Chapter 3 Government Intervention.docx

Chapter 3 Government Intervention.docx

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Chapter3GovernmentIntervention

Chapter3GovernmentIntervention

MarketFailure

•Definition:

♦‘marketfailureoccurswhenmarketimperfectionsleadstoanallocationofresourcesthatislessefficientthanitmightbe’

♦‘Themarketfailstodelivereconomicefficiency（Productiveorallocative）

♦‘whentheinteractionofsupplyanddemandinamarketdoesnotleadtoproductiveand/orallocativeefficiency

•Marketsfailformanyreasons:

♦Externalities

♦Meritanddemeritgoods

♦Publicgoods

♦Informationfailureorimperfectinformation

♦Adverseselectionormoralhazard

♦Lackofcompetitioninamarket/MonopolyPower

♦Inequality/Unfairdistributionofincomeandwealth

•Whenamarketfailsthegovernmentmaydecidetointervenebutnotalwayssuccessfully!

♦Wewillalsolookatgovernmentfailure!

!

Governmentintervention

•Whenthegovernmentintervenesittakesadecisiononwhethersomethingisharmfulorbeneficialtosociety.

•Thegovernmentmakesavaluejudgement.

•Governmentsgetinvolvedinthemarketwhereifitwaslefttothemarkettherewouldbemarketfailure.

•Thereareanumberofwaysgovernmentsintervene.

•Theywilltryandminimisenegativeexternalitiesandmaximisepositiveexternalities.

Externalities

•Themarketworkswellwhenonlythebuyer/consumerandproducer/supplierareinvolvedinandaffectedbyatransactionoreconomicdecision.

•Ifsomeonewhoisnotapartytotheeconomicdecisionbutisaffectedbythedecisionisaneconomicconceptknownasanexternality

•Canbepositiveornegative

Negativeexternalities

•Howdogovernmentsgetinvolvedtopreventthefollowingnegativeexternalitiesoccurring?

-pollution,

-trafficcongestion,

-environmentaldegradation,

-chewinggum,

-illegaldumpingofwaste?

•Decisionmakersdonottakeintoaccountthecostimposedonsocietyandothersasaresultoftheirdecision

♦e.g.pollution,trafficcongestion,environmentaldegradation,depletionoftheozonelayer,misuseofalcohol,tobacco,anti-socialbehaviour,drugabuse,poorhousing

Postiveexternalities

•Howdogovernmentsgetinvolvedtopromotethefollowingpositiveexternalities:

-educationandtraining,

-publictransport,

-healtheducation,

-inoculations,

-refusecollection?

•Inthiscasetoolittleofsomething（agoodorservice）isbeingproducedbythemarket

•Onlytheprivatebenefitsarebeingconsideredbytheproducersandconsumersandexternalbenefitstosocietyarenotconsideredorpaidforthusnotenoughofthegoodorserviceisproduced

UnderproductionCausedbyapositiveexternality

CostsandBenefits

•Economistsareveryinterestedinexternalitiesbecauseofthevariouscostsandbenefitsthatariseoutoftheactionsofothers

♦Forexamplewhoshouldpaythecosttoclearupotherpeopleschewinggum?

♦Whoshouldpaythehospitalcostsofpeoplesufferingfromcancerdueto‘passivesmoking’

♦Inoculations.Forfluetc.Bypeoplebeinginoculatedpreventsotherpeoplecatchingavirusandhavingtimeoffworkorhavingtopaymedicalfees

♦Whoshouldpayforthese?

♦Howwouldthemoneybecollected?

♦Whowouldpayforaninoculationtostopsomeonetheydidn’tknowfromcatchingflu?

Therearethreetypesofcostsandthreetypesofbenefits

PrivatecostsandPrivatebenefits

•Thesearethecostsandbenefitsexperiencedbythepeoplewhoaredirectlyinvolvedinthedecisiontotakeaparticularaction

•Privatecostsarethecostsincurredbyfirmsorconsumerscarryingouttheaction,eitherasproducersorconsumers

•Theprivatebenefitsaredirectlyreceivedbythosewhoproduceorconsumetheproductoftheaction

ExternalCostsandexternalbenefits

•Thesearetheconsequenceofexternalitiesthatariseoutofaparticularprivateaction

•Theyarenotpaidfornoraretheyaccruedtothoseresponsiblefortheaction

•Thefallon‘thirdparties’

SocialcostsandSocialbenefits

•Thetotalcostsandbenefitsincurredbyoraccruedbysocietyasaresultofaparticularaction

SC=PC+EC

SB=PB+EB

Paternalism

•thepolicyorpracticeonthepartofpeopleinpositionsofauthorityofrestrictingthefreedomandresponsibilitiesofthosesubordinatetotheminthesubordinates'supposedbestinterest:

thearroganceandpaternalismthatunderliescradle-to-graveemploymentcontracts.

Informationfailure

•Asymmetricinformation

–Onesidedinformation

–Eitherthebuyerorsellerhasmoreinformationthantheotherparty

–Oftenthebuyerisnotfullyawareoftheconsequencesoftheirdecision

–Agoodexamplesisillegaldrugconsumption

–Thereislittlethoughtorknowledgeofthelongtermconsequences!

•Externalities

•Meritanddemeritgoods

•MoralHazard

–Seeingadoctor!

–Hemightbewrong!

•Adverseselection

–Buyinginsurance!

–Ionlysmoke5cigarettesaday’!

Publicgoods

•Definition:

Goodsconsumedcollectivelybysociety.Itisusuallyimpossibletochargedirectlyfortheirprovision.Theywouldnotbeprovidedbythemarketatall.Theyarecharacterisedbynon-excludabilityandnon-rivalry.

Publicgoodsandmarketfailure

•Businessesintheprivatesectoroftheeconomymaynotprovidepublicgoodsleadingtomarketfailure.

•Itisimportanttodistinguishbetweenprivateandpublicgoodsandtounderstandwhythefreemarketmaynotofferpublicgoods!

!

!

!

Characteristicsofprivategoods

1）Privategoodsareexcludable

---consumersofprivategoodscanbeexcludedfromconsumingtheproductiftheyarenotwillingorabletopayforit

---Example:

-atheatreticket,asportsevent,amealinahoteletc.

---Ifonedoesnotpay-onedoesnotconsumeandbenefitfromgood/service

•Characteristicsofprivategoods

2）Privategoodsarerival.

---oneperson’sconsumptionreducestheamountleftforotherstoconsume.

---Scarceresourcesareusedupinproducingandsupplyingthegoodorservice

---Thereisanopportunitycostinvolved.

•Characteristicsofprivategoods

3）Privategoodsarerejectable

---Privategoodscanberejected.

---Examples-Digital”payperview”-anexcludableprivategood!

!

Movies,sportingevents,news,internetservices,onlinelibrariesetc

Purepublicgoodscharacteristics

1）Non-excludability

--Thebenefitsofpublicgoodscannotbeconfinedtothosewhohavepaidforit.

--Nonpayerscanenjoythebenefitsofconsumptionatzerofinancialcosttothem

Afireworkdisplay!

Howcanyoustopsomeoneenjoyingit

2）Nonrivalryinconsumption

--Consumptionofapublicgoodbyonepersondoesnotreducethaeavailabilityofgoodtoothers.

--Inotherwords,ifthegoodisprovidedforoneperson,itmustbeprovidedforothers.

Example:

Defense.Thearmydefendseveryone.Bymebeingdefendeddoestn’tstopanyoneelsebeingdefended

3）Nonrejectable

--Ifapublicgoodisprovided,wecannotavoidit.

•Example.Icannotdecidetonotbedefendedbythearmy!

Purepublicgoodsarealsoknownascollectiveconsumptiongoods

•NationalDefenseSystems

•SewageandWasteDisposalSystems

•LighthouseProtection

•NationalRailSafetySystems

•Streetlighting

•FireworksDisplays

Semi-public/Quasipublicgoods

•Theseareproductsthatarepublicinnature,butdonotfullyexhibitthefeaturesofnon-excludabilityandnonrivalry

Someexamplesare:

-

•Motorwaysandmajorroads

•Parks

•GalleriesandMuseums

•Publicgoodsandmarketfailure

•Freemarketeconomywillfailtodelivertheefficientquantityofpublicgoods

-Aproblemarisingfrompublicgoodsisthe“free-rider”issue.

-Peopletakeafreeridewhentheybenefitfromconsumingagoodorservicewithoutpayingforthecostsofprovision.

TheFreeRiderProblem

•Consumershaveanincentivenottorevealtheirwillingnessandabilitytopayforpublicgoodsiftheybelievethattheywillbeexpectedtocontributetofinancingthepublicgood.

•Example:

-

Agroupofresidentsinablockofflatswhoallstandtobenefitfrombetterlightingandsecuritysystems,butwhoindividuallymightavoidpaymentandbenefitoncetheimprovedamenitiesareinplace.

•Giventhenatureofthefreeriderproblem,publicgoodsareoftenfinancedthroughsomeformofenforcement.

•NeedforStateIntervention

Thestateprovidespublicgoods:

-

•Ongroundsofequity-sothatpeopleonalllevelsofincomecanhaveanaccesstothem

---Provisionongroundsofneedratherthanabilitytopay

•Ongroundsofefficiency,asiteasiertoprovidethemcollectively.

•Toovercomethe“free-rider”problemTocorrectthemarketfailure

---thefailureofthemarkettoprovidesufficientpublicgoods

•Payingforpublicgoods

•Marketscannotprovidetheincentivesneededtosupplyessentialservicessuchaspoliceanddefenseetc,causingallocativeinefficiency.

•Hence,publicgoodsareprovidedcollectivelybygovernmentandfinancedthroughgeneraltaxation.

•PublicBads

•Environmentaldamageandglobalwarmingaffectseveryone-nooneisexcludedfromthedis-benefitsofothers’pollutingeconomicactivity.

•Incidencesofthisarecalled‘publicbads”

•Asummary–publicgoods

–Marketswouldnotprovidesuchgoodsandservicesatall!

•Non-excludability–Personpayingforthebenefitcannotpreventanyoneelsefromalsobenefiting-the‘freerider’problem

•Non-rivalry–Largeexternalbenefitsrelativetocost–sociallydesirablebutnotprofitabletosupply!

Meritgoods

●Definition:

Somethingthatisgoodandbetterforapersonthantheymightrealise.Wouldbeunderconsumediflefttothemarket.

●Examplesofgovernmentintervention:

-Education–governmentorstateprovides

-Health–governmentprovidesinformation

Marketfailure:

Caseofmeritgoods

•An