasian Bargaining

  • Requirements: Clearly defined property rights and low transaction costs.

  • Predictions: Efficient outcomes can emerge through negotiation without regulation.

Market Power

Sources

  • Monopoly: A single seller controls market prices.

  • Monopsony: A single buyer influences market prices.

  • Oligopoly/Oligopsony: Few sellers or buyers dominate the market.

  • Natural Monopoly: Market characterized by declining average costs, benefiting from economies of scale.

Contestable Markets

  • Low barriers to entry can maintain competitive pressure even within monopolistic frameworks.

  • X-Inefficiency: Occurs when firms do not reach minimum operational costs due to lack of competition.

Governing Anticompetitive Conduct

  • Laws: Sherman Act & Clayton Act regulate monopolistic behaviors.

  • Enforcement Bodies: Antitrust Division of DOJ and FTC monitor and enforce compliance.

Information Asymmetry

Types

  • Moral Hazard: Individuals take more risks when insulated from loss.

  • Adverse Selection: Information disparity leads one party to exploit knowledge for personal gain.

Search Goods vs. Experience Goods

  • Search Goods: Quality known before purchase.

  • Experience Goods: Quality determined after purchase; often requires consumer experience.

  • Post-Experience Goods: Quality remains uncertain post-purchase, complicating consumer decision-making.

Upcoming Classes

  • Next Session (February 20): Focus on market failures and introduce government failures.

  • Assignments:

    • Assignment #2 due March 6th

    • Midterm Exam on March 13th during class.

Extra Content (Slides 36-42)

  • Illustrate key concepts in market competition, cost structures, and social welfare impacts.

  • Emphasize consumer surplus and deadweight loss descriptions in varying market conditions.