Government Intervention
A.S 3.4
INTERNAL
5 CREDITS
GOVERNMENT INTERVENTION
Providing an explanation of:
• Each market failure
• Government interventions to correct
each market failure in terms of
efficiency or equity
Market failure refers to situations
when a market fails to deliver an
efficient or equitable outcome
The different market failures relate to:
• consumption externalities,
• production externalities,
• public goods,
• imperfect information,
• inequitable income distribution
GOVERNMENT INTERVENTION
The different market failures relate to:
• consumption externalities,
• production externalities,
• public goods,
• imperfect information,
• inequitable income distribution
Government interventions refer to:
• subsidies, taxes, regulations, property
rights and government provision
(consumption externalities)
• subsidies, taxes, regulations, property
rights and government provision
(production externalities)
• government provision (public goods)
• regulation (imperfect information)
• progressive taxes, welfare benefits,
collective provision and minimum
wage (inequitable income distribution).
Failure
• Task; (In groups)
You are to come up with your best example of a
famous international/national FAILURE!!!!!!
It can be;
• A moment in history
• A sporting event
• Report back;
•
•
•
•
Outline what the failure is,
How the failure occurred (describe the event),
Describe how you would have prevented the failure!
A conclusion about the incident.
BACKGROUND
Aim: An economy wants to achieve allocative efficiency!
(producing the combination of Goods and Services consumers
actually want!)
Adam Smith
Described how an economy can achieve this!
Markets work correctly when the
forces of demand and supply
interact and price systems work to
allocate resources!
Note: equilibrium, consumer and
producer surpluses are maximised
(no D.W.L)
Adam Smith
Perfect information
Consumers and producers
should be well informed so
they can make sensible
decisions about the use of
their resources!
Market failure occurs
No externalities of
when the market
Public goods
No side effects imposed onsystem does not work
others and private sector perfectly i.e conditions
of the invisible hand
provides all goods to
are not met!
consumers!
Consumer Sovereignty
Belief that consumers are
the best judge of their own
well-being!
Perfect mobility
Reallocate resources in
order to deal with changes
in consumers tastes and
preferences and also other
factors;
• Geographic mobility
• Occupational mobility
Perfect competition
Requirements for a perfect
competitor!
e.g. price taker etc…
Discussion-Market Failures
Adam Smith
Perfect information
Consumers and producers
should be well informed so
they can make sensible
decisions about the use of
their resources!
No externalities and
Public goods
No side effects imposed on
others and private sector
provides all goods to
consumers!
Consumer Sovereignty
Belief that consumers are
the best judge of their own
well-being!
Perfect mobility
Reallocate resources in
order to deal with changes
in consumers tastes and
preferences and also other
factors;
• Geographic mobility
• Occupational mobility
Perfect competition
Requirements for a perfect
competitor!
e.g. price taker etc…
Questions:
1. How much does a replacement battery for an iPod cost?
2. Exactly how are the Nike jerseys made?
3. Is Telecom a price taker?
4. Are there barriers to entry and exit for the airline industry?
5. When you buy a boy racer car with a noisy muffler are you the
only one affected by the use of the car?
6. When people consume cigarettes are they the only people
affected by it?
7. When you buy a pair of shoes or a hoodie are you being
influenced?
8. Is purchasing 3 Big Macs a good consumer decision?
9. Is the market able to convert to a different fuel source other
than petrol next week?
10. Do we have the human resources available to start producing
cars tomorrow?
Market has failed!
This is a
Justification
for
Government
intervention
Overview
Main aim of an economy is Allocative Efficiency
Consumer
Sovereignty
Perfect
Competition
Perfect
Mobility
Perfect
Information
Externalities
public
goods
The free market and price systems guides producers
This
is a and make the items
to use scarce
resources
consumers want
Justification
for
Market does Government
not always provide resources which are
efficient and fair.
intervention
Market failure provides justification for intervention. It is the aim of the
Government to help price signals carry the correct information. There are
four roles the Government can provide
Regulatory
Role
Distributive
Role
Allocative/
provisional
Role
Stabilisation
Role
Regulations
and laws
Income
distribution
Providing
collective or
public
goods
Maintain a
stable
economy.
e.g. drinking
age, WOF’S
for cars
Progressive
Taxation,
Transfer
payments
Schools,
defence,
national
parks
Control
inflation,
Employment
levels
 regulatory
 stabilisation
 distributive
 allocative
Taxation
Subsidies
Regulation
Public Provision
EXTERNALITIES
Market Situation
Buyer
Seller
Demand
Supply
Third Party
Externalities
Externalities
Externalities in Private Goods
• Lets start with the effects of:
Alcohol
Do we know the
risks and effects?
http://tvnz.co.nz/nigel-latta/s1-ep3-video-6041406
What are Private Goods?
Goods can be classified as either private, mixed or
public!
•
Rival or Depletable:
If one person has the good then it is not available to others
•
Excludable by price
Cannot enjoy benefits with out paying for the good/service
•
No Externalities
•
Property rights are clear
Those goods with externalities. These goods are not produced
or consumed in socially desirable quantities.
Externalities
Externalities are spill over costs/benefits that
are imposed on people other than the buyer
and/or seller.
These spill over costs or benefits can be a
result of consumption or production.
Private Market Equilibrium
Unregulated free market equilibrium!
Doesn’t account for the spillover
benefits or costs of
consumption/production!
The private costs
associated with the
production of a good or
service. MC/supply
curve for a producer
MC
The private benefits
associated with the
consumption of a good
or service e.g. catching
a bus saves us from
walking
P
MB
Q
Quantity
What are the
spillover costs?
Alcohol
Cost and
price
MC
When we take into
account the spillover
costs there is MARKET
FAILURE. As a result
this product is under
priced and over
consumed
PM
Costs get
greater as
more is
consumed!
MB
SMB
QM
Quantity
Externalities in Society!!!
• Explain why these could be an issue for the
economy of Agnewland. Why should
Government intervene?
•
Cigarettes
•
Synthetic highs
•
Marijuana
•
Petrol (including diesel)
•
Fatty foods
Obesity Epidemic Hits New Zealand
New Zealand is ranked 17th of the world’s most obese populations.
Example
The problem is New Zealanders are eating more calories than they can burn in their increasingly exercisefree lives in front of TV and computers.
Source: The Press 3 March 2007
(a) On GRAPH 1, identify:
(i)the market quantity (label it
Q1 )
(ii)the socially desirable
quantity
(label it QS).
(b) From GRAPH 1, identify
the letter(s) that show the:
(i) deadweight loss area that
illustrates this market’s failure
(ii)per unit tax required to fully
internalise the externality.
(c)Explain why QS is a more
desirable output level than Q1.
b) i) def
ii) ce or PP2
Eg:
(I) Consumers of obesity-causing foods don’t (directly) pay
the full costs of their consumption, market does not take into
account spillovers, junk food is overconsumed and
underpriced, at Q1 MSC is greater than MSB, market failure
at Q1
(E) Qs is more desirable than Q1 because Qs reflects social
preferences, achieves allocative efficiency, MSC=MSB, no
DWL at Qs, reduces surpluses.
C)
What are the
spillover
Benefits?
University
Cost and
price
MC
PM
When we take into
account the spillover
costs there is MARKET
FAILURE. As a result
this product is under
priced and over
consumed
SMB
Benefits get
greater as
more is
consumed!
MB
QM
Quantity
University
What benefits?
Cost and
price
MC
Private equilibrium
problem?
PM
SMB
Internalise?
MB
Conclude?
QM
Quantity
Positive Externalities of Production
Mountain biking tracks from forestry production
When we take into
account the spillover
benefits there is
MARKET FAILURE. As
a result this product is
over priced and under
produced
SMC
Private market
equilibrium
P (social)
Social market
equilibrium
Q(social)
Example!
In recent years, a number of movies have been filmed in
New Zealand, including The Lord of the Rings trilogy, The
Last Samurai and Whale Rider.
Give 3 examples of Positive Externalities of Production for
the movie industry producing in NZ
Draw and appropriately label
a new curve that shows the
effect of Positive Externalities
of Production.
Label the social equilibrium
quantity QS and the social
equilibrium price PS.
Identify and label the per unit
subsidy that would be
needed to internalise the
positive externality.
Pollution caused by the production of dairy cows
SMC
Social market
equilibrium
Private market
equilibrium
P (social)
Q(social)
When we take into
account the spillover
costs there is MARKET
FAILURE. As a result
this product is under
priced and over
produced
Equity and Efficiency
• When setting policies to internalise
externalities, you may not achieve both!
• Lets explore
Lower the catch limit
of recreational
fisherman to 2
fish/person/day
Group work presentation!
• Groups of 3-4
• Current policy and action
• Present to the class.
• Winner may have their phone out for 1 period of
the class to receive calls, use facebook, do
texts, snap chat Tully.
Examples
• Must be current!
• Must have clear externalities (be mixed goods)
• Equity and Efficiency?
• EXAMPLES:
Government
should fund
Team NZ
Increase rules,
regulations
around alcohol
(tax, age, outlets)
Increase
subsidies on
dental care
Reduce subsidies
on University
Fees
Equity and Efficiency Debate
Equity (fair)
Inequity (unfair)
A situation that is considered
fair!
A situation that is considered
unfair!
e.g. A child pays a lower fair
on the bus!
e.g. Rich people can get an
education but poor people
can’t
Equal (same)
Unequal (different)
A situation where everyone
is treated the same
A situation where everyone
is treated differently
e.g. Everybody gets a medal
at the olympics
e.g. A child has to go to bed
earlier than adults
Equity and Equality Box of Debate
Unequal
(different)
Equal
(same)
Equity
(fair)
Inequity
(unfair)
Debate
• Should Maori and Pacific Island students have
greater access to scholarships?
• Is it fair that children are supposed to stand up
for adults on the bus?
• Is it fair that people under the age of 16 get
cheaper movie tickets than adults?
How does this relate to Economics
Market Failure (loss of Allocative Efficiency)
occurs when unfair situations happen in the
Economy in terms of;
•
•
•
•
Market income
Purchasing power
Opportunity
Access to resources
Distribution of Income
Economies generate incomes.
How incomes are earned is determined by the
market. In a free market (interaction of demand
and supply) and our skills and abilities dictate
our level of income.
e.g Doctors vs Bus Drivers, Rugby Players vs
Lawn Bowls
How the income is spread is called;
Distribution of Income
Wealth vs Income
Wealth:
Is a stock. How much exists at a certain time!
Income:
Is a flow. Money earned over a period of time!
Distribution of Income
If all incomes were
equal the income
distribution would look
like this!
Lowest
10% of
Income
earners
2nd
10% of
Income
earners
3rd
10% of
Income
earners
4th
10% of
Income
earners
5th
10% of
Income
earners
6th
10% of
Income
earners
7th
10% of
Income
earners
8th
10% of
Income
earners
9th
10% of
Income
earners
Highest
10% of
Income
earners
Distribution of Income
People with different skills
and abilities are valued
differently in the market
More
than
equal
share
Less
than
equal
share
Lowest
10% of
Income
earners
2nd
10% of
Income
earners
3rd
10% of
Income
earners
4th
10% of
Income
earners
5th
10% of
Income
earners
6th
10% of
Income
earners
7th
10% of
Income
earners
8th
10% of
Income
earners
9th
10% of
Income
earners
Highest
10% of
Income
earners
Weighting up the stats!
• Market Failure (loss of Allocative Efficiency)
occurs when unfair situations happen in the
Economy in terms of;
•
•
•
•
Market income
Purchasing power
Opportunity
Access to resources
Distribution of Income
Household
income
groups
% of
income
earned by
group
Cumulative
% of
income
1
0.3
0.3
2
1.7
2
3
4
6
4
6
12
5
8
20
6
10
30
7
12
42
8
16
58
9
17
75
10
25
100
Lowest %
of
households
We can graph
this. This is
called a Lorenz
Curve!
Highest %
of
households
Cumulative % of income
Lorenz Curve (Inequality)
Line of complete
equality. 50% of
the economies
households earn
50% of the
income
100
90
80
70
60
50
more unequal
40
30
20
This does not represent
the market income. We
draw in the Lorenz
curve to show this!
Line of wealth.
Lineline
of market
This
is more
income.
unequal90%
due of
to
the economies
people
with high
households
earn
incomes ability
50% (generate
of the
to save
income
wealth).
10
10
20 30 40 50 60 70 80 90 100
Cumulative % of Households
10% of the
richest people
earn 50% of the
economies
income
Redistribution of income?
• Existing tools for redistribution are?
 Tax
• Top tax bracket is 33c should it go to 38c or
should it go to 30c?
• Fair or Unfair?
• Other tools?
Cumulative % of income
Issues Equitable or Inequitable
• Increase GST to
15%?
100
90
• Working for
families subsidy?
80
70
60
• Raising the
minimum wage?
50
40
30
20
10
10
20 30 40 50 60 70 80 90 100
Cumulative % of Households
• Lowering tax to
high income
earners?
• Lowering welfare
payments to the
elderly?
Equity and Efficiency Trade off
Fairness
(income
market)
When the Government aims to
improve equity in income
distribution it will come at a
cost of Efficiency. We can use
the PPF to draw this!
Economy
producing at
a high level
of activity.
Efficiency
Government
introduces
Working For
Families to
help families
with children
Equity
Equity and Efficiency
Efficiency
Government
introduces
Working For
Thetofamily
Families
help will not try to solve
theirwith
financial issues by being
families
more productive and as a result
children
the economy will lose Efficiency
from the Government pushing
for equity
Equity
A family with 2 children!
Due to the Government
supplementing their income
there is a less incentive for
both parents to be
productive!
Ie:
The difference between
earning $60,000/year or
earning $38,000/year plus
WFF supplement is
$8000/year.
Equity and Efficiency
Country A is highly
efficient but has a
very unequal
distribution of income
Efficiency
Country B is very
equal but is very
inefficient.
Equity
Efficiency or Equity policy??????
An increase in the minimum wage
Lowering of Transfer Payments
Progressive tax rates
Providing benefits for single
mothers
Removal of the community
services cards
Increasing the pension for elderly
Questions
A government can use progressive taxes to
redistribute an economies income.
Give 2 other ways the government can redistribute income:
1.
2.
Explain how progressive taxes redistribute incomes.
On the Lorenz curve show the effect of increase the top tax rate.
Explain why some level of income inequality may be equitable.
Answers
1. Community services card, Transfer payments,
gold card, Working for families…..
2. Progressive taxes redistribute income through
taxing higher income earners a higher
average/marginal tax rate per dollar earned.
The government redistributes the extra tax
revenue to lower income earners…..
3. On board
Answers
4.
If people are working longer hours or are
more skilled/productive (via qualifications)
they may earn more than those with less
skills. This creates unequal income
distribution (income inequality)between
households, however this is fair as those
who are unskilled/less productive are paid
lower due to lower contributions to the
economy.
Answers
In a market system, incomes are allocated by the forces of supply and
demand (in factor markets) and supply and demand are different in each
market.
(E) If you have skills to produce products that are demanded, you earn income(and if
the product demand is high and the number with the skills to produce it is small, you
earn a high income).
Because supply and demand are different in different markets, uneven incomes are
earned. (Q)
Answers
This could be seen as unfair (inequitable).
E The free market means that only those who work can gain income.
Q Some who cannot work (sick, invalids, retired) will receive no income.
Equity means fairness; equality means the same.
Everyone receiving the same income could be seen as unfair as those who worked
longer hours would be no better off than those who did not work.
Q There would be no incentive to work longer hours etc if you were getting the same
income as those who worked less / had fewer skills.
Public Goods vs Private Goods!!!
What is the difference?
Public Goods vs Private Goods!!!
• Private goods
 Excludable
 Rival
 Depletable
Producers can
exclude users
through price
Consumers
use excludes
others from
using it.
Once used it
cannot be
consumed
again.
Public Goods vs Private Goods!!!
• Public goods
Producers
cannot
exclude users
 NonExcludable
 NonRival
 NonDepletable
Has Zero
MARGINAL
COST
Consumers
use does not
exclude others
from using it.
Once used it
can be
consumed
again.
Public goods
• Often have positive externalities of
production/consumption
 Examples?
What would
happen if we turn
this into a private
good?
Why provided this good?
Who pays?
Other examples?
Public Goods
Equity and Efficiency???
Equity and efficiency to providing
the community with a Library:
Equity?
Efficiency?
Problem – Free rider
People who refuse to
contribute to the cost of
providing the good on
the grounds no one can
be excluded from using
it!
Firms have very little
option when the free rider
problem occurs! It is
difficult to charge for the
products use!