Explorations in Economics
Alan B. Krueger & David A. Anderson
Chapter 9: Market Failure and Government Failure
- Module 26: When the Invisible Hand Is All Thumbs:
Market Failure
- Module 27: The Heavy Hand of Government:
Government Failure
MODULE 26:
MARKET FAILURE
KEY IDEA:
Market outcomes can be inefficient if there are spillover effects
from the production or use of goods, if some consumers cannot
be excluded from consuming a good, if information is imperfect,
or if firms have market power (as discussed in Chapter 8).
OBJECTIVES:
• To define market failure.
• To explain the concepts of public goods, externalities, and
imperfect information.
• To identify possible solutions to the sources of market failure.
EFFICIENCY AND
MARKET FAILURE
Market failure is the inability of a market to
achieve an efficient outcome.
Markets can be judged by equity and efficiency,
but these two ideas do not always work together.
PRIVATE GOODS AND
PUBLIC GOODS
A public good is nonrival and nonexcludable.
•
A good is nonexcludable if it is not possible to
prevent others from consuming it.
•
A good is nonrival if one person’s consumption of
the good does not makes it impossible for others to
consume it.
PRIVATE GOODS AND
PUBLIC GOODS
Private goods is excludable and rival.
• A good is excludable if it is possible to
prevent others from consuming it.
• A good is rival if one person’s consumption of
the good makes it impossible for others to
consume it.
PRIVATE GOODS AND
PUBLIC GOODS
The Underprovision of Public Goods
• Little incentive to supply the good privately
because there is lack of incentive to pay.
• The free-rider problem is that people take
advantage of the nonexcludable and nonrival
nature of public goods to avoid paying for them.
PRIVATE GOODS AND
PUBLIC GOODS
• The drop- in- the bucket problem arises when no
one person’s payment for a good is essential,
which diminishes each person’s incentive to
contribute.
• Providing Public Goods: Government and taxes
• The Tragedy of the Commons is that
nonexcludable but rival goods become overused.
EXTERNALITIES
An externality is an effect felt beyond those
whose decisions caused the effect.
• A positive externality will bring benefits to
those beyond the decision-makers.
• A negative externality causes spillover costs to
those not involved in the decision.
EXTERNALITIES
Solving the NEGATIVE Externality Problem:
Tax on Consumers
EXTERNALITIES
Solving the NEGATIVE Externality Problem:
Tax on Producers
EXTERNALITIES
Solving the POSITIVE externality problem:
Subsidies
Example: Education is provided publicly by the
government and with subsidies (grants) for
college students that qualify.
EXTERNALITIES
Creating a Market for Negative Externalities
• Tradable permits grant the right to emit a specific
amount of pollution.
• Benefits of Emission Trading Programs
 They allow flexibility and creativity.
 They allocate emissions rights to those who value
them the most.
 They provide an incentive to minimize emissions.
IMPERFECT INFORMATION
Asymmetric information is an imbalance of
information between parties, meaning that one party
knows things that the other does not.
• lemon laws
• Carmax
When there is adverse selection, people with the
greatest need for a particular type of product are the
ones most likely to buy it.
• health, fire or life
insurance
CONDITIONS FOR MARKET
EFFICIENCY
In the absence of perfect information or other
sources of market failure, can we expect markets
to be efficient?
MODULE 26 REVIEW
What is…
A. Market failure?
B. Private good?
C. Excludable?
D. Rival?
E. Public good?
F. Free- rider problem?
G. Drop- in- the- bucket
problem?
H. Tragedy of the
commons?
I. Externality?
J. Asymmetric information?
K. Adverse selection?
MODULE 27:
GOVERNMENT FAILURE
KEY IDEA:
The government can create problems of its own when it
tries to prevent market failure.
OBJECTIVES:
• To explain the meaning of government failure.
• To identify six reasons for government failure.
• To explain influences that can reduce government failure.
SIX REASONS FOR
GOVERNMENT FAILURE
Electoral Pressures and Interest Group Politics:
Interest groups seek influence on
government policy.
To logroll is to work toward the
passage of legislation by trading
votes with other legislators.
Short-termism is a tendency to place
too much weight on immediate
benefits and not enough weight on
longer- term benefits and costs.
SIX REASONS FOR
GOVERNMENT FAILURE
Regulatory capture is the
control of a regulatory
agency by the industry it is
supposed to regulate.
Rent seeking is the pursuit
of profit by shifting
existing gains rather than
by creating new gains for
society.
SIX REASONS FOR
GOVERNMENT FAILURE
Missing Valuations
• Negative externality
problems are hard since
there is not marketdetermined price.
• There is no market that
assesses the value of a
public good.
• Are there tools that
efficiently measure
value?
SIX REASONS FOR
GOVERNMENT FAILURE
Incentive Effects
• Most taxes create
disincentives for
productive activity.
• Income Taxes reduce
take-home pay and
reduces incentive to
work at all.
SIX REASONS FOR
GOVERNMENT FAILURE
According to the law
of unintended
consequences,
intervention in a
complex system can
have surprising and
undesirable
consequences.
VOTING WITH YOUR FEET: A CHECK
ON GOVERNMENT FAILURE
Voting with your feet!
The idea that households or firms will move out of a
city or state to remove themselves from adverse
conditions of high taxes, poor schools, or a lack of parks
and other public goods.
Should the Government Ever Intervene?
When the government should or should not intervene
is often met a divided electorate.
MODULE 27 REVIEW
What is…
A. Government failure?
B. Interest groups?
C. Logroll?
D. Short- termism?
E. Regulatory capture?
F. Rent seeking?
G. Missing valuations?
H. Law of unintended consequences?