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CHAPTER 28
GOVERNMENT AND MARKET FAILURE
SUMMARY
1.
What is economic freedom?

Economic freedom is the degree to which individuals are able to engage in
voluntary transactions without government involvement. Preview

The index of economic freedom is a measure of the involvement of
government in an economy.
2.
What is a market failure?

A market failure occurs when the market is not able to reach the equilibrium
that is most efficient, when resources are not allocated to their highest-valued
use. Preview §1

The government is often called upon to resolve market failures. Preview §1

A freely functioning market results in resources being allocated to their
highest-valued use. When something occurs that leads resources not to be so
allocated, we say that a market failure has resulted. Preview §1
3.
What are externalities?

Private benefits of a transaction are the gains from trade that the individuals
involved in the transaction achieve. Private costs are the opportunity costs that
the individuals involved in the transaction must bear. §1

Social costs and benefits are the total costs and benefits created by a
transaction. When some costs are borne by those who are not involved in the
private transaction, a negative externality occurs, so that social costs exceed
private costs. When some benefits are received by those who are not involved
in the private transaction, a positive externality occurs, so that social benefits
exceed private benefits. §1

When social costs and benefits are not equal to private costs and benefits, the
market outcome is either over-utilization or under- utilization: resources are
not allocated to their most highly valued use. §1.a

There are several approaches to reducing the inefficiencies created by
externalities. One approach is to impose a tax on the individual or institutions
creating the externality. In another approach, the government requires or
commands that those creating negative externalities reduce the amount created
or that more production of positive externalities occur. In yet another, the
government creates a market for the negative externalities by establishing
ownership of the right to create the negative externality and allowing that
ownership to be exchanged. §1.b.1–§1.b.3

The Coase theorem states that as long as private property rights can be
established, private individuals will be able to solve an externality problem
without government intervention. §1.c
4.
Why are chickens not listed as an endangered species?

Chickens are privately owned. A market failure problem occurs when no one
owns something or when everyone owns something. The list of endangered
species are species not privately owned. §2.a

Common ownership results in a market failure. Too much of the commonly
owned good is consumed, and not enough is produced. §2.a

The solution to a common ownership problem is to create private property
rights in any case where such rights can be created. §2.c.1
5.
Why do governments create, own, and run national parks?

One approach taken to resolve common ownership problems is for the
government to claim ownership of the common good and to provide it as the
government defines. §3.a

Private property rights provide ownership. In order to buy or sell something,
one must be able to decide how that something is to be used. §3.a

Without private property rights, anyone can claim partial ownership of an item
and thereby consume that item. Without private ownership, no one would be
willing to purchase an item, since others could consume that item. §3.a

Free riding means that one person will contribute less than what that person
expects to get in return because the person expects others to make up the
difference. §3.a

People free-ride because they can—their self-interest tells them to get the most
for the least. §3.a

The problem with free riding is that if many people or everyone free-rides,
nothing gets done. §3.a

Solutions to public good problems include private provision of the public good
and government provision of the good. §3.b
6.
Why are ingredients required to be listed on food packaging?

When buyers have less information than sellers, a situation can arise in which
high-quality products are driven out of the market, leaving just low-quality
products. This is called adverse selection. §4.a

When buyers have more information than sellers about a particular item,
buyers may alter their behavior with regard to that item once they have
purchased it. For instance, once someone is insured, that person may act
differently, taking on more risk. This is called moral hazard. §4.b

Problems of adverse selection and moral hazard are often resolved privately
through copayments, deductibles, and other such arrangements that reduce the
incentives to change behavior or not reveal information. §4.c
7.
What is rent seeking?

Since the government has no competition, it is generally less efficient than the
private market. §5

Government failures may result from logrolling and rent seeking. §5