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

Agenda
• Free Rider Problem
• Externality Basics and Practice
• Coase Theorem

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

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

Free Rider Problem
• People get benefit from good/service without paying for it.
• Market will underprovide
• Solutions
– Government provides and taxes
– Market provides and seeks donations

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
• Consequences of production or consumption that affect an *uninvolved third party*
*Someone other than the producers and consumers
• The Rule
– MSC=MSB

Tax Incidence

Tax Incidence
• Nominal (Statutory) versus Economic Incidence
• If “law” doesn’t matter, what does?

Agenda
- I was a free rider today!
- Externality
- Review
- Finding DWL
- Tax Notes
- Externality Free Responses

• “The only thing we have to fear is fear itself”
• “It depends on what the meaning of the word is is”
• “Ask not what your country can do for you- ask what you can do for your country”
• “Half of anything is never as good as all of everything”
• “Read my lips- no new taxes”
• “Speak softly and carry a big stick”

Free Rider

Free Rider
Solutions
Government provides public goods using tax dollars
Public shaming?

Externalities- simplified
• Negative
– MPC < MSC
– P is too low and Q is too high
– Over allocation of resources
– Per unit tax equal to MEC
• Positive
– MPB<MSB
– 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”

Agenda
• FRQ
• Tax Philosophies
• Wealth and Income Inequality
• Other Market Failures
• Set Up- On My Back Review

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)

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
– Example- 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
• Gini Coefficient
– 0 = complete equality
– 1 = complete inequality
– A/A+B

Redistribution of Wealth
Reduction of Inequality
– Transfers
• WIC
• TANF
• SNAP
• Unemployment Comp
• Obamacare
– Control Market Prices
• Minimum wage
• Rent control
– Progressive Taxes
• Income Tax – largest federal revenue source

Asymmetric Information
Adverse Selection
-Before Transaction
Moral Hazard
-After Transaction
Examples
-Used Cars
-Health Insurance
-Loans
-Infomercials
*I was watching QVC
Examples
-Health Insurance
-Car Insurance
-Loans
-Helmet Requirements

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
• Lack of Profit Motive

Economic Rent- in other words
• Payment for/to any factor above the payment required by its owner

Quiz- Factor Market Stuff
• Cost-Min. and Profit Max. Combo of Resources
• Minimum Wage and Monopsony
• Economic Rent and Land
• Human Capital

Wage Determinant
• Productivity
*American worker overseeing mechanized assembly line
*Foreign worker hand painting a decoration

Wage Differential
• Skills/Knowledge
– Limits supply
• MRP
• Risk
• Access
• More inelastic supply = More economic rent

Human Capital
• Investment to improve skills and productivity of labor
• Self or Firm
• High wage jobs OFTEN include large human capital investments
*Profession/Unions often push for high human capital requirements.