Unit 7

1. Unit 7 The Role of Government

2. Chapter Objectives • Market Failure & Government Failure • How Public Goods are Distinguished from Private Goods • Review 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 • Lorenz Curve & Gini Coefficient • Tariff Graph

3. Economic Functions of US Gov’t • Enforce laws & contracts • Maintain competition • Provide an economic safety net • Provide public goods • Correct market failures • correct negative externalities, subsidize positive externalities, provide market information • Stabilize the economy (macro) • Unemployment, inflation, promote economic growth

4. W 28.1 Public Goods • Private Goods • Rival • Excludable • Public Goods • Nonrival • Nonexcludable • The Free-Rider Problem

5. Public vs. Private Goods

6. Public vs. Private Goods

7. Public vs. Private Goods

8. Cost-Benefit Analysis • Concept • Marginal Cost = Marginal Benefit Rule (MC=MB) Private vs. Social

9. P P O 28.2 O 28.1 G 28.1 0 Q Q Externalities Negative Externalities Positive Externalities • Negative Externality: • draw MSC above MPC • Positive Externality: • draw MSB above MPB • Note diff. between Qe & Qo S=MPC Negative Externalities MSC Positive Externalities MPC D1=MSB D=MPB D=MPB Overallocation Underallocation 0 Qo Qe Qe Qo

10. Negative Externalities Negative Externalities MSC S=MPC Creates costs in addition to the private costs Examples: Pollution, Drum Set, ethanol plant, 2nd hand smoke… (MSC > MPC) How we can compensate for neg. externality? • Individual bargaining • Liability through lawsuit • Price Control (ie. ceiling) • Taxes • Market Externality Rights • ie. fee for creation of X amount of pollution. D=MPB Overallocation Qo Qe

16. Positive Externalities S=MPC Positive Externalities Provides benefits in addition to the private Benefits (MSB > MPB) Examples: rose bushes, education, … How we can compensate for pos. externality? • Individual bargaining • Subsidize either production or consumption (the one producing the externality MSB D=MPB Underallocation 0 Qe Qo

18. GLOBAL PERSPECTIVE Example: Neg. Externality 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

19. Asymmetric Information Discuss with a partner... • BRAINSTORM Question: • WHY does a new car lose substantial market value as soon as it is purchased?

20. 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

22. Types of Taxes Progressive Proportional Regressive

23. Measuring Income InequalityThe Lorenz CurveGini = A / (A+B) [larger = more unequal]

26. Tariff Graph

27. private goods public goods free-rider problem cost-benefit analysis marginal-cost-marginal-benefit-rule Externalities (+/-) market for externality rights optimum reduction of an externality asymmetric information moral hazard problem adverse selection Lorenz Curve Gini Coefficient Tariff Graph Key Terms

28. 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