GOVERNMENT INTERVENTION IN
THE ECONOMY
SPILLOVER BENEFITS & COSTS

When 1 person’s consumption of a good provides
utility to a 3rd party who has not directly
purchased the good, we have spillover benefits
Not reflected in the market price of the good
 AKA. Positive externality

EXAMPLE

A home in a neighborhood spends money to
professionally landscape their front yard. As a
neighbor rides her bike past the yard, she smells
the lovely scent of the roses. Although the
neighbor did not spend any money on the roses,
she is benefitting.
AND, ON A GRAPH
P
S
}
P
market
Spillover D social
benefits
D private
Q market
Q social
Q
SO, WHAT DOES THIS MEAN?





The market demand curve for roses captured the private
benefits received by consumers of roses, but not the
additional benefits received by neighbors of those who
consumed roses
The private demand curve, which does not include the
spillover benefits, lies below the societal demand curve.
The market produces only Qmarket roses, but the optimal
amount is greater at Qsocial
Since the market produces less than the socially optimal
amount, there is an underallocation of resources to rose
production—society wants more than the market provides
The existence of spillover benefits in a market results in an
underallocation of resources in that market= there’s not
enough of a good thing
AND…

The neighbor provided a public good (community
beautification) while the other neighbors were
free riders

How could we have contributed to the provision of the
public good?
SUBSIDIES FOR CONSUMERS
Market failures on a larger scale, are remedied
through subsidies
 The goal is to move the EQ from the Qmarket to
the Qsocial


In the ex. of roses, the govt could provide a subsidy to
gardeners, equal to the amount of the spillover
benefit

By sending a check to the home who had the yard
landscaped, the demand for roses would have increased, &
shifted the Dprivate to the Dsocial
SUBSIDY FOR CONSUMERS
P
S
Pfirm
}
Pmarket
Subsidy
Pcons
D social
D private
Qmarket
Qsocial
Q
SUBSIDIES FOR PRODUCERS
What happens to the supply curve with a
subsidy?
 Let’s look at the next graph to see…

SUBSIDY FOR PRODUCERS
P
S
Pfirm
}
Pmarket
S1
Subsidy
Pcons
D social
D private
Qmarket
Qsocial
Q
POLLUTION & SPILLOVER COSTS

When a person’s consumption of a good imposes a
negative utility on a 3rd party who did not
purchase the good, we have spillover
costs/negative externalities
EX. CIGARETTE SMOKE

The thought is to move the spillover costs from
those who do not smoke, and onto the producers
(hence the cigarette tax)
ON A GRAPH…
P
Ssocial
}
Sprivate
spillover cost
Pmarket
D
Qsocial
Qmarket
Q
COASE THEOREM
Ronald Coase is a Nobel Laureate in Economics
 His theory states that resources can be allocated
efficiently if private ownership rights are assigned and
when there are no transaction costs.
 no matter who receives the legal rights to ownership,
the assignment will have no effect on the way economic
resources are used.

CONTINUED….

The Coase Theorem changes the way people look
at economic problems.
There is less need for govt intervention
 In any economic transaction, solutions that can
benefit most parties can be achieved by negotiations.
 Ex. Environmental problems can be resolved if
property rights are assigned rather than relying on
government command & control.


Sounds like the free market to me!
PUBLIC CHOICE
IS IT RATIONAL FOR GOVERNMENT LEADERS
TO FAVOR SPECIAL INTERESTS OVER THE GENERAL
PUBLIC INTEREST?
The idea is that special interests have a big stake
in govt, or a big interest in govt.
 When special interests give politicians
contributions & support, each member of the
public may lose just a little when a special
interest gets its way, so the public doesn’t pay
attention.
 The public is ignorant. Therefore, the politician
goes with the special interest.


The more concentrated the benefit for the special
interest and the more diffused the cost to the public,
the more likely the special interest will get its way.
WHY ARE POLITICIANS MAINLY IN THE
MIDDLE OF THE ROAD?
The median-voter hypothesis predicts that
politicians, regardless of party, will appeal
to the median voter in the constituency they
represent.
 It also predicts that politicians will take a
more extreme position in the party primary
election (when they are appealing to the
median voter in the party) than in the
general election.

ARE PEOPLE RATIONAL OR IRRATIONAL
WHEN THEY SPEND LITTLE TIME EVALUATING
CANDIDATES BEFORE THEY VOTE AND WHEN THEY DON’T
VOTE?


This is known as rational ignorance! Why be
informed about the candidates when your
vote counts so little? Why even vote?
If this is true, why do so many people vote?
The public-choice answer is that voting is a
consumption activity.

Voting gives people a feeling that they did their
civic duty. By voting, they can complain without
guilt when they don’t like a government policy.
WHAT IS THE EFFECT OF BUREAUCRATIC
ENTREPRENEURS ON GOVERNMENT?
A business is successful if it can maximize profits.
 A bureaucrat is successful if he or she can
maximize power.
 Bureaucrats are rewarded when they expand the
duties & clientele of their departments.
 A bureaucrat will have a smaller department if it
becomes more efficient.


Bureaucrats have an incentive to expand their
departments, not to reduce them. With larger
departments come more power, a bigger office, a
higher salary etc.
EFFICIENCY, EQUITY & TAX
STRUCTURE
INCOME DISTRIBUTION & TAX STRUCTURE
The govt is also called to action to remedy issues
of equity or fairness
 Markets do not provide equity or fairness

Ex. Some consumers can afford a new Mercedes,
come cannot
 Ex. Some parents can not afford pediatric care for
their children

EQUITY AS A GOAL


Some purpose that economics resources should be
equally divided amongst all members of society
Egalitarianism: belief in the equality of all people,
especially in political, social, or economic life.

Incentive to work hard, take risk or seek a competitive
advantage are gone
EX.
Everyone in class is guaranteed to be
compensated with a “B” regardless of your effort.
 What does this mean?

“C” level students won’t work hard because their
grade will increase anyways
 “A” students lack motivation to do well because they
are compensated below their quality of work


Everyone works less
HOW DO WE MEASURE INCOME
DISTRIBUTION?
Let’s see what Reff Enomics has to say!
 http://www.reffonomics.com/TRB/chapter19/Lore
nzCurveLesson5.swf

TAX STRUCTURES

Tax: is a mandatory payment to local, state, or nat’l
govt

Revenue: is govt income from taxes & other nontax
sources.

Revenues raised from taxes fund programs & govt
services such as highways, police, education, & parks.

Other forms of revenues include lotteries & fees
TAX
STRUCTURES

Equity—tax applied uniformly; people in same
situations pay the same

Simplicity—should be easy for taxpayers to
understand & govt to collect

Efficiency—how well tax raises revenue with least
administrative cost & how small the effort & expense
are required to pay the tax

Criteria sometimes conflict; a given tax may not meet
all
TAX STRUCTURES

All taxes fall under the classification of 1 of these:

Proportional tax—flat tax—all taxpayers pay same %age of
income Ex. Corporate income tax (35%)

Progressive tax—higher income earners pay higher %age of
income Ex. Federal Income Tax

Regressive tax—lower income earners pay higher
percentage of income, Ex. sales tax
And that… ladies
& gentlemen is
the end of
Microeconomics!