Microeconomics Ch 4
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Transcript of Microeconomics Ch 4
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M i c r o e c o n o m i c
s
Dr. Karim Kobeissi
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Chapter 4: The Role of Government
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Intervene?
The free market is not always able to achieveallocative eciency !ccor"in#ly$ we have a MarketFailure
!n allocative ecient point is where
All resources are allocated to their most efcient use
!ll markets are in e%&ilibri&m
The economy is operating on its production possibility curve.
It is not possible to make someone better o' witho&t makin# someoneelse worse o' ()ociety*s well bein# is ma+imise",
This sit&ation is also calle" Pareto efciency
Market ailure provides governments ith the
reason to intervene in the economy or in
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)ociety*s Goal
To pro"&ce an optimalmi+ of o&tp&t
-ptimal mi+ ofo&tp&t: the most"esirable combinationof o&tp&t attainable&sin# e+istin#
reso&rces$ technolo#y$an" social val&es
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.arket /ail&re
)ociety wants thecombination atpoint 0
The marketmechanism wo&l"lea" &s to point .
Market ailure!an
imperfection in themarket mechanismthat preventsoptimal o&tcomes
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.arket /ail&re
.arket /ail&re can occ&r from any of thefollowin#:
Market Poer
"ne#uity in "ncome Distribution
$%ternalities
Public &oods
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.arket 1ower
Market poer! ! company2s abilityto manip&late price by in3&encin# anitem2s s&pply$ "eman" or bothTh&s$ the rm can restrict s&pply in
or"er to ma+imi5e prots rather thanpro"&ce society*s "esire" mi+ of o&tp&t
Government role: Restrict market power
1romote more competition
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. a r k e t 1 o w e rPrice
Quantity/time
P2
P1
Q1
D
S1(competitive supply)
Q2
S2(restricted supply)
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Income Ine%&ity
Income Ine%&ity:The #ap between in"ivi"&als or ho&sehol"s makin# most of the
income in a #iven co&ntry an" those makin# very little
Government re"istrib&tes income &sin#:
! pro#ressive income ta+ system Collect ta+es from income earners at a pro#ressive ta+ rate
Transfer payments 1rovi"e payments to in"ivi"&als for which no c&rrent #oo"s
an" services are e+chan#e"
1rovi"es a minim&m amo&nt of merit #oo"s Merit good! Goo"s or services (s&ch as e"&cation an"
vaccination, provi"e" free for the benet of the entire societyby a #overnment$ beca&se they wo&l" be &n"er6provi"e" ifleft to the market forces or private enterprise
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7+ternalities 8 )pillovers
$%ternalities !n e+ternality is an e'ect of a p&rchase or
&se "ecision by one set of parties on otherswho "i" not have a choice an" whose
interests were not taken into acco&ntThe "i'erence between the social an"
private costs (benets, of a market activity
When e+ternalities are present$ market
prices are not a vali" meas&re of a#oo"*s val&e to society
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Correctin# for 7+ternalities
1ositive 7+ternality Thir" parties benet
beca&se of a markettransaction
9ot enoh is pro"&ce"
an" sol" at price pbeca&se society*sbenets are #reater thanmarket benets
Government steps in to#enerate benets for
society Government action
ca&ses more to bepro"&ce" by s&bsi"i5in#pro"&ction or p&rchase
1ro"&ct is sol" at pricep;
1rice ofvaccines
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Correctin# for 7+ternalities
9e#ative 7+ternality Thir" parties are h&rt
beca&se of a markettransaction
Too m&ch is pro"&ce" an"sol" at price p beca&se
society*s costs are #reaterthanmarket costs
Government steps in toshift costs from society tothe pro"&cer an" the b&yer
'ising costs cause the
supply curve to shitlet.
Government action ca&sesless to be pro"&ce" an"sol" at a hi#her price p=
7+ample: poll&tion
1rice ofpoll&tin# #oo"
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Correctin# for 7+ternalities
9e#ative 7+ternality Thir" parties s&'er
beca&se of a markettransaction
Too m&ch is pro"&ce"
an" sol" at price p=beca&se society*sbenets are less thanmarket benets
Government steps intore"&ce benets for
market Government action
ca&ses less to bepro"&ce" by restrictin#pro"&ction or
purchase 7+ample: ci#arette
1rice
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)&mmary: 7+ternalities
1ositive e+ternality )ociety*s benet > market benet
The market &n"erpro"&ces
The #overnment s&bsi"i5es
9e#ative e+ternality )ociety*s benet market benet$ or
)ociety*s cost > market cost
The market overpro"&ces
The #overnment restricts cons&mption orpro"&ction
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1&blic Goo"s
Private good! a #oo" or servicewhose cons&mption by one person
e+cl&"es cons&mption by others ! b&r#er
Public good! a #oo" or servicewhose cons&mption by one person"oes not e+cl&"e cons&mption byothers ! p&blic hi#hway
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1&blic Goo"s
The ree(rider dilemma!The free ri"er problem refers to a sit&ation where some
in"ivi"&als in a pop&lation either cons&me more thantheir fair share of a common reso&rce$ or pay less than
their fair share of the cost of a common reso&rce Free rider!
! commonly &se" e+ample of the economic notion ofthe free ri"er problem is fo&n" in national "efense !ll
citi5ens of a co&ntry benet from bein# "efen"e"@however$ in"ivi"&als who eva"e ta+es (free ri"ers, arestill protecte" by the same public resource ofnational "efense$ even thoh they "i" not pay for
their fair share of the reso&rce
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.acro Instability
The #oal of macro intervention is to fostereconomic #rowth an" to move towar"s amore allocatively ecient position
.ove o&t of ineciency an"8or p&sh the 11C
o&twar" Re"&ce &nemployment
!voi" in3ation )table prices
Increase o&r capacity to pro"&ce 7conomic #rowth
Government &ses macroeconomic policiesin an attempt to meet these #oals
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Growth of Government
When society perceives a problem$ itlooks to #overnment to B+ the problem$
which provi"es E&stication for#overnment intervention in the economy
!s a res<$ #overnment has #rown overthe last cent&ry:
-ver F times more employees since FF
! b&"#et H$FFF times lar#er since FF
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Growth of Government
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Government /inances
7ach level of #overnment (fe"eral$ state$an" local, creates a b&"#et of f&n" in3owsan" o&t3ows
In3ows (so&rces of f&n"s, Ta+es (an" fees8&ser char#es,
orrowin#
-&t3ows (&ses of f&n"s, 1&rchases of #oo"s an" services 1ayments for reso&rces &se"
Transfer payments
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)o&rces of Government Growth
.ost of the #rowth is "&e to
transfer payments$ "efense
spen"in#$ an" health pro#rams
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Ta+ation
Ta+es pay for #overnment spen"in#
There is a chan#e in the o&tp&t mi+ as
more #overnment spen"in# absorbs factorsof pro"&ction that co&l" be &se" to pro"&cecons&mer #oo"s
The opportunity cost o ta%ation is
meas&re" by the private6sector o&tp&tsacrice" when #overnment employsscarce factors of pro"&ction
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Ta+ation
The primary f&nction of ta+es is totransfer comman" over reso&rces
(p&rchasin# power, from the privatesector to the p&blic sector
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/e"eral Ta+es
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Income Ta+
Income ta+es: the lar#est sin#leso&rce of #overnment reven&e
It is a pro#ressive ta+ system !s income rises$ the ta+ rate also rises
Compare" to those with lower incomes$
those with hi#her incomes: 1ay more ta+es
1ay a #reater fraction of their income inta+es
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)ocial )ec&rity Ta+
It is a re#ressive ta+ system !s income rises$ the ta+ rate falls
Compare" to those with lower incomes$those with hi#her incomes: 1ay more ta+es
&t pay a smaller fraction of their income in
ta+es
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-ther Ta+es
Corporate ta+es
Js&ally passe" on to the c&stomer in hi#herprices
It is a pro#ressive ta+ system to thecorporation
7+cise ta+es
Impose" on a specic #oo" or service
)ome are impose" to "isco&ra#e pro"&ctionan" cons&mption of these #oo"s
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-ther Ta+es
1roperty ta+ ! maEor so&rce of local ta+es
It is a re#ressive ta+$ since poorer people "evotea lar#er portion of their income to ho&sin# costs
)ales ta+ !nother maEor so&rce of local ta+es
It is also a re#ressive ta+$ since poorer peopleten" to spen" all of their income while richerpeople "o not
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Government /ail&re
Governmentintervention sho&l"move the mi+ ofo&tp&t closer tosociety*s "esire"mi+
&overnmentailure! #overnmentintervention fails toimprove economico&tcomes an" mayworsen o&tcomes
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1erceptions of Waste
1&blic perception is that the #overnmentisn*t pro"&cin# as many services as itco&l" with the reso&rces at its "isposal
This ineciency p&shes the economy insi"ethe 11C
! relate" %&estion is: are we #ivin# &ptoo many private6sector #oo"s in or"erto #et those p&blic services?
Is the opport&nity cost too hi#h?
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Kal&ation of Costs an" enets
!""itional p&blic6sector activity is"esirable only if the benets from
that activity e+cee" its opport&nitycosts of ta+ation Low "o we i"entify the benets?
Low "o we en&merate the costs? Whose val&es sho&l" be &se" to "o this?
1 bli Ch i t C t ! l i
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1&blic Choice: enet6Cost !nalysis
1rivate6sector enets an" costs
&s&ally accr&e to thesame person
.akes it easy tocompare the two an"make a "ecision
Government
enets an" costs &s&allyaccr&e to "i'erent #ro&ps
.akes it more "ic< forthe "ecision maker
1olitics enter into the"ecision
The "ecision maker mayhave no stake in theo&tcome
"n the governmentsector) the bene*ciaries
see only the bene*tsand the payers see onlythe costs. The decisionmaker may not seeeither.
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What Does )ociety Want 1ro"&ce"?
Can either the market base" or the state6r&nsystem$ or a combination of the two$ pro"&cethe mi+ of o&tp&t "esire" by society in
#eneral? ! p&re market system will not pro"&ce a"e%&ate
%&antities of some #oo"s
! p&re #overnment system cannot "etermine themi+ of o&tp&t "esire" by b&yers an" sellers
+y trial and error) a combination o the tosystems may arrive at the optimal mi% ogoods produced
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The 7conomy Tomorrow
Ri#ht6si5in# Government The optimal mi+ is 0 G$ G=$ G;$ an" G4
in"icate a wron#6si5e"#overnment$ "&e to poorbenet6cost analysis$politics$ an" b&rea&cracypower #rabs
Improvement is not likelyin the economy tomorrow