Government and Market Failure

1. 28 Government and Market Failure

2. Chapter Objectives • How Public Goods are Distinguished from Private Goods • The Method of Determining the Optimal Quantity of a Public Good • The Basics of Cost-Benefit Analysis • About Externalities (Spillover Costs and Benefits) and the Methods to Remedy Them • How Information Failures Can Justify Government Interventions in Some Markets

3. W 28.1 Public Goods • Private Goods • Rivalry • Excludability • Public Goods • Nonrivalry • Nonexcludability • Free-Rider Problem • Optimal Quantity of a Public Good

4. Demand for Public Goods Two Individuals (1) Quantity Of Public Good (2) Adams’ Willingness To Pay (Price) (3) Benson’s Willingness To Pay (Price) (4) Collective Willingness To Pay (Price) = = = = = $9 7 5 3 1 + + + + + $5 4 3 2 1 $4 3 2 1 0 1 2 3 4 5 Graphically…

5. P $9 7 5 3 1 0 Q 1 2 3 4 5 P $6 5 4 3 2 1 0 Q 1 2 3 4 5 P $6 5 4 3 2 1 0 Q 1 2 3 4 5 Demand for Public Goods S Collective Demand Optimal Quantity $7 for 2 Items Collective Willingness To Pay $3 for 4 Items DC Connect the Dots Comparing MB and MC Collective Demand and Supply Benson’s Demand $4 for 2 Items D2 $2 for 4 Items Benson Adams’ Demand $3 for 2 Items $1 for 4 Items D1 Adams

6. Cost-Benefit Analysis • Concept • Marginal-Cost-Marginal-Benefit Rule

7. P P O 28.2 O 28.1 G 28.1 0 Q Q Externalities Negative Externalities Positive Externalities • Individual Bargaining: Coase Theorem • Limitations • Liability Rules and Lawsuits Negative Externalities St St Positive Externalities S Dt D D Overallocation Underallocation 0 Qo Qe Qe Qo

8. Externalities • Government Intervention • Direct Controls • Specific Taxes • Subsidies and Government Provision • Subsidies to Buyers • Subsidies to Producers • A Market-Based Approach • The Tragedy of the Commons • A Market for Externality Rights

9. P Price Per Pollution Right Q 0 Quantity of 1-Ton Pollution Rights Externalities • Operation of the Market • Advantages • Real-World Examples S=Supply of Pollution Rights D2016 D2006 $200 $100 500 750 1000

10. Externalities • Society’s Optimal Amount of Externality Reduction • MC, MB, and Equilibrium MC Socially Optimum Amount Of Pollution Abatement Society’s Marginal Benefit and Marginal Cost of Pollution Abatement (Dollars) MB 0 Q1

11. GLOBAL PERSPECTIVE Global Warming Carbon-Dioxide Emissions, Tons Per Capita, Selected Nations 2004 0 5 10 15 20 25 United States Australia Canada Czech Republic Germany Japan United Kingdom Italy Spain France 19.8 17.0 16.2 11.8 10.3 9.2 8.8 7.4 7.2 6.2 Source: OECD Environmental Data

12. O 28.3 Information Failures • Asymmetric Information • Inadequate Information Involving Sellers • Example: Gasoline Market • Example: Licensing of Surgeons • Inadequate Information Involving Buyers • Moral Hazard Problem • Adverse Selection Problem • Workplace Safety • Qualification

13. Lojack: A Case of Positive Externalities Last Word • Private Crime Reduction Expenditures $300 Billion • Some Redistribute Rather than Reduce Crime • Lojack Car Recoveries are 95% Versus 60% for Others • Locates and Stops Chop Shops • Estimated 15 Times MSB to Consumers • Underallocation Result • Subsidize Consumer Purchase with Lower Insurance Rates • Discounts too Small to Offset Underallocation

14. private goods public goods free-rider problem cost-benefit analysis marginal-cost-marginal-benefit-rule externalities Coase theorem tragedy of the commons market for externality rights optimum reduction of an externality asymmetric information moral hazard problem adverse selection problem Key Terms

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