ECO 101 Ch.9 Governing the Market
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Transcript of ECO 101 Ch.9 Governing the Market
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8/13/2019 ECO 101 Ch.9 Governing the Market
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Ch.9 Governing the marketDr.Agim Mamuti
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The McGraw-Hill Companies, 2009
Governing the market
By the end of this section, you should understand:
Horizontal equity and vertical equity
EfficiencyExternalities and public goods
Moral hazard and adverse selection
Direct and indirect taxes
Competition policy
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Equity and efficiency
Equity is where income is distributed in a
way that is considered to be fair or just.
Economic efficiency is thus achieved when
each good is produced at the minimum cost
and where individual people and firms get
the maximum benefit from their resources.
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Horizontal and vertical equity
Horizontal equityis the identical treatment
of identical people.
Vertical equityis the different treatment of
different people in order to reduce the
consequences of these innate differences.
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Vilfredo Paretos definition of
efficiency
For given tastes, inputs and technology, an
allocation is efficient if no one can then be
made better off without making at least one
other person worse off
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Market failure
Market failure (or a distortion in the market)
exists if societys marginal cost of making a
good/service does not equal societys
marginal benefit from consuming that
good/service
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Market failure (contd)
There are four principal sources of market
failure:
Taxation
Imperfect competition
Externalities
Other missing markets
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Externalities
Costs or benefits of production or consumption experiencedby society but not by the producers or consumers themselves.
Sometimes referred to as spillover or third-party costs or
benefits.
When people use their cars, other people suffer from their
exhaust, the added congestion, the noise, etc. These
negative externalities make the marginal social benefit of
using cars less than the marginal private benefit (i.e.
marginal utility).
There is a category of goods where the positive
externalities are so great. They are calledpublic goods.
Examples include public lights, public services such as the
police and army, etc.
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Free rider problem
A free rider arises when no one is willing to
contribute to the cause!
A free rider knowing he/she cannot be
excluded from consuming a good/service,
has no incentive to buy it
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Other missing markets
Information is not always free to acquire!
People often know more about their ownbehaviour than others can easily find.
Fear that people will exploit thisinformational advantage may then preventmarkets from developing.
This can lead to:
Moral hazardexploits inside information to take advantage of theother party to the contract
Adverse selectionuse of inside information to accept or reject acontract. Those accepting are no longer an average sample of the
population
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How to tax fairly
In taking proportionately more from the rich than from
the poor, income tax reflects the principle of ability to
pay based on vertical equity.
Taxationcan either been seen as:
Progressive tax. A tax whose average rate with respect to
income rises as income rises.
Regressive tax. A tax whose average rate with respect toincome falls as income rises.
Proportional tax.A tax whose average rate with respect to
income stays the same as income rises.
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Competition policy
Competition policy tries to promoteefficiency through competition between
firms.
Competition Commission examines whethera monopoly, or potential monopoly, is
against the public interest.
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Merger policy
Competition policy also scrutinizes the formation of
large new companies.
A mergeris the union of two companies wherethey think they will do better by amalgamating.
Mergers can be: Horizontal Vertical
Conglomerate