Market Failures Rebecca Tuttle Baldwin. Market Failure Market mechanism (price signal) fails to...
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Market Failures
Rebecca Tuttle Baldwin
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Market Failure
Market mechanism (price signal) fails to deliver what is socially optimum
Justification for government to intervene
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Types of Market Failures
Equity Excessive Market Power Externalities Public Goods Imperfect Information
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Equity
An issue of property rights? An issue of allocation or
redistribution
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Solutions for Equity
Exempt/grand-father in Special programs Income redistribution
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Excessive Market Power
Monopoly, predatory pricing, higher prices/lower quantity than
under PC competitor)
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Solutions for “Excessive” power
Break-up/disallow mergers Regulate Set P or Q
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Externalities
Costs (negative) or benefits (positive) imposed beyond the private decision-maker
By-products like pollution So social benefits do NOT equal
private benefits/social costs do NOT equal private costs
MSB=MSC
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Externalities
Where Marginal Social cost is greater than marginal private cost (negative externality)
Air pollution, smoking Education
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Typical Solutions for Externalities
Clarify property rights (common property issues)
Establish a market Regulate quantity to socially
optimal Tax undesirable behavior Negotiate
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Public Goods
Hard to exclude others Free riders, so price signal does not
capture total value to consumers and end up under-producing
Most goods are private goods with clearly defined property rights
Examples, National defense, police protection
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Public Goods
Nonrival, nonexclusive Hiking trails? National defense
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Solutions
Produce the good Require firms to provide it
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Related Issue
How to measure value of non-market good?
WTP vs WTA issue
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Review
Whenever there is a market failure, there is a potential role for government.
Government needs to assess the alternatives and may conclude it is better off not to intervene
PROBLEM NOT SOLVED
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Government Failure?
Is the government perfect? Poll results from 1995 finds only 4% has
a lot of confidence in federal government
How do we measure a government failure?
Society worse off….intergenerational equity
Tax distortions
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Sources of Public Failures
Imperfect Information Problems of incentives Failure to assess the full
consequences of programs
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Imperfect Information
Poses a problem in the public as well as in the private sector.
For example, government would like to ensure that public welfare assistance goes only to those who really “need” it. But costly to sort out.
Screening applicants lets fewer undeserving through but the more spent on screening programs leaves less for benefits.
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Incentives
Private homeowners have an incentive to maintain property..attractive house more enjoyable but also when sold will yield a higher price. Generally, induces a “good response” in private
Not true in public. Examples, public housing, civil servant rules about salary and tenure, concern for votes leads to pork barrel legislation
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Unforeseen Responses
doesn’t take into account, private sector responses.
Example, Medicare. In 1990, government required that drug companies provide drugs to the government at the lowest price sold on the market. Government had observed drug companies sold drugs to some customers at prices lower than they were receiving and calculated the program could save billions by taking advantage of these discounts.
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Summary Statement
Government plays an important role in modern economies: it redresses market failures, redistributes income, and provides social insurance against risk. Although the design and scope of government activity are often debated, there is broad agreement about the importance of the role of government.