ECN 203 1nd Edition Lecture 17Outline of Last Lecture II. Public Goodsa. Pure Public Goods b. The Problem III. Externalities a. Sourceb. As market failure c. Negative and Positive Externalities d. Building the Graph Outline of Current Lecture IV. Market Failure – Conclusion V. The Role of Government a. Assumptions b. At the Micro-Leveli. Interventionists vs. Non-Interventionists VI. Solving an Externality VII. Solving a Positive Externality Current LectureLecture 2/25/15- Market Failure – Conclusion o When individuals or firms act in a way that optimizes their own private well-being, they may generate effects that unintentionally benefit or cost bystanders.  If property rights are not defined, no market will form.  Without a market there is no signal, no price. - The individual will ignore her external effects w/o a price. o As a consequence, this private activity is privately optimal, but not socially optimal. These notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute. Activities with private negative external effects are overdone and activities with positive external effects are underdone. o Due to a failure to define or enforce property rights, no market forms… So no price signal is generated to coordinate choices. This leads to social inefficiency… a less than Pareto Optimal market outcome.  Leads to sustainability issues. - The Role of Government o The first question we need to ask is: Is there any role at all for gov’t in the market economy?o Assume we live in a world of angels…. Everyone pursues their self-interest to maximize their utility… a world where no one would cheat to get ahead because everyone honors Commutative Justice. Do we need government?- Yes, even in a world of angels we need judges to resolve differences of opinion (contracts).- We’d have to resolve distributive justice issues. o Realistically, we are not all angels.  There are some who would cheat and steal to get more market power and increase the size of their “pie” at our expense. o Is there a role for government in solving this problem of market power? Gov’t can definitely be part of the problem - Ex. North Korea Gov’t is usually the greatest source of power in society and that power can clearly be used for oppression.  Abe Lincoln believed in, “gov’t for the people, by the people, of the people”- These gov’t polices destructive behavior w/o becoming a police state. o At the micro-level Interventionists believe gov’t is capable of constructive policy. - They want gov’t to be there to police socially destructive behavior  Non-Interventionist policy, often called laissez-faire, see the interventionist belief as a slippery slope to a police state. Gov’t faces a challenge because designing policies to address externalities is not simple- Solving an Externality o “give then exact measure of EC”o The very signal we turn to in order to measure values is missing the price o When the price is absent, in order to measure the EC we have to turn to a “proxy” An estimate that can be used as a substitute for the actual value.  These can be problematic - Solving a Positive Externality o In this case, the simplest solution is to internalize the externality. o Since the issue is external, a subsidy equal to the size of the positive externality would internalize