Download ap microeconomics unit #5 market failure/ role of

AP MICROECONOMICS
UNIT #6
MARKET FAILURE/
ROLE OF GOVERNMENT
Lecture 6
Public vs. Private Goods
“The best things in life are free. . .”
■ Most goods in our economy are allocated in
markets…
■ Market Failure: market forces that normally allocate
resources are absent when a good is free of
charge…
■ Government policy can remedy the market failure
and raise economic well-being.
CATEGORIES OF GOODS
■ Excludability
– Excludability means sellers can exclude people
who do not pay for a good from receiving the
benefits
■ Rivalry
– Rivalry occurs when one person’s use of a
good makes it unavailable for another’s
consumption
Four Types of Goods
Rival?
Yes
Yes
No
Private Goods
Natural Monopolies
• Ice-cream cones
• Clothing
• Congested toll roads
• Cable TV
• Uncongested toll roads
Common Resources
Public Goods
• Fish in the ocean
• The environment
• Congested nontoll roads
• Tornado siren
• National defense
• Uncongested nontoll roads
Excludable?
No
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PRIVATE VS. PUBLIC GOODS
■ Private Goods
– Rival and Excludable
– Examples?
■ Public Goods
– Nonrival and Nonexcludable
– Create Free-Riders: a person who receives the
benefit of a good but avoids paying for it.
– Examples?
The Free-Rider Problem
■ Why should I pay for something if I can’t be
excluded from it?
■ Prevents private markets from supplying
public goods.
■ Solving the Free-Rider Problem
– The government can decide to provide the
public good if the total benefits exceed the
costs.
– The government can make everyone better off
by providing the public good and paying for it
with tax revenue.
Optimal Amount of Public Goods
■ Achieving MB = MC
– Government must “estimate” demand since
market is not operating
– Demand for a public good is the collective
willingness to pay for an additional unit
•
Determined by adding the prices people are
willing to pay for the good
– Supply curve is MC, so law of diminishing
returns applies
Optimal Amount of Public Goods
■ Marginal Cost-Marginal Benefit Analysis
– Government should “produce” a good when
MB > MC
– Take action with maximum net benefit
– Economists consider it to be uneconomical or
wasteful if the government does not provide
when MB > MC
Government Allocation
■ Corrects for market failure called externalities
– Cost or benefit taken on by an external party
– These 3rd party costs or benefits are also called
spillovers
– Externalities cause markets to be inefficient, and
thus fail to maximize total surplus
Negative Externalities
■ The intersection of the demand curve and
the social-cost curve determines the
optimal output level
– The socially optimal output level is less than
the market equilibrium quantity.
– Marginal Social Costs > Marginal Private Costs
or MSC > MPC
EXTERNALITIES AND MARKET
INEFFICIENCY
■ Negative Externalities
–
–
–
–
Automobile exhaust
Cigarette smoking
Barking dogs
Loud stereos in an apartment building
Negative Externality: Pollution and the Social Optimum
Price of
Aluminum
MSC
Cost of
pollution
Supply
(MPC)
Optimum
Equilibrium
Demand
(MPB = MSB)
0
QOPTIMUM QMARKET
Quantity of
Aluminum
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Positive Externalities
■ When an externality benefits the bystanders, a
positive externality exists
– The social value of the good exceeds the private
value.
– Marginal Social Benefit > Marginal Private Benefit
or MSB > MPB
Positive Externalities
■ The intersection of the supply curve and the
social-value curve determines the optimal
output level.
– The market produces a smaller quantity than is
socially desirable.
– The social value of the good exceeds the
private value of the good.
EXTERNALITIES AND MARKET
INEFFICIENCY
■ Positive Externalities
– Immunizations
– Restored historic buildings
– Research into new technologies
Positive Externality: Education and the Social Optimum
Price of
Education
Supply
(MPC = MSC)
MSB
Demand
(MPB)
0
QMARKET
QOPTIMUM
Quantity of
Education
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