Post on 02-Jan-2016
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Market FailuresMarket Failures
The role of government and economics The role of government and economics is to enhance public welfareis to enhance public welfare
Both seek to allocate scarce Both seek to allocate scarce resources among alternative resources among alternative desirable endsdesirable ends
When the market fails to allocate When the market fails to allocate goods adequately, then the goods adequately, then the government should step in government should step in
Three questionsThree questions
What are the desirable ends towards which What are the desirable ends towards which society should allocate its scarce resources?society should allocate its scarce resources?
What are these scarce resources, and what are What are these scarce resources, and what are their characteristics relevant to allocation? their characteristics relevant to allocation?
Based on the nature of the scarce resources Based on the nature of the scarce resources and human nature, what allocative mechanisms and human nature, what allocative mechanisms is best for achieving these desired ends?is best for achieving these desired ends?
What allocative mechanisms are available?What allocative mechanisms are available?
The desirable ends: what improves The desirable ends: what improves social welfare?social welfare?
Is it ever greater consumption of Is it ever greater consumption of market goods?market goods? Can you buy and sell clean water, clean Can you buy and sell clean water, clean
air, stable climate, biodiversity, ozone air, stable climate, biodiversity, ozone layer?layer?
Why are we so obsessed with growth?Why are we so obsessed with growth? Does sustainability matter?Does sustainability matter? Does distribution matter?Does distribution matter?
Who should own goods and services Who should own goods and services created by nature and by society?created by nature and by society?
Is stability desirable?Is stability desirable?
What are the scarce resources?What are the scarce resources?
Economic goods and servicesEconomic goods and services Ecosystem goods and servicesEcosystem goods and services Laws of thermodynamicsLaws of thermodynamics
11stst law: matter energy is constant law: matter energy is constant You can’t make something from nothingYou can’t make something from nothing Economics is transformation, not wasteEconomics is transformation, not waste
22ndnd law: entropy increases in an isolated law: entropy increases in an isolated system (supreme law of nature)system (supreme law of nature)
Economic activity results in wasteEconomic activity results in waste Economy can’t grow forever. We can’t grow Economy can’t grow forever. We can’t grow
our way out of povertyour way out of poverty
From Empty From Empty World to Full World to Full
WorldWorld
What are the characteristics of the What are the characteristics of the scarce resources?scarce resources?
ExcludabilityExcludability
Excludable resource regimeExcludable resource regime One person can prevent another from using One person can prevent another from using
the resourcethe resource Necessary for markets to existNecessary for markets to exist
Non-excludable Non-excludable No enforceable property rights due to No enforceable property rights due to
technology or social institutionstechnology or social institutions Can’t charge for useCan’t charge for use
Some resources non-excludable by nature. Some resources non-excludable by nature. None are inherently excludable. None are inherently excludable.
Excludability is a product of institutions.Excludability is a product of institutions.
RivalnessRivalness Rival GoodsRival Goods
My use leaves less for you to useMy use leaves less for you to use All ecosystem goods are rivalAll ecosystem goods are rival
Non-rival (or non-depletable)Non-rival (or non-depletable) My use does not leave less for you to useMy use does not leave less for you to use Marginal cost for additional user = 0Marginal cost for additional user = 0 Efficient allocation: Price = marginal cost of Efficient allocation: Price = marginal cost of
productionproduction All non-rival resources are servicesAll non-rival resources are services
Rival or non-rival is an innate characteristic Rival or non-rival is an innate characteristic of the good, not a result of institutionsof the good, not a result of institutions
Rivalness (cont.)Rivalness (cont.)
Non-rival but congestibleNon-rival but congestible Non-rival as long as few people use it, Non-rival as long as few people use it,
becomes rival with excessive use (e.g. becomes rival with excessive use (e.g. roads)roads)
Empty planet vs. full planetEmpty planet vs. full planet
So What?So What?
Rival
Non-rival
Excludable Non-Excludable
Market Good: cars, houses, land, oil, timber, waste absorption capacity?
Potential market good but inefficient: patented information, e.g. energy efficiency, toll roads.
Pure Public Good:Information, streetlights, public roads, defense, laws, public health, most ecosystem services
Open Access Regime:Oceanic fisheries, undiscovered minerals, waste absorption capacity
Non-rival,congestible
MG when crowded: toll roads at rush hour, toll bridges, beaches, etc.
OAR when crowded: e.g. public parks, beaches, roads, bridges, etc.
Open AccessOpen Access
The “Tragedy of the commons”The “Tragedy of the commons” Common property vs. open accessCommon property vs. open access Individuals try to capture benefits for Individuals try to capture benefits for
themselves, share costs with societythemselves, share costs with society Market alone leads to over-exploitationMarket alone leads to over-exploitation
Threat of extinctionThreat of extinction Loss of profit (to be explained later)Loss of profit (to be explained later)
Role for government to step inRole for government to step in
Non-rival & ExcludableNon-rival & Excludable Patents are protected by Patents are protected by
governmentsgovernments Why do we have patents?Why do we have patents? Patents, profit motive and innovationPatents, profit motive and innovation When did patents come about?When did patents come about?
1790s in US1790s in US 1947 international, rarely used before 1947 international, rarely used before
1980s1980s
Non-rival & Excludable (cont.)Non-rival & Excludable (cont.) Patents and the WTOPatents and the WTO
97% owned by developed nations97% owned by developed nations Neem tree, steel drums, etc.Neem tree, steel drums, etc.
Samuel Slater, “Father of American Samuel Slater, “Father of American industry”industry”
Should government spend scarce Should government spend scarce resources to make these information resources to make these information excludable?excludable?
Public GoodsPublic Goods
Free-ridingFree-riding No price signal as feed-back mechanismNo price signal as feed-back mechanism
Scarcity Scarcity price increase price increase innovation innovation
•Lack of Incentives for market to produce them•Lack of incentives for markets to create technologies that provide them
Public Goods (cont.)Public Goods (cont.)
• How important are public goods?How important are public goods?• Life support functions (Vermont’s forests)Life support functions (Vermont’s forests)• Flood protection (Winooski river)Flood protection (Winooski river)• Water purificationWater purification• Lake ChamplainLake Champlain
InfrastructureInfrastructure• Research and developmentResearch and development
if all the scientists are working for profit, if all the scientists are working for profit, none are making PGsnone are making PGs
Provision widely accepted as government duty
Is government provision efficient?Is government provision efficient?
Privatization debate Privatization debate Read chapter on political economyRead chapter on political economy
Market goods: The theory of Market goods: The theory of ExternalitiesExternalities
ExternalitiesExternalities
DefinitionDefinition ““an activity by one agent causes a loss an activity by one agent causes a loss
(gain) of welfare to another agent”(gain) of welfare to another agent” ““The loss (gain) of welfare is The loss (gain) of welfare is
uncompensated”uncompensated”
Completely Internal to the Economic Completely Internal to the Economic Process. Why?Process. Why?
How are these related to public How are these related to public goods?goods?
ExamplesExamples Individual consumptionIndividual consumption
Waste outputsWaste outputs Status effectStatus effect
IndustryIndustry PollutionPollution BrownfieldsBrownfields
AgricultureAgriculture Ecosystem conversion- loss of Ecosystem conversion- loss of
riparian zonesriparian zones Phosphorous emissionsPhosphorous emissions SiltationSiltation Factory farmingFactory farming
Examples (cont.)Examples (cont.)
Natural resource harvestNatural resource harvest Depletion of ecosystem servicesDepletion of ecosystem services Waste emissionsWaste emissions
Community issuesCommunity issues Crime reductionCrime reduction Economic stabilityEconomic stability EducationEducation HealthHealth
‘ ‘Optimal’ externalities for societyOptimal’ externalities for society
Agricultural production
Property RightsProperty Rights
Who owns the environment?Who owns the environment? polluter rights (privilege, no rights)polluter rights (privilege, no rights) sufferer rights (rights, duties)sufferer rights (rights, duties) What about future generations?What about future generations?
Obstacles to OptimalObstacles to Optimal
Transaction costsTransaction costs in absence of transaction costs, no negative in absence of transaction costs, no negative
externalitiesexternalities What are transaction costs likely to be for What are transaction costs likely to be for
externalities affecting public goods?externalities affecting public goods?
Wealth effectWealth effect Intergenerational externalitiesIntergenerational externalities
Government roleGovernment role
What can the government do about What can the government do about externalities, and how does it relate externalities, and how does it relate to finance?to finance?
RegulationsRegulations Cost money to enforceCost money to enforce
Government roleGovernment role
What can the government do about What can the government do about externalities, and how does it relate externalities, and how does it relate to finance?to finance?
RegulationsRegulations Cost money to enforceCost money to enforce Economically inefficientEconomically inefficient No incentives to go beyond complianceNo incentives to go beyond compliance
TaxesTaxes Auctioned quotasAuctioned quotas
Controlling price or quantityControlling price or quantity
Marginal abatement costs
Firm 1 Firm 2 Firm 3
First 20% $50,000 $10,000 $25,000
2nd 20% $200,000 $25,000 $50,000
3rd 20% $400,000 $50,000 $100,000
4th 20% $800,000 $100,000 $175,000
Final 20% $1600,000 $500,000 $200,000
Marginal pollution abatement costs for three firms emitting 5000 tons of pollution each.
Pigouvian taxes and subsidiesPigouvian taxes and subsidies
Tax (subsidy) equal to value of Tax (subsidy) equal to value of negative (positive) externality negative (positive) externality theoretically leads to efficient theoretically leads to efficient outcomeoutcome
What is value of externality?What is value of externality? IncentivesIncentives
Tradable quotasTradable quotas
Example of sulfur dioxideExample of sulfur dioxide First determine scaleFirst determine scale Next decide on distributionNext decide on distribution
Justice vs. feasibilityJustice vs. feasibility Allow market to allocateAllow market to allocate
Tax or quota?Tax or quota?
With a tax, you can theoretically get right With a tax, you can theoretically get right amount, but amount will change with amount, but amount will change with economic change. Better to let prices vary economic change. Better to let prices vary (economic) than amount of resource to be (economic) than amount of resource to be used (ecological)used (ecological)
tax or quota on single resource leads to tax or quota on single resource leads to substitution, on all resources will notsubstitution, on all resources will not
Tax or quotaTax or quota
UncertaintyUncertainty We don’t know marginal abatement cost curves, We don’t know marginal abatement cost curves,
nor marginal benefit curvesnor marginal benefit curves
not only do we not know where we are on the curve, not only do we not know where we are on the curve, we don’t know the slope of the curvewe don’t know the slope of the curve
Slope of curve very importantSlope of curve very important In full world, lower risks from quotas, in In full world, lower risks from quotas, in
empty world, lower risks from taxempty world, lower risks from tax
Ignorance and UncertaintyIgnorance and Uncertainty
Perfect markets require perfect Perfect markets require perfect informationinformation
Asymmetric informationAsymmetric information Nobel Prize in 2000Nobel Prize in 2000 Poverty insurancePoverty insurance
Irreducible ignoranceIrreducible ignorance Time lagsTime lags Ecosystem functionEcosystem function
How do ignorance and uncertainty relate to How do ignorance and uncertainty relate to budgeting and finance?budgeting and finance?
Who pays clean up costs when Who pays clean up costs when unexpected negative impacts occur?unexpected negative impacts occur? Health impactsHealth impacts Superfund sitesSuperfund sites
Role of government in providing Role of government in providing social security (poverty insurance)social security (poverty insurance)
Natural MonopolyNatural Monopoly
High fixed cost, low marginal costHigh fixed cost, low marginal cost RoadsRoads How should hey be regulated?How should hey be regulated?
ConclusionsConclusions
Many market economists and Many market economists and politicians argue that there is little politicians argue that there is little role for government, market is best role for government, market is best allocative mechanismallocative mechanism
Market systematically fails to provide Market systematically fails to provide many goodsmany goods
Government is essentialGovernment is essential Future lectures will examine just and Future lectures will examine just and
efficient mechanisms for coping with efficient mechanisms for coping with these market failuresthese market failures
Naural Monopolies, Naural Monopolies,
PG: the Privatization debatePG: the Privatization debate
Private ProvisionPrivate Provision
ExamplesExamples 3 private police for every public officer in US3 private police for every public officer in US 2/3 of homes in Denmark with private fire 2/3 of homes in Denmark with private fire
serviceservice SUVs or plowed roads?SUVs or plowed roads?
Relative costsRelative costs Administrative costsAdministrative costs Diversity of tastesDiversity of tastes Distributional issuesDistributional issues SkimmingSkimming
Private Production: examplesPrivate Production: examples
Skating rink in Central parkSkating rink in Central park Trains in WWITrains in WWI Military personnel in IraqMilitary personnel in Iraq Airport securityAirport security Municipal water supplyMunicipal water supply EducationEducation
Private Production : issuesPrivate Production : issues
ExamplesExamples Skating rink in Central parkSkating rink in Central park Trains in WWITrains in WWI Military personnel in IraqMilitary personnel in Iraq Airport securityAirport security Municipal water supplyMunicipal water supply EducationEducation