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The Government’s Role. Economic Efficiency and the Role of Government. or What can the Government do for less cost?. What does Efficiency mean?. efficiency - the maximum value/benefit of output from the cost. 2 conditions necessary for ideal efficiency :

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slide2
Economic Efficiency and

the Role of Government

or

What can the Government do for less cost?

slide3

What does Efficiency mean?

  • efficiency - the maximum value/benefit of output from the cost.
  • 2 conditions necessary for ideal efficiency:
    • All activities with more benefits than costs must be undertaken.
    • No activities that provide benefits less than costs should be undertaken.
slide4

Efficiency Graphed

  • Marginal Benefit Provided to Society.
  • Marginal (or Additional) Cost to Provide

Price

Marginal Cost

Q1 too little

Q3 too much

Q1 just right

Marginal Benefit

Quantity/time

Q1

Q2

Q3

slide5

Functions of Government

1. Protection of individuals and their property against acts of aggression.

  • Including prosecution of aggressors
  • 2. Provision of goods difficult to supply through the market.
    • Also a stable monetary and financial environment
slide6
The Role of Government

and Shortcomings of the

Invisible Hand

slide7

4 Reasons the Invisible Hand May

Fail to Allocate Resources Efficiently

Lack of Competition

Externalities

Public Goods

Poor Information

slide8

S2(restricted supply)

(1) Lack of Competition

  • Too few units will be produced.
  • Sellers may restrict output and raise price.

Price

S1(competitive supply)

P2

P1

D

Quantity/time

Q1

Q2

slide9

(2) Externalities (Spillovers)

  • Externalities - the market fails to register fully costs and benefits.
  • External costs:
    • When the actions of an individual or group incur acost to 3rd party.
  • External benefits:
    • Present when the actions of an individual or group generate benefits for3rd parties.
slide10

sweater factory

beach

brewery

slide11

S2(including external costs)

Actual price and output

Actual price and output

Ideal price and output

External Cost (Spillover)

  • All of the costs of production are not fully registered, so the supply curve understates the true cost of production. (Shifts left)

Price

S1

P2

P1

D

Quantity/time

Q1

Q2

  • Too many units are produced.
  • Pollution problems are often a side effect.
slide12

Actual price and output

Ideal price and output

D2(including external benefits)

External Benefit

  • The demand curve understates the total value of the output.

Price

S1

P2

P1

D1

Quantity/time

Q1

Q2

  • From the viewpoint of efficiency, too few units may be produced.
slide13

Why the Invisible Hand May Fail

(3) Public Goods

  • Public goods are:
  • 1. jointly consumed– Individuals can simultaneously enjoy consumption of same product or service
  • If a public good is made available to one, it is simultaneously made available to others.
slide14

Characteristics of a Public Good

  • 2. non-excludable– Consumption of the good is not able to be restricted to the customers who pay for it
  • Because those who do not pay can not be excluded, no one has much of an incentive to pay for such goods; each has an incentive to become afree rider.
    • Free rider:– a person who receives the benefits of the good without helping to pay for its cost.
  • When a lot of people become free riders, too little of the good is produced.
slide15

Examples of public goods:

    • national defense
    • radio and television broadcast signals
    • clean air.
slide16

Question for Thought:

  • Which of the following are public goods?
  • (using the definition of a public good.)

a. An anti-missile system surrounding Washington.

a. An anti-missile system surrounding Washington.

b. A fire department.

c. Tennis courts.

d. Shenandoah National Park.

e. Elementary schools

slide17

(4) Poor Information

  • A minimal problem if the item is purchased regularly.
  • Problems can arise if goods are:
    • difficult to evaluate on inspection and seldom repeatedly purchased from the same producer, or,
    • potentially capable of serious and lasting harmful side effects that cannot be predicted by a lay person.
slide18

(4) Poor Information

  • Market responses to poor information:
    • Consumer information publications
      • Provide expert evaluation and unbiased information
    • Brand names and franchises
      • Provide standardized quality and dependability
    • Warranties
      • Supplier promises to repair possible problems
slide19
The Opportunity Cost of Government
  • Opportunity cost of resources used to produce goods supplied through the public sector.
  • Cost of resources expended in the collection of taxes and the enforcement of government mandates.
  • Excess burden (deadweight loss) of taxation.
slide20

Which of the following is the most fundamental function of government?

  • protection of individuals and their property
  • imposing progressive taxes to fund income-transfer programs
  • regulating prices and wages
  • provision of postal services and garbage collection

2. Economic efficiency requires that

a. individuals produce at their maximum level.

b. only long-lasting, high-quality products be produced without regard to cost.

c. income be distributed equally among consumers.

d. all economic activity generating more benefits than costs be undertaken

slide21

3. When production of a good generates external costs, the

a. demand curve for the good will overstate the true social benefits from consumption of the good.

b. demand curve for the good will understate the true social benefits from consumption of the good.

c. supply curve for the good will overstate the true social cost of producing the good.

d. supply curve for the good will understate the true social cost of producing the good.

4. From the viewpoint of economic efficiency, when competitive forces in an industry are weak, market allocation will often lead to

a. an output of the product that exceeds the amount consistent with ideal economic efficiency.

b. an output of the product that is less than the amount consistent with ideal economic efficiency.

c. an output of the product that equals the amount consistent with ideal economic efficiency.

d. product prices that are below the cost of production.

slide22

5. Competitive markets generally give consumers and producers correct incentives when

a. externalities are present in the market.

b. property rights are well-defined and enforced.

c. the good being produced and consumed is a pure public good.

d. there is a substantial lack of information on the part of either buyers or sellers.

  • 6. Which of the following correctly describes the external benefit resulting from an individual’s purchase of a winter flu shot?
  • The flu shot is cheaper than the cost of treatment when you get the flu.
  • The income of doctors increases when you get the flu shot.
  • The flu shot reduces the likelihood others will catch the flu.
  • The flu shot reduces the likelihood you will miss work as the result of sickness; therefore, you will earn more income.
slide23

7. Which of the following is the best example of a public good?

a. a government-run health care system

b. the Walt Disney World amusement park

c. national defense

d. long-distance telephone service

  • 8. Markets may have difficulty providing the proper quantity of a public good because
  • individuals will tend to become free riders, and private firms will have difficulty generating enough revenue to produce an efficient quantity of the good.
  • the good generally has a very large value to consumers relative to its cost of production.
  • the good is one that tends to benefit a large number of people.
  • the large profit involved in the production of a public good is generally too much for private firms to effectively pay out to shareholders.
slide24

9. Suppose paper pulp mills are permitted to emit harmful pollutants, free of charge, into the air. How will the price and output of paper in a competitive market compare with their values under conditions of ideal economic efficiency?

a. The price will be too high, and the output will be too large.

b. The price will be too low, and the output will be too large.

c. The price will be too low, and the output will be too small.

d. The price will be too high, and the output will be too small.

10. Which of the following is a source of information that helps consumers acquire information about the quality of a good or service?

a. brand names

b. franchising

c. consumer ratings magazines

d. all of the above