THE ROLE OF THE STATE
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The role of Government
Market failure – the invisible hand pushes in such a
way that individual decisions do not lead to socially
desirable outcomes
A market failure occurs when the market outcome is
not the socially efficient outcome. Some action by
the government is sometimes necessary to ensure
that the market does work well.
This topic examines the relationship between
business and government, and in particular, the
government’s role in influencing business.
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Government’s Role in
Influencing Business
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Prescribes the rules of the game for business.
Purchases business’ products and services.
Uses its contracting power to get business to do things it wants.
Is a major promoter and subsidizer of business.
Is the owner of vast quantities of productive equipment and
wealth.
Is an architect of economic growth.
Is a financier.
Is the protector of various interests in society against business
exploitation.
Directly manages large areas of private business.
Is the repository of the social conscience and redistributes
resources to meet social objectives.
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Clash of Ethical Systems
Business Beliefs
Government Beliefs
 Individualistic ethic
 Maximizes concession to
 Collectivistic ethic
 Subordinates individual goals
self-interest
 Minimizes the load of
obligations society imposes
on the individual (personal
freedom)
 Emphasizes inequalities of
individuals
and self-interest to group
goals and group interests
 Maximizes obligations
assumed by the individual
and discouraging self-interest
 Emphasizes equality of
individuals
Figure 11-1
4
Interaction Among Business,
Government, and the Public
Lobbying
Business
• Interest
groups
• Not buying
products
• Protests
Regulations and Other
Forms of Persuasion
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• Advertising
• Public Relations
Government
Political Process
Voting
Interest Groups
Contributions
• Politicking
• Political
influence
Public
Figure 11-2
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Interaction Among Business,
Government, and the Public
 Government / Business Relationship
• Lobbying
 Public / Government Relationship
• Voting
• Electing officials
 Business / Public Relationship
• Advertising
• Public Relations
• Other forms of communication
6
Privatization
Privatization
The process of “turning over to”
the private sector some function
that was previously handled
by government.
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Other Nonregulatory
Government Influences
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Major employer
Standard setter
Largest purchaser
Use of Subsidies
Transfer payments
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Major competitor
Loans and loan guarantees
Taxation
Monetary policy
Moral suasion
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Government’s Regulatory
Influence on Business
Factors to Consider Regarding
Government Regulation
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Fair treatment
Protection
Scope
Cost
Burden
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Reasons for Regulation
Controls natural monopolies
Controls negative externalities
Achieves social goals
Controls excess profits
Controls excessive competition
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Types of Regulation
EWURA
TCAA
TCRA
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Types of Regulation
NEMC
Occupational Safety and
Health Administration
TBS
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Benefits of Regulation
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Fair treatment of employees
Safer working conditions
Safer products
Cleaner air and water
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Costs of Regulation
 Direct costs
 Indirect costs
 Induced costs
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Effects
1. Innovation may be affected.
2. New investments in plant and equipment may be
affected.
3. Small business may be adversely affected.
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Deregulation
Purpose
Intended to increase competition with the expected
benefits of greater efficiency, lower prices, and
enhanced innovation.
Dilemma
Many competitors are unable to compete with the
dominant firms.
Must enhance competition without sacrificing applicable
social regulations (e.g., health and safety requirements).
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Externalities
 An externality is present when the activity of
one entity (person or firm) directly affects
the welfare of another entity in a way that is
outside the market mechanism.
• Negative externality: These activities impose
damages on others.
• Positive externality: These activities benefits on
others.
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Externality
 If externalities exist, it means that those
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involved in the demand and supply in the
market are not considering all the costs and
benefits when making their market decisions.
As a result, the market fails to yield optimal
results.
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 When there is a negative externality, marginal
social cost is greater than marginal private cost.
• A steel plant benefits the owner of the plant and the
buyers of steel.
• The plant’s neighbors are made worse off by the
pollution caused by the plant.
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Examples of Externalities
 Negative Externalities
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Pollution
Cell phones in a movie theater
Congestion on the internet
Drinking and driving
Student cheating that changes the
grade curve
The “Club” anti-theft device for
automobiles
 Positive Externalities
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Research & development
Vaccinations
A neighbor’s nice landscape
Students asking good questions in
class
The “LoJack” anti-theft device for
automobiles
 Not Considered Externalities
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Land prices rising in urban area
Known as “pecuniary” externalities
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Nature of Externalities
 Arise because there is no market price attached
to the activity
 Can be produced by people or firms
 Can be positive or negative
 Public goods are special case
• Positive externality’s full effects are felt by everyone in the
economy
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Graphical Analysis:
Negative Externalities
 For simplicity, assume that a steel firm dumps
pollution into a river that harms a fishery
downstream.
 Competitive markets, firms maximize profits
• Note that steel firm only cares about its own profits, not the
fishery’s profits.
• Fishery only cares about its profits, not the steel firm’s
profits.
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Graphical Analysis, continued
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MB = marginal benefit to steel firm
MPC = marginal private cost to steel firm
MD = marginal damage to fishery
MSC = MPC+MD = marginal social cost
22
Pollution Tax
 One class of solutions to the externality
problems involve internalizing the costs and
benefits, so that the market can work better.
 Pollution Tax: if a firm is creating a negative
externality in the form of pollution, create a
tax on the polluting firm equal to the cost of
cleaning up the pollution.
Regulation Through Taxation*
Marginal social cost
Cost
Marginal private cost
P1
Efficient tax
P0
Marginal social
benefit
0
Q1 Q0
Quantity
Pollution Tax
Command
 Another approach is command—rather than
imposing a tax or offering a subsidy, the
government simply requires or commands the
activity.
• For a negative externality like pollution, the
government simply requires the company to stop
polluting.
• For a positive externality, like inoculation, the
government requires certain classes of citizens to be
inoculated.
Marketable Pollution Permits
 Another approach to pollution is the
introduction of marketable pollution
permits.
• The government sells the permits, which in total
allow the amount of pollution that the government
believes to be acceptable.
• Demanders, typically firms, purchase the permits,
allowing them to pollute up to the amount specified
by the permits they own.
• If a firm is able to employ a cleaner technology, then
it can enjoy additional revenues by selling its
pollution rights to someone else.