Market Failure and Government
The Role of Government
and
Market Failure
Public v. Private Goods
• Excludability- Can producer keep benefits
from those who do not pay?
– Excludable
– Non-Excludable
• Rivalry- Does use by one reduce usefulness to
others?
– Rival
– Nonrival
Public v. Private Goods
• Pure Private
– Excludable and Rival
– Example: Chia Pets
• Pure Public
– Nonexcludable and Nonrival
– Example: National Defense
– Government generally must provide
– Free Rider Problem
• Solutions: taxes versus donations
Free Rider Problem
• People get benefit from good/service without
paying for it.
• Market will underprovide
• Solution
– Government provides and taxes
– Market provides and seeks donations
Free Rider
Free Rider
Solutions
Government provides
public goods using tax
dollars
Public shaming?
Public v. Private Goods
• Toll Goods
– Excludable and nonrival
– Example: Cable TV, Toll Road (often natural monopolies)
• Common-pool Resources
– Nonexcludable and rival
– Example: fish in the public waters, congested roads
– Government often regulates
• Quotas, licensing fees
True or False (according to economists)
• The government should mandate that all cars
produce zero emissions by 2020.
True or False (according to economists)
• The government should mandate that cars
meet efficiency standards such that the
marginal social cost of reducing emissions is
equal to the marginal social benefit.
Externalities
• Unintended consequences of production or
consumption that hurt (negative) or help (positive)
an uninvolved third party
*Someone other than the producers and consumers
Externalities
• Negative Externality:
– Marginal Social Cost > Marginal Social Benefit
• Positive Externality:
– Marginal Social Benefit > Marginal Social Cost
• *Socially Optimal:
– Marginal Social Benefit = Marginal Social Cost
*Requires government intervention when
externalities exist
• MSB = MSC
Per Unit Tax = to Marg. External Cost
will eliminate DWL
Per unit tax
Per Unit Subsidy = Marg. External Benef
will eliminate DWL
Schedule
•
•
•
•
•
•
•
M- Externalities and Tax Intro
T- Taxes and Wealth Inequality
W- Other Market Failures and Gov’t Failures
TH- QUIZ
Friday- On Your Back Graph Review
T and W- Bull’s eye Physical Challenge
TH- Practice Exam
$13
Tax Incidence
• Nominal versus Economic Incidence
*Tax burden determined by relative elasticity
*More inelastic, more of the burden
Subsidy Incidence
• Nominal versus Economic Incidence
*Subsidy benefit determined by relative elasticity
*More inelastic, more benefit
*In the diagram, demand is more inelastic, so the consumers’
price drops more than the producers’ price increases.
Externalities- simplified
• Negative
–
–
–
–
MPC < MSC and MSC > MSB
P is too low and Q is too high
Over allocation of resources
Per unit tax equal to MEC
• Positive
–
–
–
–
MPB<MSB and MSB > MSC
P is too low and Q is too low
Under allocation of resources
Per unit subsidy equal to MEB
Coase Theorum
"if trade in an externality is possible and there
are no transaction costs , bargaining will lead to
an efficient outcome regardless of the initial
allocation of property rights”
Types of Taxes
*Based on % of income
Progressive
Proportional/Flat
Regressive
Examples of Taxes
*Based on % of income
Progressive- Federal Income Tax
Proportional/Flat- State Income Tax
Regressive- Sales Tax
Income Tax
• Progressive Tax (Federal)
Income Tax
• Progressive Tax (Federal)
State Income Tax
• Proportional Tax/Flat Tax
• PA = 3.07%
Sales Tax- Regressive or Proportional?
• 6%
Sales and Excise Taxes are Regressive
Paying for Public Goods- Tax Philosophies
• Benefits Received Principle
– Closer to free market solution
– Example- Gas tax to fund highways
• Ability to Pay Principle
– Examples- Progressive Income Tax
- School Property Tax
Income/Wealth Inequality
• Measures of the Distribution of Wealth/Income
– Graphical: Lorenz Curve
– Numeric: Gini Coefficient
Lorenz Curve (wealth OR income)
Line of
Equality
Lorenz Curve
Line of
Equality
Lorenz Curve
Line of
Equality
Gini Coefficient
Measuring Inequality
• Lorenz Curve
– Farther from 45 = greater inequality
– Closer = more even distribution
• Gini Coefficient
– 0 = complete equality
– 1 = complete inequality
– A/A+B
Wealth Gini
Income Gini
Redistribution of Wealth/Income
Reducing Inequality
– Transfers (tax some and give to others)
•
•
•
•
•
WIC
TANF
SNAP
Unemployment Comp
Obamacare
– Control Market Prices
• Minimum wage
• Rent control
– Taxes
• Progressive Income Tax – largest federal revenue source
• Estate “Death” Tax
Asymmetric Information
Adverse Selection
-Before Transaction
Moral Hazard
-After Transaction
Examples
Examples
-Used Cars
-Health Insurance
-Health Insurance
-Car Insurance
-Loans
-Loans
-Infomercials
-Helmet Requirements
*I was watching QVC
Government Failure
Government Failure
Government Failure
Government Failure
Government Failure
Government Failure
Government Failure- government intervention decreases
efficiency, leads to poor allocation of resources, and
diminishes economic welfare.
• Public Choice Theory
– economic self-interest motivates in the public sector as it does
in the private sector
– people vote for the candidate who promises the greatest
economic gain for them
• Rent Seeking
– $$ spent on lobbying for economic gain
– Attempts to increase income without any human capital or
productivity gains
• Lack of Profit Motive
• Enforcement Costs
• Red Tape
Economic Rent- in other words
• Payment for/to any factor above the payment
required by its owner
Sides
2 characteristics of a pure public good
2 characteristics of a pure private good
Types of good the market is least likely
to provide
Problem caused by the nonexcludability of public goods
Because millions can watch TV at the
same time without inhibiting each
others watching ability, cable
television service is
• Non _______
The government should regulate
pollution to the point where _____ =
____
If a competitive market in equilibrium
has MSC > MSB
If a competitive market in equilibrium
has MSB > MSC
Which type of externality results in an
under allocation of resources?
When graphing a negative externality,
the DWL falls to the _____ of the
socially optimal point
Would a per unit tax move society
closer or farther from the socially
optimal quantity?
Would a lump sum subsidy move
society closer or farther from the
socially optimal quantity?
Quantify a government solution to this
market failure.
$30
$23
$20
Quantify a government solution to this
market failure.
$100
$90
$75
$13
When graphing a positive externality,
the DWL falls to the _____ of the
socially optimal point
The Federal income tax is a ___ tax
The sales tax is a ___ tax
If one person controls all income in a
nation, the Gini coefficient is
The 45 degree line is also known as the
line of
If the government increases transfers
to low income households, what will
happen to the Lorenz curve
If the government increases transfers
to low income households, what will
happen to the Gini coefficient?
I should sleep with a mouth guard, but
I have zero deductible dental
insurance.