Chapter 5
Difficult Cases for the Market and
the Role of Government
1
Overview



Economic efficiency
The role of government within the market
The four types of market failure
2
Economic Efficiency
To be economically efficient:
1. All actions generating more benefits then
costs should be undertaken
2. No actions generating more costs then
benefits should be undertaken
3
Economic Efficiency
4
Role for Government
The government should…
1. Protect individuals and their property
rights
2. Provide goods that cannot be easily
provided by the market (overcome
market failure)
5
The Role of Government
6
Market Failure
1.
Lack of Competition
2.
Externalities
3.
Public goods
4.
Lack of information
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1. Lack of Competition
With no competition, a firm can hold back
production and raise price
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1. Lack of Competition
Role for Government?
1. Refrain from activities that reduce
competition: licenses, price controls, etc.
2. Antitrust legislation:


Sherman Antitrust Act (1890)
Clayton Act (1914)
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2. Externalities
Externalities: The effects of an activity
that influence the well-being of nonconsenting third parties
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2. Externalities
Negative externality: Producer gains the
benefit, everybody bears the cost
ex. pollution, loud music


Producer will produce more than society
wants (too much).
Role for government: tax or regulate
negative externalities
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2. Externalities
Positive externality: producer bears the cost,
everybody gains the benefit.
ex. education, vaccinations


Producer will produce less than society
wants (too little)
Role for government: subsidizes positive
externalities
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3. Public Goods
Public goods have two characteristics:
1. Non-rival in consumption: making the good
available to one consumer does not reduce its
availability to others.
2. Non-excludable: it is impossible (or incredibly
costly) to exclude nonpaying customers from
receiving the good.
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3. Public Goods
Free-rider: A person who receives the
benefit of a good without paying for it
This will cause the good to become undersupplied
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3. Public Good
Role for the Government?


The government forces people to pay
through taxes.
Private market can provide a public good
by tying it to a private good: radio
broadcasts and advertising.
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4. Lack of Information
When purchasing a good, consumers may
not have the information necessary to
make an informed choice.
Role for government?
 Help provide information through
regulations
 However, the market may be able to
provide information as well
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Review
1.
2.
3.
4.
5.
What do we mean by economic
efficiency
What are the two roles that the
government should play in the market
Know the 4 types of market failure
Understand the concept of externalities
Understand the characteristics of public
goods
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