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28. Government and Market Failure. Chapter Objectives. How Public Goods are Distinguished from Private Goods The Method of Determining the Optimal Quantity of a Public Good The Basics of Cost-Benefit Analysis About Externalities (Spillover Costs and Benefits) and the Methods to Remedy Them

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Government and market failure

28

Government and Market Failure


Chapter objectives

Chapter Objectives

  • How Public Goods are Distinguished from Private Goods

  • The Method of Determining the Optimal Quantity of a Public Good

  • The Basics of Cost-Benefit Analysis

  • About Externalities (Spillover Costs and Benefits) and the Methods to Remedy Them

  • How Information Failures Can Justify Government Interventions in Some Markets


Public goods

W 28.1

Public Goods

  • Private Goods

    • Rivalry

    • Excludability

  • Public Goods

    • Nonrivalry

    • Nonexcludability

    • Free-Rider Problem

    • Optimal Quantity of a Public Good


Demand for public goods

Demand for Public Goods

Two Individuals

(1)

Quantity

Of Public

Good

(2)

Adams’

Willingness

To Pay (Price)

(3)

Benson’s

Willingness

To Pay (Price)

(4)

Collective

Willingness

To Pay (Price)

=

=

=

=

=

$9

7

5

3

1

+

+

+

+

+

$5

4

3

2

1

$4

3

2

1

0

1

2

3

4

5

Graphically…


Demand for public goods1

P

$9

7

5

3

1

0

Q

1

2

3

4

5

P

$6

5

4

3

2

1

0

Q

1

2

3

4

5

P

$6

5

4

3

2

1

0

Q

1

2

3

4

5

Demand for Public Goods

S

Collective Demand

Optimal

Quantity

$7 for 2 Items

Collective

Willingness

To Pay

$3 for 4 Items

DC

Connect the Dots

Comparing

MB and MC

Collective Demand and Supply

Benson’s Demand

$4 for 2 Items

D2

$2 for 4 Items

Benson

Adams’ Demand

$3 for 2 Items

$1 for 4 Items

D1

Adams


Cost benefit analysis

Cost-Benefit Analysis

  • Concept

  • Marginal-Cost-Marginal-Benefit Rule


Externalities

P

P

O 28.2

O 28.1

G 28.1

0

Q

Q

Externalities

Negative Externalities

Positive Externalities

  • Individual Bargaining: Coase Theorem

    • Limitations

  • Liability Rules and Lawsuits

Negative

Externalities

St

St

Positive

Externalities

S

Dt

D

D

Overallocation

Underallocation

0

Qo

Qe

Qe

Qo


Externalities1

Externalities

  • Government Intervention

    • Direct Controls

    • Specific Taxes

    • Subsidies and Government Provision

      • Subsidies to Buyers

      • Subsidies to Producers

  • A Market-Based Approach

    • The Tragedy of the Commons

    • A Market for Externality Rights


Externalities2

P

Price Per Pollution Right

Q

0

Quantity of 1-Ton Pollution Rights

Externalities

  • Operation of the Market

    • Advantages

    • Real-World Examples

S=Supply of

Pollution

Rights

D2016

D2006

$200

$100

500

750

1000


Externalities3

Externalities

  • Society’s Optimal Amount of Externality Reduction

    • MC, MB, and Equilibrium

MC

Socially

Optimum Amount

Of Pollution

Abatement

Society’s Marginal Benefit and Marginal

Cost of Pollution Abatement (Dollars)

MB

0

Q1


Global warming

GLOBAL PERSPECTIVE

Global Warming

Carbon-Dioxide Emissions, Tons Per Capita, Selected Nations 2004

0 5 10 15 20 25

United States

Australia

Canada

Czech Republic

Germany

Japan

United Kingdom

Italy

Spain

France

19.8

17.0

16.2

11.8

10.3

9.2

8.8

7.4

7.2

6.2

Source: OECD Environmental Data


Information failures

O 28.3

Information Failures

  • Asymmetric Information

  • Inadequate Information Involving Sellers

    • Example: Gasoline Market

    • Example: Licensing of Surgeons

  • Inadequate Information Involving Buyers

    • Moral Hazard Problem

    • Adverse Selection Problem

    • Workplace Safety

  • Qualification


Lojack a case of positive externalities

Lojack: A Case of Positive Externalities

Last

Word

  • Private Crime Reduction Expenditures $300 Billion

  • Some Redistribute Rather than Reduce Crime

  • Lojack Car Recoveries are 95% Versus 60% for Others

  • Locates and Stops Chop Shops

  • Estimated 15 Times MSB to Consumers

  • Underallocation Result

  • Subsidize Consumer Purchase with Lower Insurance Rates

  • Discounts too Small to Offset Underallocation


Key terms

private goods

public goods

free-rider problem

cost-benefit analysis

marginal-cost-marginal-benefit-rule

externalities

Coase theorem

tragedy of the commons

market for externality rights

optimum reduction of an externality

asymmetric information

moral hazard problem

adverse selection problem

Key Terms


Next chapter preview

Next Chapter Preview…

Public Choice Theory

and the Economics

Of Taxation

Chapter 29!


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