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Efficiency and Non-Market Forces

Efficiency and Non-Market Forces. Going ga-ga about markets Review of Market Efficiency Government’s Role in Economic Efficiency Provides infrastructure for economic activity Market Failures 4 reasons markets break down / do not exist Public Goods What are they? How best to manage them?.

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Efficiency and Non-Market Forces

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  1. Efficiency and Non-Market Forces • Going ga-ga about markets • Review of Market Efficiency • Government’s Role in Economic Efficiency • Provides infrastructure for economic activity • Market Failures • 4 reasons markets break down / do not exist • Public Goods • What are they? How best to manage them?

  2. Revisiting Some Economic Concepts • Value of Free Markets (bidding mechanism) • Maximize (total social benefit - cost) • Pareto Efficient • Competition drives societies to PPF • Pareto Improvements • Sharing the Economic Pie • Efficiency, Growth, Better Living Standards • Markets work under some assumptions

  3. The Government: not there just to take your money! • Physical Infrastructure • Networks, Lifelines • Institutional Infrastructure • Legal System • Regulation • Security • Internal; External; Preserves conditions for trade. • Taxation • Pays for public goods; helps redistribute econ growth • Can increase efficiency & help create markets

  4. Legal System • Criminal • Property • Contract • Tort • Antitrust Law • Price fixing; Monopoly; Mergers

  5. Reasons for Market Failure Why do markets fail in general? • Economic: Wealth Effect /Market Power • Externalities • Negative • Positive • Public Goods and Common Property Resources • Asymmetric Information • Adverse selection (market for lemons) • Moral Hazard (risk insurance problem)

  6. Externality Unintended costs or benefits that are imposed on unsuspecting people and that result from the economic activity of others • Subsidize the production of an environmentally friendly good making it less expensive

  7. MSC = S + tax $1.50 1.30 B 0.80 Q eff Negative Externality – graph Price per Gallon S A 1.00 D Q Gasoline ineff (Gallons)

  8. $65,000 B MSB = D + Subsidy Positive Externality - graph Price S 50,000 A D Q Number of Bachelor’s Degrees

  9. What is Market Failure A market left on its own will not address the problem of negative externalities

  10. Some Environmental Terms related to Market Failure • Social Cost • This cost includes both the private costs of production and the externalities cost generated by its production • Free Rider • Someone who consumes a good or service without paying for it • Property Rights • The right to own a good or service and the right to receive the benefits of the goods or service

  11. Public Goods • Goods whose benefits are not diminished even when additional people consume it and no one is excluded from its benefits • Roads • National defense • Lighthouse

  12. Private / Mixed / Pure Public Goods Non Excludable Excludable

  13. Private / Mixed / Pure Public Goods Rival Non Rival

  14. Private / Mixed / Pure Public Goods Excludable Non Excludable Rival Non Rival

  15. Government Failure • The failure of the government to buy the quantity of public goods that generates maximum efficiency

  16. Solutions to the Externality Problem • Command & Control • Export (NIMBY) • Convert to private goods (property rights) • Create new property forms • Internalize the cost • Impose penalty taxes • Enforce standards • Modern market based measures • Quantity: quotas / permits • Price: taxes

  17. Examples of Environmental Solutions • New Property Form • Giving legal title to a public beach • Pollution Tax • A tax of 5 cents per kilowatt-hour levied on a firm using coal to generate electricity • Standard • Mandate the use of scrubbers in smokestacks

  18. Market Failure Externality Negative Externality Socially Optimal Output Positive Externality Internalizing Externalities Transaction Costs Coase Theorem Public Good Rivalry in Consumption Nonexcludability Excludability Free Rider Asymmetric Information Adverse Selection Moral Hazard Some Cool Environmental Buzzwords!

  19. ADDITIONAL MATERIAL for the real nerds

  20. Negative Externality

  21. The Triangle

  22. Positive Externality

  23. A Corrective Tax Gone Wrong

  24. Cost of Reducing Pollution - 3 Firms example

  25. Asymmetric Information in a Product Market Price and Cost S1 = MPC E1 E2 D1 = MPB1 (asymmetric info.) D2 = MPB2 (symmetric info.) 0 Q2 Q1 Quantity Output with Symmetric info. Output with Asymmetric Info.

  26. Wage Rate Asymmetric Information in a Factor Market S2= MPC2 (symmetric info.) S1= MPC1 (asymmetric info.) Wage with Symmetric info. E2 W2 E1 W1 Wage with Asymmetric Info. D1 = MPB 0 Q2 Q1 Quantity of Labor Quantity of Labor with Symmetric info. Quantity of Labor with Asymmetric Info.

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