Ch. 16

 

Terms
market failure

market power

Externalities

Public goods

Common resources

Non-rivalry/non-excludability

Free rider problem

Tragedy of the commons

Equity/efficiency

Progressive/regressive taxes

Social security

Safety net

Transfer programs

 

Review:

Previously we talked about the role of the government in both creating and eliminating market power

On the one hand, market power can create DWL and should thus be discouraged.

On the other hand, market power may be necessary to encourage innovation.

 

The government must ask 2 questions:

1. When is market power an issue of concern?

2. What is the appropriate action to take when market power becomes a concern.

 

Once it has been determined that a firm has market power –

Policy options included

1. regulation – eg. impose a price ceiling.  (Note that in this case a price ceiling increases rather than reducing efficiency! – this works primarily for natural monopolies.)

2. public ownership (alternative policy in case of natural monopoly.)

3. break up firm or prevent mergers

4. Do nothing.

 

Other policies include assigning patent and copyright rights – thus granting monopoly power to a firm.

 

Enforcing anti-trust law costs the taxpayers money, but is seen as necessary – protect consumers, encourage innovation

 

Today we will talk more generally about the role of government

 

In theory, what are the economic roles of government:

1. to address market failures:

a. to encourage or discourage market power, where appropriate

b. to manage common resources

c. to decide on optimal level of negative externalities

d. to provide public goods (education/defense)

e. to encourage positive externalities

2. to address equity concerns

 

A public good is something that everyone benefits from and no one can be excluded from using (non-excludability).

A second property of public goods is that by using them, you do not diminish how much others can benefit from them non-(rivalry).The problem with public goods is that people tend to underestimate the value of these goods to them, and thus they will not pay what they are worth. Also, since people will benefit whether they pay or not, some people are likely to ‘free ride’ (in other words to use the good, while not paying for it.)

 

Examples of public goods include:

 

basic research

poverty programs

national defense

fireworks display (and other forms of beauty, such as sunsets)

 

Public goods are neither rival nor exclusionary and thus can be distinguished from private goods which are both. Some goods are somewhere in between.

 

What about national parks? Are they public goods?

In some ways, yes. Some are nonexclusionary and unless very crowded they may be nonrival.

On the other hand, what if there is a fence around the park. Then it may be excludable but not rival (up to a point, for instance unless it gets crowded.)

 

How about a highway? Is that a public good?

How about a public museum?

 

Note that there is not always a perfect division between public/private and (non)rivalry and (non)exclusivity.

 

A public park may be a public good, or a "common resource." These are a subset of "natural resources." Common resources are rival but not excludable.

 

Examples of common resources:

fish in the ocean

air and water

roads

 

The MAIN message concerning public goods though is because of their nonexcludability (possibility for a free rider problem) and nonrivalry qualities, the private market does not generally do a good job of supplying such goods. As such the government jumps in.

 

Then we get into a political struggle over HOW MUCH of the public good to supply.

 

Doing a cost-benefit analysis of a public good may be very tricky (valuing what it is worth to a society). Clearly different individuals will value a public good to differing degrees, based on their values, etc. Notice how much of the debates around public office concern the management of public goods and common resources.

 

Examples?

 

There may also be a close link between externalities and both public goods and common resources. Because the use of common resource (such as air) may cause negative externalities (such as pollution) it may again be necessary for the government to step in.

 

Many items that we previously viewed as public goods, we now realize are common resources, because one person’s use may affect another’s. A park which is not crowded may be a public good, but when it becomes crowded, reducing the enjoyment people experience, then it is more like a common resource.

 

Economists have argued that another problem with common resources is that they may be overused. This economists label "the tragedy of the commons." As an example a field may become overgrazed because all the shepherds use it, without taking into consideration how the combined grazing will lead to the destruction of the field. Another example is fishing - fishing companies may not realize that when they all fish, they may overfish, which in the end may destroy their livelihoods. Unfortunately, these same fishers tend to get angry when the government tries to limit their fishing because they don’t understand that if they overfish they will destroy the fish crop leading to no future jobs in fishing.

 

Unfortunately, market systems do not manage common resources at all well. After all our system is based on the individual and on profit maximization and if one can fish to one’s heart’s content now, who cares if the fishstock eventually gets so low that no more fish exist, as long as one can make a profit for oneself.

 

Solutions within market systems include "privatizing" a good - as Coase points out - making explicit the property rights. But this raises the question of how those property rights should be determined/distributed. Why should a handful of individuals be able to profit from this common resource? On the other hand, if fishing companies can’t make money, they won’t fish and so consumers won’t get fish. So what is the solution in this case? What criteria should be used to determine when a good should be privatized and when it should be public. An alternative to making fishing public is to regulate fishing, so that fishers have quotas, or are limited in when they can go out.

 

Another reason for government intervention is that markets may be efficient, but they are not concerned about equity issues. Thus one of the roles of government may be income redistribution. This occurs in the case where taxes are progressive (taxation rate). Progressive taxes are those where the rich pay a higher proportion of taxes. The argument behind progressive taxes is that the rich are more able to pay, and therefore should pay more.  Some taxes are regressive in that the poor pay a higher portion of the tax, relative to their income – sales tax, cigarette tax are examples.

 

Almost all countries agree that some level of redistribution may be needed, but cultural norms in conjunction with politics, determine how much redistribution occurs.

 

As we can see from the hand-out given out in class, the US is country with a fairly high degree of tolerance for inequality and in fact, inequality has been growing in recent years.

 

Why is inequality worse in the US than in Europe?

Why has inequality worsened in recent years? Should something be done about this?

Why should government be concerned about distribution issues?

The future welfare of society is at stake – majority of children now raised in poverty.  So part of this argument may stem from a public good notion.

Notions of equity/fairness also come into play. Is it fair to have people living in poverty in a society that is very wealthy?

 

Book then briefly discusses notion of “merit” goods. I am not sure I agree with that discussion.

Most ‘merit goods’ are in fact linked to externalities.