Chapter 2: When is a Market Socially Optimal?Basic DefinitionsPotential Reasons for Gov't Intervention in the MarketFacilitate information flowManage externalitiesProvide public goodsAdjust income distributionManage non-competitive behaviorChapter 2:When is a Market Socially Optimal?Basic DefinitionsPotential Reasons for Government Intervention in the Market1. Government Policies to Disseminate Information2. Externalities3. Public Goods4. Transfer Policies5. Noncompetitive BehaviorBasic DefinitionsCompetitive Economy: An economy, which consists of many small economic units, each with no market power.Pareto Optimal: A resource allocation such that you cannot improve any individual’s welfare without hurting at least one other individual. Efficient allocations. Main Theorem of Welfare Economics: Competitive economy will result in a pareto optimal resource allocation when:- Full information exists- No externalities exist- There are no increasing returns to scale in technologyPotential Reasons for Gov't Intervention in the Market1.Facilitate information flow2.Manage externalities3.Provide public goods4.Adjust income distribution 5.Manage non-competitive behaviorFacilitate information flowEducation and extensionPublic supported media and information deliveryCollection and distribution of price and other economic dataLabeling requirements (truth-in-advertising policies)Manage externalitiesExternalities: when activities of one agent affect preferences/technologies of other agents. Negative externalities reduce utility or productivity (pollution).Positive Externalities increase utility or productivity (bees and pollinating trees).Production Externalities: when productivity of an individual is affected by activities of others (smoke from a factory affects a nearby "air-dry" laundry).Consumption Externalities: when welfare of some individuals is affected by the consumption activities of other individuals (noise pollution).Provide public goodsPublic Goods are characterized by two features:1) Nonrivalry: Goods can be consumed concurrently by more than one individual2) Nonexcludability: Goods can be accessed freelyExamples of Public Goods-Knowledge from education and public research-National Security-International Trade Agreements-Infrastructure, such as roads, bridges, etc.-Environmental Amenities, such as clean airAdjust income distributionTransfer Policies are policies designed to change the distribution and/or wealth in society.Examples of transfer policies:-Income taxes-Inheritance taxes-Social Security-Medicare, Medicaid, and AFDC-Tax breaks of various kinds to corporations-Subsidized loans for home buyingManage non-competitive behaviorThere are many forms of noncompetitive behavior including the following three forms as the extremes.1) Monopoly: One agent controls supply of a good.2) Monopsony: One agent controls demand for a good.3) Middleman: One agent buys the product from the supplier and sells it to
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