CH16 - Market Failures and Government Intervention Flashcards
What are the 2 approaches for defending free market?
- Formal defence, based on allocative efficiency
- Informal defence, 3 central arguments
i. automatic coordination of actions of decentralised decision makers
ii. Pursuit of profits provides stimulus for innov + increase living standards
iii. Decentralisation of economic power
What is market failure?
failure of the unregulated market system to achieve allocative efficiency
When are resources allocated efficiently?
When P=MC
Why does increased market power fail in free markets fail to achieve allocative efficiency?
Economies of scale only allow room for a few firms operating at low costs and an ability to influence the market, they sell different products, set their prices and innovate to gain temporary monopoly.
Firms w market power will maximise profit at a level of output where P>MC, which is not efficient although it is inevitable.
What are externalities?
= whenever actions taken by firms or consumers directly impose costs/confer benefits on others.
What is the relation between MB and MC for the economy to allocate efficiently?
MB>MC
What is the difference between private cost and social cost?
Private cost - value of resources used in production as valued by producer
Social cost - includes private cost to producers plus any external costs imposed on third parties
What are the two types of benefits?
Private benefit - benefit received by consumer from using product (however intangible)
Social benefit - private benef + whatever benefits accrue to third parties
What is the effect of externalities on cost and benefits?
Discrepancies between private cost and social cost, or between private benefit and social benefit, occur when there are externalities. The presence of externalities, even when all markets are perfectly competitive, leads to allocatively inefficient outcomes.
What is the effect of a positive externality?
With a positive externality, a competitive free market will produce too little of the good.
What is the effect of a negatice externality?
With a negative externality, a competitive free market will produce too much of the good.
What kind of good is private goods?
rivalrous, excludable
what kind of goods are common-property resources
non-excludable, rivalrous
what kind of goods are club goods?
non-rivalrous, excludable
what kind of goods are public goods?
non-excludable, non-rivalrous
What is a big problem with public goods, and how are they addressed?
Free-rider problem, impossible to prevent anuone from using once provided
Because of the free-rider problem, private markets will usually not provide public goods. In such situations, public goods must be provided by government
In which 4 situations do free markets fail to achieve allocation efficiency?
Market Power
externalities
non-rivalrous and non-excludable goods
asymmetric information
What is paternalism?
intervention in the free choices of individuals by others (including gvt) to protect them against what is presumed to be their own ignorance/folly
What are 5 reasons the government can intervene in Free markets?
- Address income distribution
- Preferences for public provision
- Protecting individuals from others
- Paternalism
- Social responsibility
What is the leaky bucket theory?
Suppose we have a well-supplied reservoir of water and we want to get some water to a household that is not able to come to the reservoir. The only vessel available for transporting the water is a leaky bucket; it works, in that water can be delivered to the intended location, but it works at a cost, in that some of the water is lost on the trip. Thus, to get a litre of water to its destination, more than a litre of water has to be removed from the reservoir. It may be possible to design better or worse buckets, but all of them will leak somewhat.
The analogy to an economy is this: The act of redistribution (carrying the water) reduces the total value of goods and services available to the economy (by the amount of water that leaks on the trip). Getting a dollar to the poor reduces the resources available to everyone else by more than a dollar. Thus, pursuing social goals—like the redistribution of income—conflicts with the goal of allocative efficiency.
=Always leaky bc no wau to redistribute income w/o changing incentives for households
=Redistribution reduces overall efficiency of the market
What is a cost-benefit analysis?
an approach for evaluating the desirability of a given policy, based on comparing total opportunity costs w total benefits - used only on measurable factors
What are 3 tools for government intervention?
- Public provision
- Redistribution programs
- Regulation
What kinds of indirect costs occurs with gvt intervention?
1) Changes in costs of production
2) Costs of compliances
3) Rent seeking = private firms and special-interest groups often lobby governments for policies in their own interest but at the expense of the public interest.
