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Market Failures and Government Policy

Market Failures and Government Policy. Market Failures: Externalities and Public Goods. Society's microeconomic objectives equity social efficiency marginal social benefits and costs production where MSB = MSC. Market Failures: Externalities and Public Goods. Externalities

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Market Failures and Government Policy

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  1. Market Failures and Government Policy

  2. Market Failures: Externalities and Public Goods • Society's microeconomic objectives • equity • social efficiency • marginal social benefits and costs • production where MSB = MSC

  3. Market Failures: Externalities and Public Goods • Externalities • External costs of production • MSC > MC

  4. External costs in production MC = S P D Q1 Costs and benefits O Quantity

  5. External costs in production External cost Q2 Social optimum MSC MC = S Costs and benefits P D O Q1 Quantity

  6. Market Failures: Externalities and Public Goods • Externalities • External costs of production • MSC > MC • External benefits of production • MSC < MC

  7. External benefits in production MC = S Costs and benefits P D O Q1 Quantity

  8. External benefits in production External benefit Q2 Q1 Social optimum MC = S MSC Costs and benefits P D O Quantity

  9. External benefit External cost External costs and benefits in production MSC MC = S MSC MC = S Costs and benefits (£) Costs and benefits (£) D P P D O O Q Q Q Q 2 1 2 1 Quantity Quantity (b) External benefits (a ) External costs

  10. Market Failures: Externalities and Public Goods • Externalities • External costs of production • MSC > MC • External benefits of production • MSC < MC • External costs of consumption

  11. Market Failures: Externalities and Public Goods • Externalities • External costs of production • MSC > MC • External benefits of production • MSC < MC • External costs of consumption • MSB < MB

  12. External costs in consumption (MB) MU = D Q1 Costs and benefits P D O Quantity

  13. External costs in consumption External cost (MB) MU = D Q2 Social optimum Costs and benefits P D MSB O Q1 Quantity

  14. Market Failures: Externalities and Public Goods • Externalities • External costs of production • MSC > MC • External benefits of production • MSC < MC • External costs of consumption • MSB < MB • External benefits of consumption

  15. Market Failures: Externalities and Public Goods • Externalities • External costs of production • MSC > MC • External benefits of production • MSC < MC • External costs of consumption • MSB < MB • External benefits of consumption • MSB > MB

  16. External benefits in consumption (MB) MU = D Costs and benefits P D O Q1 Quantity

  17. External benefits in consumption External benefit (MB) MU = D Q2 Social optimum Costs and benefits P D MSB O Q1 Quantity

  18. External benefit External cost Q Q Q Q 2 2 1 1 External costs and benefits in consumption Costs and benefits (£) Costs and benefits (£) P P P P MSB MB MB MSB O O Rail miles Car miles (b) External benefits (a ) External costs

  19. Market Failures: Externalities and Public Goods • Externalities • External costs of production • MSC > MC • External benefits of production • MSC < MC • External costs of consumption • MSB < MB • External benefits of consumption • MSB > MB • Public goods

  20. Market Failures: Externalities and Public Goods • Externalities • External costs of production • MSC > MC • External benefits of production • MSC < MC • External costs of consumption • MSB < MB • External benefits of consumption • MSB > MB • Public goods • non rivalry

  21. Market Failures: Externalities and Public Goods • Externalities • External costs of production • MSC > MC • External benefits of production • MSC < MC • External costs of consumption • MSB < MB • External benefits of consumption • MSB > MB • Public goods • non rivalry • non-excludability

  22. Market Failures: Monopoly Power • The demand curve under monopoly • production at less than the social optimum

  23. A monopolist producing less than the social optimum MC P1 MC1 AR MR Q1 Monopoly output £ O Q

  24. A monopolist producing less than the social optimum Perfectly competitive output Monopoly output £ MC = MSC P1 P2= MSB = MSC MC1 AR = MSB MR O Q Q2 Q1

  25. Market Failures: Monopoly Power • The demand curve under monopoly • production at less than the social optimum • Deadweight loss under monopoly • consumer and producer surplus • consumer surplus

  26. Market Failures: Monopoly Power • The demand curve under monopoly • production at less than the social optimum • Deadweight loss under monopoly • consumer and producer surplus • consumer surplus • producer surplus

  27. Market Failures: Monopoly Power • The demand curve under monopoly • production at less than the social optimum • Deadweight loss under monopoly • consumer and producer surplus • consumer surplus • producer surplus • total surplus

  28. Deadweight loss under monopoly a Ppc Qpc MC (= S under perfect competition) £ Consumer surplus Producer surplus AR = D O Q (a) Industry equilibrium under perfect competition

  29. Market Failures: Monopoly Power • The demand curve under monopoly • production at less than the social optimum • Deadweight loss under monopoly • consumer and producer surplus • consumer surplus • producer surplus • total surplus • the effect of monopoly on total surplus

  30. Deadweight loss under monopoly Deadweight welfare loss b Pm MR Qpc MC (= S under perfect competition) £ Consumer surplus a Ppc Producer surplus AR = D O Qpc Q (b) Industry equilibrium under monopoly

  31. Deadweight loss under monopoly Perfect competition a Ppc Qpc MC (= S under perfect competition) £ Consumer surplus Producer surplus AR = D O Q (a) Industry equilibrium under perfect competition

  32. Deadweight loss under monopoly Monopoly Deadweight welfare loss b Pm MR Qpc MC (= S under perfect competition) £ Consumer surplus a Ppc Producer surplus AR = D O Qpc Q (b) Industry equilibrium under monopoly

  33. Market Failures: Monopoly Power • The demand curve under monopoly • production at less than the social optimum • Deadweight loss under monopoly • consumer and producer surplus • consumer surplus • producer surplus • total surplus • the effect of monopoly on total surplus • Other problems with monopoly

  34. Market Failures: Monopoly Power • The demand curve under monopoly • production at less than the social optimum • Deadweight loss under monopoly • consumer and producer surplus • consumer surplus • producer surplus • total surplus • the effect of monopoly on total surplus • Other problems with monopoly • Possible advantages from monopoly

  35. Other Market Failures • Ignorance and uncertainty • Immobility of factors and time lags • Protecting people's interests • dependants • the principal–agent problem • the problem of asymmetric information • the need for monitoring • poor economic decision making by people • merit goods • Macroeconomic goals • Economists and policy advice

  36. Government Intervention: Taxes and Subsidies • The use of taxes and subsidies to correct externalities • the optimum size of a tax

  37. Using taxes to correct a market distortion MC = S P D Q1 Costs and benefits O Quantity

  38. Using taxes to correct a market distortion External cost Q2 Social optimum MSC MC = S Costs and benefits P D O Q1 Quantity

  39. Using taxes to correct a market distortion Optimum tax = MSC–MC MC Q2 MSC MC = S Costs and benefits P D O Q1 Quantity

  40. Government Intervention: Taxes and Subsidies • The use of taxes and subsidies to correct externalities • the optimum size of a tax • the optimum size of a subsidy

  41. Using subsidies to correct a market distortion MC = S Costs and benefits P D O Q1 Quantity

  42. Using subsidies to correct a market distortion External benefit Q2 Q1 Social optimum MC = S MSC Costs and benefits P D O Quantity

  43. Using subsidies to correct a market distortion MC Optimum subsidy = MC – MSC MC = S MSC Costs and benefits P D O Q2 Q1 Quantity

  44. Government Intervention: Taxes and Subsidies • The use of taxes and subsidies to correct for monopoly • use of lump-sum taxes • Advantages of taxes and subsidies • Disadvantages of taxes and subsidies • infeasible to use different tax and subsidy rates • lack of knowledge

  45. Government Intervention: Laws and Regulation • The use of laws and regulation • Advantages of legal restrictions • simple to understand • safer when size of problem is potentially great • quick to implement • a good way of dealing with imperfect information • Disadvantages of legal restrictions • a 'blunt weapon'

  46. Government Intervention: Laws and Regulation • Types of regulation • The system of regulation in the UK • UK regulatory bodies • price-cap regulation • the RPI–X formula • Advantages of the UK system • discretionary • flexible • incentive for firms to reduce costs • Disadvantages of the UK system

  47. Other Forms of Government Intervention • Changes in property rights • the problem of limited property rights • extending property rights • limitations of this solution • impractical in many situations • problems of litigation • questions of equity • Provision of information • consumer information • information on jobs • information to firms

  48. Other Forms of Government Intervention • Direct provision of goods and services • the provision of public goods • the need to evaluate costs and benefits of publicly provided goods • the provision of other goods and services by the government • social justice • large positive externalities • dependants • ignorance

  49. More or Less Intervention? • Drawbacks of government intervention • shortages and surpluses • poor information • bureaucracy and inefficiency • lack of market incentives • shifts in government policy • lack of freedom for the individual

  50. More or Less Intervention? • Advantages of the free market • automatic adjustments • dynamic advantages of capitalism • possibly high degree of competition even under monopoly/oligopoly • Judging the arguments • Should there be more or less intervention in the market? • important to consider both costs and benefits of intervention • moral issues • problem of predicting effects of intervention

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