Chapter 5 Difficult Cases for the Market, & Role of GovernmentChapter 5 Difficult Cases for the Market, & Role of GovernmentI. A Close Look at Economic Efficiencya. Economic Efficiency: A situation where the following occur:1. All activities generating more benefit than cost are undertakena. No potential gain2. No activities are undertaken for which the case exceeds the benefitii. Getting the most value from available resources, the cheapest way possibleII. If it’s worth doing, it’s Worth Doing Imperfectlya. Sometimes doing things to your best ability isn’t worth the costb. Perfection in certain areas (example: cleaning- under the bed, on top of the fridge, not worth the cost)III. Thinking about the Economic Role of Governmenta. Two functions of the government1. Protecting individuals and their property against invasions ofothers2. Providing goods that cannot easily be provided through private marketsb. Protective Function of Governmenti. Involves the maintenance of a framework of security and order- an infrastructure of rules within which people can interact peacefully with one anotherii. Example: providing police protection and prosecuting aggressors, national defensec. Productive Function of Governmenti. 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 economyIV. Potential Shortcomings of the Marketi. the invisible hand of market forces gives a strong incentive to use their resources efficiently and undertake projects that create valueii. Four major factors that reduce efficiency of markets1. Lack of competition2. Externalities3. Public goods 4. Poorly informed Buyers or Sellersb. (1) Lack of Competition i. Vital to the proper operation of pricing mechanismii. With competition, reduces the power of both to rig or alter the market in their own favoriii. If a group of sellers can restrict competition, the group could gain, byraising the price 1. Paid more to do lessiv. Governments can ensure markets are competitive:1. Do no harda. Don’t use own powers to impose licenses, discriminatory taxes, price controls, tariffs, quotas and other restrainsc. Externalities- A failure to account for all Costs and Benefitsi. 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 externalityiii. External Costs: spillover effect that reduce the well-being of nonconsenting third partiesiv. External Benefit: spillover effect that enhances the well-being of nonconsenting third partiesd. External Costsi. Could result in economic efficiencyii. 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 enforcede. External Benefitsi. 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 themii. 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 marketi. Public goods: have two distinguishing characteristics1. Nonrival in consumptiona. Making the good available for one group of people does not reduce its availability to othersb. 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. Nonexcludablea. Impossible to exclude nonpaying customers from receiving the good. 3. They are difficult for markets to allocate efficiently due to thefact they are nonexcludable a. Don’t have an incentive to pay but to become a free rideri. Free rider: people who receive the benefits of the good without helping to pay for its costii. Not very much of the good is supplied1. Example: if national defense went through the market, who would voluntarily help to pay for it? Your contribution would have little impacton 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 advertisementsg. Potential Information Problemsi. Information is scarce.ii. The consumer’s information problem is minimal if the time is purchased regularly1. Example: purchase of soap, toothpaste, law service, gas. iii. Customers can use past experience to acquire informationiv. 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 salesa. Future demand is directly related to satisfaction levelh. Informational as a Profit opportunityi. Consumers are willing to pay for information1. Example: there are thousands of publications that provide opinions about automobiles and advice for a low costii. Franchise: a right or license granted to an individual to market a company’s good or services or use its brand name. 1. the firms are individually owned2. Example: McDonalds, Wendy’s3. 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 steakV. Market & Government Failurea. 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
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