Explorations in Economics

1. Explorations in Economics Alan B. Krueger & David A. Anderson

2. Chapter 9: Market Failure and Government Failure • Module 26: When the Invisible Hand Is All Thumbs: Market Failure • Module 27: The Heavy Hand of Government: Government Failure

3. MODULE 26:MARKET FAILURE KEY IDEA: Market outcomes can be inefficient if there are spillover effects from the production or use of goods, if some consumers cannot be excluded from consuming a good, if information is imperfect, or if firms have market power (as discussed in Chapter 8). OBJECTIVES: • To define market failure. • To explain the concepts of public goods, externalities, and imperfect information. • To identify possible solutions to the sources of market failure.

4. EFFICIENCY AND MARKET FAILURE Market failure is the inability of a market to achieve an efficient outcome. Markets can be judged by equity and efficiency, but these two ideas do not always work together.

5. PRIVATE GOODS ANDPUBLIC GOODS A public good is nonrival and nonexcludable. • A good is nonexcludable if it is not possible to prevent others from consuming it. • A good is nonrival if one person’s consumption of the good does not makes it impossible for others to consume it.

6. PRIVATE GOODS ANDPUBLIC GOODS Private goods is excludable and rival. • A good is excludable if it is possible to prevent others from consuming it. • A good is rival if one person’s consumption of the good makes it impossible for others to consume it.

7. PRIVATE GOODS ANDPUBLIC GOODS The Underprovision of Public Goods • Little incentive to supply the good privatelybecause there is lack of incentive to pay. • The free-rider problem is that people take advantage of the nonexcludable and nonrival nature of public goods to avoid paying for them.

8. PRIVATE GOODS ANDPUBLIC GOODS • The drop- in- the bucket problem arises when no one person’s payment for a good is essential, which diminishes each person’s incentive to contribute. • Providing Public Goods: Government and taxes • The Tragedy of the Commons is that nonexcludable but rival goods become overused.

9. EXTERNALITIES An externality is an effect felt beyond those whose decisions caused the effect. • A positive externality will bring benefits to those beyond the decision-makers. • A negative externality causes spillover costs to those not involved in the decision.

10. EXTERNALITIES Solving the NEGATIVE Externality Problem: Tax on Consumers

11. EXTERNALITIES Solving the NEGATIVE Externality Problem: Tax on Producers

12. EXTERNALITIES Solving the POSITIVE externality problem: Subsidies Example: Education is provided publicly by the government and with subsidies (grants) for college students that qualify.

13. EXTERNALITIES Creating a Market for Negative Externalities • Tradable permits grant the right to emit a specific amount of pollution. • Benefits of Emission Trading Programs • They allow flexibility and creativity. • They allocate emissions rights to those who value them the most. • They provide an incentive to minimize emissions.

14. IMPERFECT INFORMATION Asymmetric information is an imbalance of information between parties, meaning that one party knows things that the other does not. • lemon laws • Carmax When there is adverse selection, people with the greatest need for a particular type of product are the ones most likely to buy it. • health, fire or life insurance

15. CONDITIONS FOR MARKET EFFICIENCY In the absence of perfect information or other sources of market failure, can we expect markets to be efficient?

16. MODULE 26 REVIEW What is… A. Market failure? B. Private good? C. Excludable? D. Rival? E. Public good? F. Free- rider problem? G. Drop- in- the- bucket problem? H. Tragedy of the commons? I. Externality? J. Asymmetric information? K. Adverse selection?

17. MODULE 27:GOVERNMENT FAILURE KEY IDEA: The government can create problems of its own when it tries to prevent market failure. OBJECTIVES: • To explain the meaning of government failure. • To identify six reasons for government failure. • To explain influences that can reduce government failure.

18. SIX REASONS FORGOVERNMENT FAILURE Electoral Pressures and Interest Group Politics: Interest groups seek influence on government policy. To logroll is to work toward the passage of legislation by trading votes with other legislators. Short-termism is a tendency to place too much weight on immediate benefits and not enough weight on longer- term benefits and costs.

19. SIX REASONS FORGOVERNMENT FAILURE Regulatory capture is the control of a regulatory agency by the industry it is supposed to regulate. Rent seeking is the pursuit of profit by shifting existing gains rather than by creating new gains for society.

20. SIX REASONS FORGOVERNMENT FAILURE Missing Valuations • Negative externality problems are hard since there is not market-determined price. • There is no market that assesses the value of a public good. • Are there tools that efficiently measure value?

21. SIX REASONS FORGOVERNMENT FAILURE Incentive Effects • Most taxes create disincentives for productive activity. • Income Taxes reduce take-home pay and reduces incentive to work at all.

22. SIX REASONS FORGOVERNMENT FAILURE According to the law of unintended consequences, intervention in a complex system can have surprising and undesirable consequences.

23. VOTING WITH YOUR FEET: A CHECK ON GOVERNMENT FAILURE Voting with your feet! The idea that households or firms will move out of a city or state to remove themselves from adverse conditions of high taxes, poor schools, or a lack of parks and other public goods. Should the Government Ever Intervene? When the government should or should not intervene is often met a divided electorate.

24. MODULE 27 REVIEW What is… A. Government failure? B. Interest groups? C. Logroll? D. Short- termism? E. Regulatory capture? F. Rent seeking? G. Missing valuations? H. Law of unintended consequences?