Government and Market
Failure
SLIDES PREPARED BY JUDITH SKUCE, GEORGIAN COLLEGE
© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
1
In this chapter you will
learn
17.1 To distinguish between a public
and private good
17.2 The nature of externalities and the
ways of dealing with them
17.3 About the economics of solidwaste disposal, and recycling
17.4 About information failures and
ways of rectifying them
© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
2
Chapter 17 Topics
17.1 Public Goods
17.2 Externalities Revisited
17.3 The Economics of Solid-waste
Disposal and Recycling
17.4 Information Failures
© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
3
Private Goods
rivalry
 excludability
 demand curve is horizontal
summation of individual demand
curves

© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
4
Public Goods
non-rivalry
 non-excludability
 free-rider problem
 government must provide

© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
5
Demand for Public Goods
Table 17-1
Quantity
1
Adams’
willingness
to pay (price)
Benson’s
willingness
to pay (price)
$4
© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
6
Demand for Public Goods
Table 17-1
Quantity
1
Adams’
willingness
to pay (price)
$4
© 2005 McGraw-Hill Ryerson Ltd.
+
Benson’s
willingness
to pay (price)
$5
Microeconomics, Chapter 17
7
Demand for Public Goods
Table 17-1
Quantity
1
Adams’
willingness
to pay (price)
$4
© 2005 McGraw-Hill Ryerson Ltd.
+
Benson’s
willingness
to pay (price)
$5
Collective
willingness
to pay (price)
=
Microeconomics, Chapter 17
$9
8
Demand for Public Goods
Table 17-1
Quantity
1
2
Adams’
willingness
to pay (price)
$4
3
© 2005 McGraw-Hill Ryerson Ltd.
+
+
Benson’s
willingness
to pay (price)
$5
4
Collective
willingness
to pay (price)
=
=
Microeconomics, Chapter 17
$9
7
9
Demand for Public Goods
Table 17-1
Quantity
1
2
3
4
5
Adams’
willingness
to pay (price)
$4
3
2
1
0
© 2005 McGraw-Hill Ryerson Ltd.
+
+
+
+
+
Benson’s
willingness
to pay (price)
$5
4
3
2
1
Collective
willingness
to pay (price)
=
=
=
=
=
Microeconomics, Chapter 17
$9
7
5
3
1
10
Optimal Amount of a Public Good
Figure 17-1
P
$9
7
5
3
1
0
1
© 2005 McGraw-Hill Ryerson Ltd.
2
3
4
5
Adams’s
willingness
to pay
Q
Microeconomics, Chapter 17
11
Optimal Amount of a Public Good
Figure 17-1
P
$9
7
Benson’s
willingness
to pay
5
3
1
0
1
© 2005 McGraw-Hill Ryerson Ltd.
2
3
4
5
Microeconomics, Chapter 17
Q
12
Optimal Amount of a Public Good
Figure 17-1
P
$9
When vertically
added equals
collective
willingness
to pay
7
5
3
DC
1
0
1
© 2005 McGraw-Hill Ryerson Ltd.
2
3
4
5
Microeconomics, Chapter 17
Q
13
Optimal Amount of a Public Good
Figure 17-1
P
$9
S
7
The good’s
marginal cost
as shown by S
5
3
DC
1
0
1
© 2005 McGraw-Hill Ryerson Ltd.
2
3
4
5
Microeconomics, Chapter 17
Q
14
Optimal Amount of a Public Good
Figure 17-1
P
$9
S
7
5
Yields the
optimum amount
of the public good
3
MB = MC
DC
1
0
1
© 2005 McGraw-Hill Ryerson Ltd.
2
3
4
5
Microeconomics, Chapter 17
Q
15
Cost-Benefit Analysis

rule for deciding whether to provide
a public good, & how much to
provide:
MB=MC
illustrated…
© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
16
Cost-Benefit Analysis
Plan
No new
construction
A: Widen
existing
highways
B: Two-lane
C: Four-lane
D: Six-lane
Total
Cost
MC
0
Total
Benefit
0
4
5
6
8
18
28
0
5
4
10
MB
1
8
13
10
23
10
26
3
5
3
not justifiable
© 2005 McGraw-Hill Ryerson Ltd.
Net
Benefit
Microeconomics, Chapter 17
-2
17
Cost-Benefit Analysis
Plan
No new
construction
A: Widen
existing
highways
B: Two-lane
C: Four-lane
D: Six-lane
Total
Cost
MC
0
Total
Benefit
0
0
5
4
4
MB
5
what
6 level of
8
10
13
8
10
activity
is
18
23
10
3
optimal?
28
26
© 2005 McGraw-Hill Ryerson Ltd.
Net
Benefit
Microeconomics, Chapter 17
1
3
5
-2
18
Analysis
isCost-Benefit
MB >
Total
Total
Net
MC?
Plan
MC
MB
No new
construction
A: Widen
existing
highways
B: Two-lane
C: Four-lane
D: Six-lane
Cost
Benefit
Benefit
0
0
0
4
4
8
18
28
© 2005 McGraw-Hill Ryerson Ltd.
5
5
6
10
yes
10
yes
13
yes
23
no
26
1
8
10
3
5
3
Microeconomics, Chapter 17
-2
19
Cost-Benefit Analysis
Plan
No new
construction
A: Widen
existing
highways
B: Two-lane
C: Four-lane
D: Six-lane
Total
Cost
MC
0
Total
Benefit
0
4
5
6
1
8
13
8C is
Plan
18
23
10
optimal
28
26
© 2005 McGraw-Hill Ryerson Ltd.
0
5
4
10
MB
Net
Benefit
10
3
5
3
Microeconomics, Chapter 17
-2
20
Chapter 17 Topics
17.1 Public Goods
17.2 Externalities Revisited
17.3 The Economics of Solid-waste
Disposal and Recycling
17.4 Information Failures
© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
21
Externalities Revisited
a spillover is a cost or benefit
accruing to an individual or group
that is external to a market
transaction
 e.g., pollution, immunization

illustrated…
© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
22
Figure 17-2
P
St
Spillover
costs
S
too much is
produced
Overallocation
D
0
Q0
© 2005 McGraw-Hill Ryerson Ltd.
Qe
Microeconomics, Chapter 17
Q
23
Figure 17-2
P
too little is
produced
S
Spillover
Benefits
Dt
D
Underallocation
0
© 2005 McGraw-Hill Ryerson Ltd.
Qe
Q0
Microeconomics, Chapter 17
Q
24
Externalities

Individual Bargaining: Coase
Theorem
– example: forest land
– limitations

Liability Rules & Lawsuits
© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
25
Externalities

Government Intervention
– Direct Controls
© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
26
Figure 17-3
P
St
Spillover
costs
S
Overallocation
D
direct
controls
shift
S
left
Q
Q
Q
0
0
e
© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
27
Figure 17-3
P
St
Overallocation
corrected
D
0
Q0
© 2005 McGraw-Hill Ryerson Ltd.
Qe
Microeconomics, Chapter 17
Q
28
Externalities

Government Intervention
– Direct Controls
– Specific Taxes
© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
29
Figure 17-3
P
St
Spillover
costs
S
Overallocation
TAX
D
Q
imposing
a
tax
shifts
S
left
Q
Q
0
0
e
© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
30
Figure 17-3
P
St
Overallocation
corrected
D
0
Q0
© 2005 McGraw-Hill Ryerson Ltd.
Qe
Microeconomics, Chapter 17
Q
31
Externalities

Government Intervention
– Direct Controls
– Specific Taxes
– Subsidies & Government Provision
subsidies to buyers
© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
32
Figure 17-4
P
subsidizing buyers
shifts D right S
Subsidy
to Buyers
Dt
D
Underallocation
0
© 2005 McGraw-Hill Ryerson Ltd.
Qe
Q0
Microeconomics, Chapter 17
Q
33
Figure 17-4
P
S
Dt
Underallocation
corrected
Qe
0
© 2005 McGraw-Hill Ryerson Ltd.
Q0
Microeconomics, Chapter 17
Q
34
Externalities

Government Intervention
– Direct Controls
– Specific Taxes
– Subsidies & Government Provision
subsidies to buyers
subsidies to producers
© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
35
Figure 17-4
P
subsidizing producers
shifts S right
S
St
Dt
D
Underallocation
0
© 2005 McGraw-Hill Ryerson Ltd.
Qe
Q0
Microeconomics, Chapter 17
Q
36
Figure 17-4
P
St
Dt
Underallocation
corrected
Qe
0
© 2005 McGraw-Hill Ryerson Ltd.
D
Q0
Microeconomics, Chapter 17
Q
37
Externalities

Government Intervention
– Direct Controls
– Specific Taxes
– Subsidies & Government Provision
subsidies to buyers
subsidies to producers
government provision
© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
38
Externalities

A Market-based Approach to
Spillover Costs
– The Tragedy of the Commons
– A Market for Externality Rights
– Operation of the Market
© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
39
Market for Pollution Rights
Price per pollution right
Figure 17-5
S
D2004
supply is set
by government
$100
500 750 1000
Quantity of pollution rights
© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
40
Market for Pollution Rights
Price per pollution right
Figure 17-5
S
D2004
$100
a price of $100
reduces
pollution from
750 tonnes to
500 tonnes
500 750 1000
Quantity of pollution rights
© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
41
Market for Pollution Rights
Price per pollution right
Figure 17-5
S
D2014
D2004
$200
$100
market for
pollution
rights limits
pollution as
population
expands
500 750 1000
Quantity of pollution rights
© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
42
Externalities

Market-based Approach Advantages
– reduces society’s costs
– polluters have a monetary incentive not
to pollute
– conservation groups can buy up
pollution rights
– growing revenue can be devoted to
environment
– rising price should stimulate innovation
© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
43
Externalities

Society’s Optimal Amount of
Externality Reduction
– MC, MB & Equilibrium Quantity
© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
44
Society’s marginal benefit and marginal
cost of pollution abatement
Figure 17-6
Recall the
MB = MC
rule?
0
Amount of pollution abatement
© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
Q
45
Society’s marginal benefit and marginal
cost of pollution abatement
Figure 17-6
MC
0
Amount of pollution abatement
© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
Q
46
Society’s marginal benefit and marginal
cost of pollution abatement
Figure 17-6
MC
MB
0
Amount of pollution abatement
© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
Q
47
Society’s marginal benefit and marginal
cost of pollution abatement
Figure 17-6
MC
Socially optimal
amount of
pollution
abatement
0
some pollution mayMB
be
economically
efficient
Q
Amount of pollution abatement
© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
48
Society’s marginal benefit and marginal
cost of pollution abatement
Figure 17-6
MC
Socially optimal
amount of
pollution
abatement
0
MC & MB curves may
MB
shift
over
time
Q
Amount of pollution abatement
© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
49
Chapter 17 Topics
17.1 Public Goods
17.2 Externalities Revisited
17.3 The Economics of Solid-waste
Disposal and Recycling
17.4 Information Failures
© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
50
Recycling

millions of tonnes of garbage must
be disposed of annually
– Market For Recyclable Inputs
– Policy
demand incentives
supply incentives
illustrated…
© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
51
P
equilibrium
Figure 17-7 price &
quantity
price
S1
P1
D1
Q1
amount of recycling
© 2005 McGraw-Hill Ryerson Ltd.
Q
Microeconomics, Chapter 17
52
incentives
Figure
17-7
P
for
producers shift D right
price
S1
P2
P1
D2
D1
Q1 Q2
amount of recycling
© 2005 McGraw-Hill Ryerson Ltd.
Q
Microeconomics, Chapter 17
53
P
incentives
for households
Figure 17-7
shift S right
price
S1
S2
P1
P3
D1
Q1 Q3
amount of recycling
© 2005 McGraw-Hill Ryerson Ltd.
Q
Microeconomics, Chapter 17
54
Global Warming
progress in pollution reduction
 global warmingclimate change
predictions
 Kyoto Protocol 1997
 costs vs benefits
 transition costs
 U.S. has refused to sign

© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
55
GLOBAL PERSPECTIVE 17.1
Carbon Dioxide Emissions (Per Capita, 2001)
United States
Australia
Canada
Czech Republic
Germany
Britain
Japan
Italy
Spain
France
0
© 2005 McGraw-Hill Ryerson Ltd.
5
10
15
20
Microeconomics, Chapter 17
56
Chapter 17 Topics
17.1 Public Goods
17.2 Externalities Revisited
17.3 The Economics of Solid-waste
Disposal and Recycling
17.4 Information Failures
© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
57
Information Failures
asymmetric information
 inadequate information about sellers

– example: gasoline market
– example: licensing of surgeons
© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
58
Information Failures

inadequate information about buyers
– moral hazard problem
Canada’s health care system & “excess”
demand
– adverse selection problem
– workplace safety

qualification
© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
59
Chapter 17 Topics
17.1 Public Goods
17.2 Externalities Revisited
17.3 The Economics of Solid-waste
Disposal and Recycling
17.4 Information Failures
© 2005 McGraw-Hill Ryerson Ltd.
Microeconomics, Chapter 17
60