27_Econ8e_PPT_Ch27

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Market failures, government failures,and rent seeking : 

Market failures, government failures,and rent seeking Chapter 27 Economics, 8th Edition Boyes/Melvin

Economic Freedom : 

Economic Freedom Economic freedom refers to the degree to which private individuals are able to carry out voluntary exchange without government involvement. Economic freedom leads to a higher quality of living. 2 Copyright © Cengage Learning. All rights reserved.

Economic freedom and correlation with standard of living : 

Economic freedom and correlation with standard of living 3 Copyright © Cengage Learning. All rights reserved.

Economic freedom and human development : 

Economic freedom and human development 4 Copyright © Cengage Learning. All rights reserved.

Market Failure : 

Market Failure A market failure occurs when the market outcome is not the socially efficient outcome. Some action by the government is sometimes necessary to ensure that the market does work well. 5 Copyright © Cengage Learning. All rights reserved.

Private property rights : 

Private property rights Private property rights are the rights of individuals to own property. When private property rights are secure, others are not allowed to steal or damage your private property. Private property rights are crucial to a market. 6 Copyright © Cengage Learning. All rights reserved.

Private, public, commons, and club goods : 

Private, public, commons, and club goods The principle of mutual exclusivity states that the owner of private property is entitled to enjoy the consumption of that property privately. The principle of rivalry states that when one consumes or uses a good or service, less remains for others. 7 Copyright © Cengage Learning. All rights reserved.

Private, public, commons, and club goods : 

Private, public, commons, and club goods Private good – a good that is both excludable and rivalrous. Club good – a good that is excludable but nonrivalrous Public good – a good that is nonexcludable and nonrivalrous. Commons good – a good that is rivalrous but nonexcludable. 8 Copyright © Cengage Learning. All rights reserved.

Classification of goods : 

Classification of goods 9 Copyright © Cengage Learning. All rights reserved.

Free rider : 

Free rider When goods are nonexcludable, an individual has an incentive to be a free rider. A free rider is a consumer or producer who enjoys the benefits of a good or service without paying for that good or service. 10 Copyright © Cengage Learning. All rights reserved.

Externalities : 

Externalities Private costs and benefits are costs and benefits that are borne solely by the individuals involved in the transaction. An externality is a cost or benefit of a transaction that is borne by someone who is not directly involved in the transaction. If externalities exist, it means that those involved in the demand and supply in the market are not considering all the costs and benefits when making their market decisions. As a result, the market fails to yield optimal results. 11 Copyright © Cengage Learning. All rights reserved.

Positive and negative Externalities : 

Positive and negative Externalities A positive externality may result when some of the benefits of an activity are received by consumers or firms not directly involved in the activity. A negative externality may result when some of the costs of an activity are borne by consumers or firms not directly involved in the activity. 12 Copyright © Cengage Learning. All rights reserved.

Social Cost : 

Social Cost Social cost: the total social cost of a transaction is the private cost plus the external cost. If all of the costs of a transaction are borne by the participants in the transaction, the private costs and the social costs are the same. 13 Copyright © Cengage Learning. All rights reserved.

Externalities and Market Failure : 

Externalities and Market Failure When there is a divergence between social costs and private costs, the result is either too much or too little production and consumption. In either case, resources are not being used in their highest-valued activity and market failure can occur. 14 Copyright © Cengage Learning. All rights reserved.

Negative Externalities : 

Negative Externalities With a negative externality, the supply curve does not reflect the true cost of the good. As a result, the supply that is provided is greater than it would be if suppliers had to pay all the costs (including the external cost). SP is the supply provided, whereas SS is the supply as it would be if the suppliers had to pay the external cost. 15 Copyright © Cengage Learning. All rights reserved.

Positive Externalities : 

With a positive externality, the demand curve does not reflect all the benefits of the good. As a result, the demand that is given in DP is less than it would be if demanders received all the benefits (including the external one). DS is the demand as it would be if the demanders received the external benefit. Positive Externalities 16 Copyright © Cengage Learning. All rights reserved.

Solutions to market failure : 

Solutions to market failure If all the costs or benefits of a private transaction belonged to the people creating them, then externalities would be no problem. When people causing externalities pay for them, we say the externality has been internalized. 17 Copyright © Cengage Learning. All rights reserved.

Government’s role : 

Government’s role Tax or subsidize the externality Command and control Marketable pollution permits: Cap and trade 18 Copyright © Cengage Learning. All rights reserved.

Pollution Tax : 

Pollution Tax 19 Copyright © Cengage Learning. All rights reserved.

Subsidy for Inoculations : 

Subsidy for Inoculations 20 Copyright © Cengage Learning. All rights reserved.

Market for Pollution Permits : 

Market for Pollution Permits 21 Copyright © Cengage Learning. All rights reserved.

Asymmetric Information : 

Asymmetric Information Exchange that occurs when one party has more information than the other is called exchange with asymmetric information. One manifestation of this is called adverse selection: the problem that occurs when higher-quality goods, consumers, or producers are driven out of the market because unobservable qualities are incorrectly valued. Lemons market: a market in which adverse selection occurs. 22 Copyright © Cengage Learning. All rights reserved.

Adverse selection : 

Adverse selection 23 Copyright © Cengage Learning. All rights reserved.

Moral Hazard : 

Moral Hazard A related issue is moral hazard—the problem that arises when people change their behavior from what was expected of them when they engaged in a trade or contract. 24 Copyright © Cengage Learning. All rights reserved.

Increasing returns : 

Increasing returns Increasing returns – each additional resource adds increasing additional output 25 Copyright © Cengage Learning. All rights reserved.

Network externalities and lock-in : 

Network externalities and lock-in Network externalities – each additional user increases the value of the entire network Lock-in – the cost of changing to a more efficient technology is higher than the benefit 26 Copyright © Cengage Learning. All rights reserved.

The market does not fail : 

The market does not fail Some economists argue that the market does not fail, that private individuals and free markets can solve problems that appear to be market failures. There are externalities everywhere. Imperfect information does not necessarily lead to market failure. 27 Copyright © Cengage Learning. All rights reserved.

Government Failure : 

Government Failure James Buchanan, who received the 1986 Nobel Prize in Economics, argues that inefficiencies arise when decisions are removed from the private sector and turned over to elected representatives. The government is a market—a market for votes, power, etc., and the same problems that arise in all markets arise in government decision making. 28 Copyright © Cengage Learning. All rights reserved.

Government failure : 

Government failure Logrolling – an inefficiency in the political process in which legislators support one another’s projects in order to ensure support for their own, can lead to government failure. Rent seeking – the use of resources simply to transfer wealth from one group to another without increasing production or total wealth. 29 Copyright © Cengage Learning. All rights reserved.

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