Market Failure and Government

Government and Market Failure

• Externalities• Coase Theorum• Public Goods• Tax Types and Theories• Wealth Disparity and Redistribution of Income• Asymmetric Information

*Chapters 12, 19, and 20*

*The next several slides are just a review of tax incidence and DWL of tax and subsidy

Tax Incidence

Tax Incidence

• Nominal (Statutory) versus Economic Incidence

• If “law” doesn’t matter, what does?

Deadweight Loss

• Allocative Inefficiency

• Do subsidies produce DWL??• If so, where does it appear?

Deadweight Loss of Subsidy

Deadweight Loss

• Could a tax eliminate deadweight loss?

Agenda• Why +MEC or –MEB won’t change tax incidence or

nominal price

• Coase Theorum Article (1 page…okay 1 ½)

• Public v. Private Goods

• Tax Philosophies and Types

**HW- Coase Theorem and PollutionDue tomorrow- collected

Externalities- simplified

• Negative– MPC < MSC– Per unit tax equal to MEC

• Positive– MPB<MSB– Per unit subsidy equal to MEB

Coase Theorum

"if trade in an externality is possible and there are no transaction costs , bargaining will lead to an efficient outcome regardless of the initial allocation of property rights”

Public v. Private Goods• Pure Private– Excludable and Rival– Example: Chia Pets

• Pure Public– Nonexcludable and Nonrival– Example: National Defense– Government generally must provide– Free Rider Problem• Solutions: taxes versus donations

Public v. Private Goods• Toll Goods– Excludable and nonrival– Example: Cable TV, Toll Road (often natural monopolies)

• Common-pool Resources– Nonexcludable and rival– Example: fish in the public waters, congested roads– Government often regulates• Quotas, licensing fees

Answers According to AP Resource GuideRed denotes a strong argument for alternative placement, but I guess we should go with the AP

guide.

Pure Private GoodsElectric PowerHaircutRabies ShotPotato Chip

Common Resource

Toll GoodsCollege educationAmusement ParkCable TVPanama CanalUncongested Toll roads and bridgesHealthcareNational Forest Campgrounds

Pure Public GoodsNational DefenseSpraying for MosquitosStreet LightsPolice and Fire Protection

Paying for Public Goods- Tax Philosophies

• Benefits Received Principle– Closer to free market solution– Example- Gas tax to fund highways/Cigarette Tax

• Ability to Pay Principle– Redistribution of Wealth/Equity– Example: Progressive income tax

State Revenue

Taxes

• Progressive• Proportional (flat)• Regressive

*Based on % of income

Income Tax

• Progressive Tax (Federal)

Income Tax

• Progressive Tax (Federal)

State (PA) Income Tax

• Proportional Tax/Flat Tax

• PA = 3.07%

State Sales Tax

• 6%

• Proportional or Regressive?

Social Security Tax

• Social Security– Employee• 6.2% on first $117,000• 0% above $117,000• Regressive tax

– Payroll Tax• Employer matches contribution

Social Security Tax

• Who really pays it?• Is it shared equally as the law would suggest?• Does it depend on the particular labor

market?

Taxes on Kevin White

Distribution of Wealth

• Measures– Lorenz Curve and Gini Coefficient (see handout)

• Redistribution/Reduction of Inequality– Transfers– Control Market Prices– Progressive Taxes

• Efficiency versus Equity

Measuring Inequality

• Lorenz Curve– Farther from 45 = greater inequality

• Gini Coefficient– 0 = complete equality– 1 = complete inequality– A/A+B

Redistribution/Reduction of Inequality

– Transfers• WIC• TANF• SNAP• Unemployment Comp• Obamacare

– Control Market Prices• Minimum wage• Rent control

– Progressive Taxes • Income Tax – largest federal revenue source

Equity versus Efficiency

• Thoughts?

• Cons of each?

Asymmetric Information

Adverse Selection-Before Transaction

Examples-Used Cars-Health Insurance-Loans-Infomercials*I was watching QVC

Moral Hazard-After Transaction

Examples-Health Insurance-Car Insurance-Loans-Helmet

Requirements

Asymmetric Information

Private Remedies-screenings-credit checks-warranties

Public Remedies-inspections-standards-certifications-reports-lemon laws

Public Choice Theory

• Rational Choice Theory- individuals act in self-interest

• Private Sector- yep

• Public Sector- yep

• Uhhh ohhh…

Public Choice Theory

• Private Sector- generally profits• Public Sector – Power– Special Interests– Rent Seeking– Bribes– Reelection– How good would some nachos and wings be right

now?

Public Choice Theory

• Market Failure v. Government Failure