Unit 6 - Market Failure and the Role of Government Guide

6.1 Socially Efficient and Inefficient Market Outcomes

  • Social efficiency is when resources are allocated effectively

  • MSB = MSC

  • Causes of Market Failure:

    • Market power (imperfectly competitive markets)

    • Asymmetric information (lack of info provided by buyers and sellers)

    • Positive and negative externalities

    • Insufficient production of public goods

  • Government policies to reduce DWL:

    • Taxes

    • Subsidies

    • Regulations

    • Public provisions

6.2 Externalities

  • Externality: when external cost/benefit is imposed on members of society who did not pay for them

  • Negative externality: MSC > MPC (correct with per unit tax)

  • Positive externality: MSC < MPC (correct with subsidy)

6.3 Public and Private Goods

  • Rivalrous good: consumption by one prevents consumption by another

  • Nonrivalrous good: consumption by one does not prevent consumption by another

  • Excludable good: non-payers can be prevented from accessing

  • Nonexcludable good: cannot prevent non-payers from accessing

  • Public goods: underproduced due to the free-loader problem

  • Private goods: produced by private markets, can be excludable

6.4 Effects of Government Intervention

  • Causes of inefficient markets:

    • Market power

    • Externalities

    • Public goods

  • Forms of government intervention:

    • Taxes

    • Subsidies

    • Price controls

    • Regulation

  • Taxes shift supply curve left in the long run; profits decrease

  • Price ceiling leads to shortage; price floor leads to surplus

6.5 Inequality

  • Income distribution measures % of income across different percentiles

  • Lorenz curve measures income equality

  • Gini coefficient: A/(A+B); closer to 0 is more equality, closer to 1 is more inequality

  • Causes of income inequality:

    • Supply + demand in labor market

    • Human capital

    • Discrimination

    • Inheritance

    • Bargaining power

  • Policies to address inequality:

    • Taxes + transfers

    • Minimum wage laws

    • Anti-poverty programs

    • Scholarships

  • Types of taxes:

    • Proportional: same % for all

    • Progressive: higher % for higher incomes

    • Regressive: lower % for higher incomes