Chapter 5 the public sector
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Chapter 5: The Public Sector. Economic and technical efficiency. Technical efficiency – no unemployed or underemployed resources ( i.e. , operating on PPC). Economic efficiency (also known as Pareto optimality) – it is not possible to benefit one or more individuals without harming someone else

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Economic and technical efficiency
Economic and technical efficiency

  • Technical efficiency – no unemployed or underemployed resources (i.e., operating on PPC).

  • Economic efficiency (also known as Pareto optimality) – it is not possible to benefit one or more individuals without harming someone else

  • Technical efficiency is a prerequisite for economic efficiency (but does not guarantee economic efficiency)

Markets and economic efficiency
Markets and economic efficiency

  • voluntary trade in markets benefits each trading partner

  • under ideal conditions, markets attain a state of economic efficiency (Pareto optimality)

Market failure
Market failure

  • Markets may fail to achieve economic efficiency as a result of:

    • imperfect information

    • externalities

    • public goods

    • the absence of property rights

    • monopoly, or

    • macroeconomic instability

Imperfect information
Imperfect information

  • One party may not benefit from a market transaction if there is imperfect information about the item being sold

  • Possible corrective action:

    • product labeling requirements (listing ingredients or including warnings)

    • requiring guarantees (such as “lemon laws”)

    • requiring “truth in advertising”

    • licensing workers in certain professions

    • providing public information about products


  • Externalities are side effects of production or consumption that affect individuals not directly involved in the activity or transaction

  • Positive externalities occur when one or more parties not involved in the transaction benefit from the activity

  • Negative externalities occur when third parties are harmed.

Positive externalities
Positive externalities

  • Those engaged in the transaction do not take the external benefits into account in their decision making

  • This results in underproduction

  • Possible remedies:

    • subsidy

    • regulation

Negative externalities
Negative externalities

  • Negative externalities result in social costs that are not borne by the parties involved in the transaction.

  • results in overproduction

  • Possible solutions:

    • taxation

    • regulation

Internalizing externalities
Internalizing externalities

  • The use of taxes or subsidies to correct for an externality is sometimes referred to as “internalizing” the externality.

Public goods
Public goods

  • nonrival in consumption (one person’s consumption does not affect the quantity or the quality of the good available to others)

  • free-rider problem results in underproduction

  • Possible solutions: government production or subsidization

Common property resources
Common property resources

  • problem of the commons - resources are commonly owned

    • benefits are received by those who use the resource

    • costs are shared by all

  • overutilization

  • government regulation


  • higher prices and lower output

  • antitrust law, regulation, or public production

Macroeconomic instability
Macroeconomic instability

  • economic inefficiency caused by unemployment during recessions

  • government policies designed to stabilize the economy

Public choice theory
Public choice theory

  • government policy is constructed by self-interested individuals

  • participants in policy formation are concerned about their own self interest, not the “public interest”

  • economic rent - a payment in excess of opportunity costs

  • rent-seeking behavior on the part of special-interest groups

Economic policy
Economic policy

  • Microeconomic policy - designed to correct for:

    • imperfect information,

    • externalities,

    • public goods,

    • the absence of property rights, and

    • monopolies.

  • Macroeconomic policy -designed to enhance macroeconomic stability and encourage economic growth.