Private vs Public GoodsWhat difference does it make?

Would you like government to provide you free college?

What might you have to give up to get it?

Three areas of concentration1. Explain how market failures, such as externalities, might justify economic functions

of government

2. Distinguish between private and public goods and explain the nature of the free-rider problem

3. Describe the political functions of government that entail its involvement in the economy

What is Market Failure?

• When the market produces more or less than the ideal optimal good or service. OR the wrong mix of input is given for output…..

• Brings about externalities and public goods.

Negative externality = overproduction of related product occurs and over allocation of resources to the product. Example: steel mill pollutes- produces more for profit and does not want to cut back to help clean the air.

Positive externality = products featuring positive effects are under produced. Example: vaccinations- if you and I get one- everyone around us can relax and not need one.

When the market fails… it is a double edge sword

Market Fails if not optimal mix.* Optimal Mix of Output…… “Most desirable combination of output attainable with existing resources, technology and social values.”

Market Failure *“An imperfection in the market mechanism that prevents optimal outcomes.”

What about Hydrocarbons in the air?

Problem in economy- Hydrocarbons in the air.Cause- SUV’s, Trucks (poor ignition system, etc.)Solution – Do not manufacture SUVs, Trucks.Regulation prevents- government permits only electric cars

and small cars.Trucks still on road – Reallocation of resources to government’s choice? What

about just taxing SUVs more rather than not permitting production?

But what about the ash from volcanos, wildfires, natural pollutants?

• Price directs resources• Business is operating to make a profit• Why would Dell want to build a park?• Why would Wal-Mart want to pay high wage?• Why would Texas not provide health insurance

for poor?

Answer: Most often Dell does not want to build a park unless it is good PR in the community or unless government demands it with tax rebates.

Now you understand why the market fails – we want to have parks and breath clean air.

In real words?Wrong mix of output

Not enough public parks… Not enough care for environment…Not enough welfare…Too much separation between top 10%

income earners and median income earners…

Not adequate security within our borders….Too many immigrants….

How do you know if optimal mix is met?

Optimal mix of ANY GOOD or SERVICE =MB = MC(Marginal benefit = Marginal Cost)If the cost exceeds the benefit… the failure

occurs. If benefit exceeds the cost, then market is functioning according to other factors (price, demand, etc.)

Plano City Council issues “no smoking” in restaurants, bars, or

outside bars on patios.

What is the marginal private cost to Sports Bar?

What is the external cost to Plano?What is the social cost? C > B?

The smoke in Sports Bar= externality

What is an externality?Result of an economic activity that harms a third person. (breathing smoke in restaurant)Negative externality (also referred to as spillover)

Can also have a positive externality.

Specific Example:

Assume no government regulation exists.Steel producing plant moves into the neighborhood.Production of steel emits dirt, smut, unhealthy air

throughout the neighborhood.This is a negative externality… the spillover is the

dirty air borne by the citizens.Who pays for this cost? Citizens- company making a

profit on steel.

Negative externality graph

Dead Weight Loss – costs to society created by market inefficiency. Can beapplied to any use of inefficient resources. If market is not in equilibrium, deadweight loss will occur.

Correcting for Externalities – is it necessary?

– Market failure occurs• Steel mill does not pay for the clean air

• Costs of production have “spilled over” to the residents (third parties)

• Lower production cost– ***More steel is produced than would otherwise be the case

Market failure = (forces of S & D not leading us to BEST point on ppc… Who decides what is defined as BEST?

Enter…. Government intervention!Did you hear the words tax and subsidy?

Will they perform magic?

Correcting for Externalities• Externalities– Occur when the consequences of an economic

activity spill over to affect third parties

• Third Parties– Parties who are not directly involved in a given

activity or transaction

• Property Rights– Rights of an owner to use and exchange property

Examples of spillovers

Throwing trash in someone’s back yardBurning ties in the alleyPlaying your stereo loudly at 3:00 a.m. Businesses dumping wastes, sludge into riversPeople trashing the beach or highway.Electric Companies burning phosphorous fuels

Spillover Examples that perpetrate on others

Calling police when loud party of teenagers next door (actions of teens imposing unwanted cost on neighbor)

Living in downstairs apartment.. Having upstairs neighbors doing Tai Bo when they get off work at 4:00 a.m.

Calling the city when a neighbor doesn’t keep his yard mowed on regular basis.

Externalities can be positive or negative

Homeowners keep lawns immaculate (benefits the neighborhood)

Scientific study for polio vaccine (others benefit beyond scientists’ recognition)

Education……. How would this be a benefit?

Positive Externality

How can spillovers be corrected?

Most obvious way is Legislation.1. To prohibit2. To heavily tax the specific product and

manufacturer. Tax would be derived to allow for off-setting the clean-up cost. (Super Fund is example)

3. ***Tax incentives… if reduction of pollution and compliance adhered to, taxes reduced.

There are two main types of economic instruments used in environmental policy, both of which aim to provide an incentive to use resources sustainably:

• Price-based measures use charges, taxes and subsidies to persuade polluters to reduce their discharges.

• Rights-based measures "create rights to use environmental resources, or to pollute the environment, up to a pre-determined limit, and allowing these rights to be traded"

Two concepts to remember

• Public goods… can be equally consumed by all… no restrictions

Skateboarding in the park… Terrorists… can also go to the park… Illegal immigrants can go to school…

• Private goods… consumption by one person excludes consumption by another..

( my doughnut… my car… etc)

The Public Sector:Government’s role.

• What is Public Sector?• When markets fail? (Housing!)• Should government step in?• Can people “ride free” in public sector?

Let’s Talk Social Costs.

• Social Cost = private cost + externality (if any)