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.