government goals & policy government intervention: 1) market failure 2) when the market fails to...
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Government Goals & PolicyGovernment Goals & Policy
Government Intervention: 1) Market Failure 2) When the market fails to perform in line with the
goals that we have for performance then there is a role for government policy
1. Eg) equitable distribution of income when markets fail to achieve social goals for equity,
government policy is called for; eg, government redistribution programs
Measuring Economic Inequality Poverty:
is a situation where a family’s income is too low to be able to buy the quantities of food, shelter, and clothing that are deemed necessary.
is a relative concept. In Canada, poverty is measured by using a low-
income cutoff.low-income cutoff is the income level at which
a family spends 54.7 percent of its income on food, shelter, and clothing.
The Sources of Economic Inequality
The combination of higher demand and lower supply for high-skilled workers relative to low-skilled workers creates a higher equilibrium wage rate for those workers who have attained greater levels of human capital.
Income Redistribution In Canada, governments use three main ways to
redistribute income to reduce the degree of economic inequality: Income taxes Income maintenance programs
Social security programsEmployment Insurance programWelfare programs
Subsidized services.education
Income Redistribution: Leads to “The Big Tradeoff” between equity and
efficiency Income redistribution can be inefficient for three
reasons:The process of redistribution uses resourcesTaxes create deadweight lossTaxes weaken the incentive to work, save,
and invest
Government Goals & Policy
1. Ensure an equitable distribution of income when markets fail to achieve social goals
for equity, government policy is called for; eg, government redistribution programs
2. Ensure the legal framework• Provide a legal system
Define property rights
Establish legal rules of behaviour
3. Ensure economy wide stability & growth Macro economic policy
Economic Functions of Government4. Ensure efficiency Markets sometimes fail to achieve “efficiency”
in the use and allocation of society’s resources
Government policy action when…..
Markets Fail: 1.) Imperfect Competition Market failure occurs if markets are not
competitive regulation of monopoly anti-combines legislation
Market Failure: 2.) Public Goods
Market failure occurs when markets fail to provide Public Goods Private Goods: can be consumed by only one
individual at a time: are both rival and excludable
Public goods: can be consumed simultaneously by everyone, that is, no one can be excluded once the good is produced, & no one’s consumption reduces the amount available for another.
Public goods: can be consumed simultaneously by everyone, that is, no one can be excluded once the good is produced, & no one’s consumption reduces the amount available for another.
1) Nonrival Consumption by one person does not
decrease consumption by another.Television show
2) NonexcludableIt is impossible, or extremely costly, to
prevent someone from benefiting from the good once it is produced.National defence
Market Failure: Public Goods
Market Failure: Public Goods Since people enjoy the benefits without paying, markets
fail to produce public goods
non excludable free ridersa free rider is a person who receives the benefit of a good but avoids paying for it.
Public goods create a free-rider problem because the quantity of the good that a person is able to consume is not influenced by the amount the person pays for the good...so why pay anything at all?
government provision e.g.fireworks
Public Goods The marginal benefit of a public good to an individual
is the increase in total benefit that results from a one-unit increase in the quantity provided. The marginal benefit of a public good diminishes with the level of the good provided.
Everyone can consume each unit of a public good, which means the marginal benefit for the economy is the sum of marginal benefits of each person at each quantity.
Benefits of a Public Good
Quantity (number of fireworks displays)Quantity (number of fireworks displays)
Lisa's Marginal Benefit
Max's Marginal Benefit
Quantity (number of Quantity (number of fireworks displays)fireworks displays)
Mar
gin
al
ben
efit
$M
arg
ina
l b
enef
it$
00 11 22 33 44
44
66
88
1010
MBMBLL
55
Mar
gin
al
ben
efit
$M
arg
ina
l b
enef
it$
00 11 22 33 44
44
66
88
MBMBMM
55
Figure shows how the marginal benefits of a public good are summed at each quantity of the good provided. Part (a) shows Lisa’s
marginal benefit. Part (b) shows Max’s
marginal benefit.
1010
1414
Quantity (number of fireworks displays)Quantity (number of fireworks displays)
Ma
rgin
al b
ene
fit
$M
arg
inal
ben
efi
t $
Benefits of a Public GoodBenefits of a Public Good
00 11 22 33 44 55
1818
Economy's Marginal Benefit
MBMB
The economy’s marginal benefit of a public good is the sum over the individuals at each quantity of the good provided.
The economy’s marginal benefit curve for a public good is the vertical sum of each individual’s marginal benefit curve.
Market Failure: Public GoodsEfficient Provision
Government should provide the efficient quantity of a public good: up to the point where :
MB = MC, ie. MSB=MSC
•At the efficient quantity, the marginal social benefit for the community is equal to the marginal social cost for the community.
MC=MSC
MB=MSB
Quantity (number of fireworks displays
Mar
gina
l ben
efit
0 1
The Efficient Quantity of a Public Good
MBEfficientuse ofresources
Marginal Benefit & Marginal Cost The marginal benefit
curve, MB, is the one we derived = MSB.
The marginal cost curve, MC, is just like the MC curve for a private good.
The efficient quantity is where marginal benefit equals marginal cost.
Market failure occurs when all the relevant costs and benefits are not registered by the market
Externality:
Cost or Benefit resulting from some activity or transaction that is imposed on parties outside the activity or transaction; that is not registered by the market
Market Failure: 3.) Externaility
Externalities: Positive and Negative Market transactions reflect individual consumer and
firm marginal private benefits and marginal private costs respectively.
Efficiency requires:
the marginal social benefit and the marginal social cost be equalized.
If MPCMSC &/or MPBMSB, then markets will fail to achieve efficiency
Market Failure: External Benefits
Pric
e of
Flu
Sho
ts
Quantity of Flu Shots per Year
S
D1
D2
P1
Q1
E
Without external benefits registered:1) Too few influenza shots are given2) Demand = D1
P2
Q2
E1
With external benefits:1) More shots are given at a higher price2) Demand shifts to D2
D1
Too little is produced, price too low when external benefits are not accounted for in the market
MSC
Market Failure: External CostsMPC
MSB
Pric
e of
Ste
el p
er T
onne
P1 E
Q1
Private costs only1) Residents incur cost of pollution2) Supply = S1
A
Q2
P2
E1
Internalize external cost:1) Steel mill pays the the cost of pollution2) Supply shifts to S2
Quantity of Steel per Year
Too much produced, price too low when external costs are not accounted for in the market: third parties bear part of the costs
Negative Externalities: Pollution
Pollution is an old problem and is faced by both rich industrial countries and poor developing countries.
It is an economic problem that is coped with by balancing benefits and costs, using policies that internalize the external costs of production.
Negative Externalities: Pollution Public Policy For Externalities in the case of
Pollution 1.)Regulation (command and control) 2.)Taxes (negative externalities) 3) Subsidies (positive externalities)
Tax equal to the marginal external costs. In equilibrium then P = MSC.
The company with the lowest cost of reducing pollution, will choose to reduce, to avoid the tax
Supply of Good Xwhen costs includeonly internal costs
Public Policy: Tax = External Cost
Quantity of Good X per Time Period
Pric
e of
Goo
d X
per
Uni
t
S1 = MC (excluding externalities)
D
P1
Q1
Supply of Good Xwhen costs = social cost
S2 MC (including externalities)
Q2
P2
In the case of a negative externality, the efficient amount of production is achieved through a tax=external costs
Tax=External Cost of Pollution
External Costs: Public Policy: Tax
Taxes provide incentives for producers or consumers to cut back on an activity that creates external costs.
Taxing an externality does not eliminate all pollution. Taxes force decision makers to consider the full costs of their decisions: internalize the externality.
External Costs: Public Policy: Tax Taxes, have two advantages over
regulation because of their incentive effects:
they give owners an economic incentive to reduce pollution – avoid the tax,
they bring about a given amount of pollution reduction in the most efficient – least costly – way possible.
Public Policy: 3.) Emission Charges
7
10
15
0 5 10 15 20
MB
MSC
Emissions (millions of tonnes per year)
Co
st a
nd b
ene
fit o
f wa
ste
(dol
lars
per
ton
ne
)
Efficient price $10per tonne at efficient qn of 10M Tonnes/yr
At an emission level of
15MTonnes MSC($15) >
MB($7)
External Costs: Public Policy: Marketable Permits
4)Tradable Pollution Rights Trading pollution rights in
essence creates a new scarce resource - pollution permits. The price will be set by the
forces of demand and supply.
The firms that can reduce pollution only at high cost will be willing to pay the most for pollution permits, others will reduce pollution for less cost.
Supply Pollution Permits
D Pollution Permits
Qn (pollution)
Priceof Polltion $