Chapter 5 Difficult Cases for the Market Role of Government I A Close Look at Economic Efficiency a Economic Efficiency A situation where the following occur II III IV All activities generating more benefit than cost are undertaken a No potential gain No activities are undertaken for which the case exceeds the benefit ii Getting the most value from available resources the cheapest way 1 2 possible If it s worth doing it s Worth Doing Imperfectly a Sometimes doing things to your best ability isn t worth the cost b Perfection in certain areas example cleaning under the bed on top of the fridge not worth the cost Thinking about the Economic Role of Government a Two functions of the government 1 Protecting individuals and their property against invasions of others 2 Providing goods that cannot easily be provided through b Protective Function of Government private markets i Involves the maintenance of a framework of security and order an infrastructure of rules within which people can interact peacefully with one another ii Example providing police protection and prosecuting aggressors national defense c Productive Function of Government i If markets are going to do well people have to know the value of what they are buying selling government s tax spending and monetary policies have a powerful influence on the stability of the overall economy Potential Shortcomings of the Market i the invisible hand of market forces gives a strong incentive to use their resources efficiently and undertake projects that create value ii Four major factors that reduce efficiency of markets 1 Lack of competition 2 Externalities 3 Public goods 4 Poorly informed Buyers or Sellers b 1 Lack of Competition i Vital to the proper operation of pricing mechanism ii With competition reduces the power of both to rig or alter the iii market in their own favor If a group of sellers can restrict competition the group could gain by raising the price 1 Paid more to do less iv Governments can ensure markets are competitive 1 Do no hard a Don t use own powers to impose licenses discriminatory taxes price controls tariffs quotas and other restrains c Externalities A failure to account for all Costs and Benefits i Externalities spillover effects of an activity that influence the well being of nononsenting third parties ii For example neighbor s loud stereo make its hard for you to study experiencing first hand externality iii External Costs spillover effect that reduce the well being of iv External Benefit spillover effect that enhances the well being of nonconsenting third parties nonconsenting third parties d External Costs i Could result in economic efficiency ii Example producing paper Mills operate purchase labor supplies etc but they emit pollutants into the atmosphere that impose costs on nearby residents iii These costs arise because property rights are poorly defined or imperfectly enforced e External Benefits i Example the homeowner who keeps a house in good condition and maintains a neat lawn improves the beauty of the entire community 2 Scientific theories benefit their authors but the knowledge can help others who did not contribute to the development of them ii Could be inefficient because potential producers may fail to undertake productive activities because they are unable to fully capture the benefits their actions create for others f Public Goods and Why they Pose a Problem for the market i Public goods have two distinguishing characteristics 1 Nonrival in consumption a Making the good available for one group of people does not reduce its availability to others b Example radio broadcast man people can listen to it all at once Also radio is a public good c However not all goods are like this Ex jeans 2 Nonexcludable a Impossible to exclude nonpaying customers from receiving the good 3 They are difficult for markets to allocate efficiently due to the fact they are nonexcludable a Don t have an incentive to pay but to become a free rider i Free rider people who receive the benefits of the good without helping to pay for its cost ii Not very much of the good is supplied 1 Example if national defense went through the market who would voluntarily help to pay for it Your contribution would have little impact on the total supply Many people would become freders and few funds would be available iii When benefit of producing public goods is high people will tempt to find innovative ways to gain by overcoming free riders 1 Example Radio is a public good and it overcomes the free rider problem with advertisements g Potential Information Problems Information is scarce i ii The consumer s information problem is minimal if the time is purchased regularly 1 Example purchase of soap toothpaste law service gas iii Customers can use past experience to acquire information iv Repeat purchase items an item purchased often by the same buyer 1 Sellers of repeat products have incentives to supply consumers with accurate information about the product because if not it would affect future sales a Future demand is directly related to satisfaction level i Consumers are willing to pay for information 1 Example there are thousands of publications that provide opinions about automobiles and advice for a low cost ii Franchise a right or license granted to an individual to market a company s good or services or use its brand name the firms are individually owned 1 2 Example McDonalds Wendy s 3 They are individually owned but the owner pays for the right to use the company name iii Advertising a brand name puts its name at steak h Informational as a Profit opportunity V Market Government Failure a Market Failure a situation in which the structure of incentives is such that markets will encourage individuals to undertake activities that are inconsistent with economic efficiency b Government failure a situation in which the structure of incentives is such that the political process will encourage individuals to undertake actions that conflict with economic efficiency
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