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Honors Economics
Unit 4
Market Failure
and the Role
of the
Government
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Karl Marx
Market Failures
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Karl Marx
The world praises the individual who makes the
most people happy. Wealth is Utility, not the
accumulation of Material Wealth
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-Das Kapital
1867
Scientific Socialism
LABOR THEORY OF VALUE
• All wealth is a direct result of combining Labor with the
other Tools of Production
ALIENATION
• The concept of Private Property has separated the
worker from access to the other Means of Production
EXPLOITATION
• Private Ownership allows the Capitalist to seize the
Surplus Labor Value of the worker as Profit by paying
Subsistence Wages
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•Disney World was completed in 1973 the final
cost of construction, land, material, display and
other expenses is estimated at $331,000,000.00
•The daily cost for running Walt Disney World is
about $259,000 a day; that’s $94,534,000 a year.
In the final year before he was fired
as CEO of the Disney Corporation,
Michael Eisner was given a bonus
of $202,000,000.
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QUESTION:
If Michael Eisner didn’t show up for work this
Saturday, could you still go to Disney World?
If all the employees didn’t show up for
work this Saturday, could you still go to
Disney World ?
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Marx’s Market Failures
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BUSINESS
CYCLES
IMPERFECT
COMPETITION
INEQUITY
ASYMMETRIC
INFORMATION
EXTERNALITIES
PUBLIC
GOODS
Marx’s Market Failures
BUSINESS
CYCLES
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Fluctuations in the
level of economic
activity as
measured by the
general levels of
unemployment and
inflation
Level of Real Output
Marx’s Theory of the Business
Cycle
Peak
Peak
Peak
Trough
Trough
Time
 Twin Problems of the Business Cycle
•
•
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Unemployment
Inflation
Business Cycles
•SEASONAL CYCLES
•36 MONTH CYCLES
•10 YEAR CYCLES
•50 YEAR CYCLES
•STRUCTURAL
•CHANGES IN
•TECHNOLOGY
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Marx’s Market Failures
INEQUITY
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economic disparity in
income and wealth
between people or
groups of people
resulting from lack of
equal treatment,
unequal opportunity
and causing inefficient
market outcomes
2007 US Family Income
Shares before Taxes and
Transfers:
–
–
–
–
–
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Lowest 5th = 1%
Second 5th = 7%
Middle 5th = 14%
Second highest 5th = 23%
Highest 5th = 55%
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Marx’s Market Failures
INEQUITY
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Marx’s Market Failures
IMPERFECT
COMPETITION
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exists when an business
has sufficient control over
a particular market to
determine the terms on
which other individuals
shall have access to it’s
product; a market in
which the seller
determines the price and
quantity rather than the
consumer.
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Marx’s Market Failures
ASYMETRIC
INFORMATION
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A situation where
access to information
in a transaction is
better for one person
than another.
Asymmetric
information gives
advantage to one while
the other may have to
suffer.
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Marx’s Market Failures
EXTERNALITIES
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An externality or spillover
is an impact on a party
that is not directly
involved in a market
production or transaction.
In such a case, prices do
not reflect the full costs
or benefits in production
or consumption of a
product or service.
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Marx’s Market Failures
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BUSINESS
CYCLES
IMPERFECT
COMPETITION
INEQUITY
ASYMMETRIC
INFORMATION
EXTERNALITIES
PUBLIC
GOODS
Marx’s Solutions
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Alternatives Considered #1
REVOLUTION
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Alternatives Considered #2
Unions
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Alternatives Considered #3
government
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SOCIALISM
• GOVERNMENT BY DIRECT POPULAR VOTE
• PUBLIC OWNERSHIP OF THE MEANS OF
PRODUCTION
–
–
–
–
–
COMMUNICATION
TRANSPORTATION
FINANCE
EDUCATION
HEALTH CARE
• PROGRESSIVE INCOME TAX
• REDISTRIBUTION OF INCOME THROUGH
TRANSFER PAYMENTS
• CREATION OF A SOCIAL WELFARE SAFETY NET
• ELIMINATION OF DISCRIMINATION
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Modern Economist and the
Debate Over the Free Market
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Friedman and Galbraith
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“The proper guardians of the public interests are
governments, which are accountable to all citizens. It is
the job of elected politicians to set goals for regulators,
to deal with externalities, to mediate among different
interests, to attend to the demands of social justice, to
provide the public goods, and to organize resources for the greater
good.”
John Kenneth Galbraith
The Economist Magazine
January 2005
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John Kenneth Galbraith
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•
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All truly important economic activity takes place within giant corporations.
Large dominant firms are immune to competitive pressure.
Wages and prices are artificial creations of large corporations.
Consumers are manipulated by advertising.
The United States is a planned economy run by large corporations.
The government in a liberal society is the ‘public conscience’ which must
– enforce law and order and protect property rights
– serve as a balance to the power of large corporations.
– protect human rights: resolve inequity, prevent discrimination and
exploitation
– promote full employment and a stable economy through taxing and
spending
– model social responsibility: correct externalities, promote culture, and
eliminate pollution
– Provide community investment in public goods such as schools,
transportation, communication, and healthcare.
• 4 Taxation
is the price paid for membership in civilized society
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John Kenneth Galbraith
Role of government in mixed economy
-protective function
-corrective function
-Distributive function
-productive function
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John Kenneth Galbraith
SOLUTION TO MARKET FAILURE:
DIRECT GOVERNMENT INTERVENTION
GOVERNMENT AS REFEREE
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The Capitalist Rebuttal
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“There is one and only one social responsibility of
business – to use its resources and engage in activities
designed to increase its profits in open and free competition without
deception or fraud.
Businessmen who talk about corporate social responsibility are unwitting
puppets of the intellectual forces that have been undermining the basis of
a free society for decades; in fact, they are preaching pure and
unadulterated socialism.”
Milton Friedman New York Times
13th September 1970
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Friedman on Capitalism
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Milton Friedman
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Economic freedom promotes political freedom.
The only role of the government is to provide order and protect property rights.
Government intervention in the market is ineffective because of
– the rational ignorance of voters,
– the special interest effect from lobbyists,
– the short-sightedness of politicians.
Taxation and spending by the government make the economy less stable.
A uniform flat ax with no deductions is more fair than a progressive income tax.
Social welfare programs don't help the poor; they reward poverty and prevent
investment in human capital.
Free public education is foolish. Anything that is perceived as free is undervalued and
abused.
There is no justification for licensing or regulation; government regulations inhibit the
freedom of individuals to produce and consume as they choose.
The only true solution to the problem of global conflict and poverty is the end of all
trade barriers.
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Friedman’s Government Failures
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RATIONAL
IGNORANCE
RENT-SEEKING
AND
SPECIAL INTERESTS
SHORT-TERM
THINKING
DEADWEIGHT
LOSS
CROWDING
OUT
BUREAUCRATIC
CAPTURE
Friedman’s Government Failures
RATIONAL
IGNORANCE
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The rational voter has little
incentive to gain more
knowledge about politics
because his or her vote is
unlikely to affect the
outcome and political
decisions have little impact
on the voter’s everyday life.
Since gaining more
knowledge offers few
benefits and substantial
costs, it is thus rational to
remain ignorant.
Friedman’s Government Failures
RENT-SEEKING
AND
SPECIAL INTERESTS
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The idea that politicians are
rational in seeking to maximize
their potential for re-election by
giving something for nothing; or
taking a small amount from a
large group of people and giving
a large amount to a small group
of people. This encourages the
formation of small groups which
lobby politicians and the
government for larger shares of
spending and favorable
regulation.
Consequences of Rent-Seeking:
The Special Interest Effect
•Pork Barrel Legislation or “Earmarks”
•The term usually refers to spending that is intended to
benefit constituents of a single politician in return for
their political support, either in the form of campaign
contributions or votes.
•“Logrolling”
•act of exchanging favors for
mutual gain; especially trading
of influence or votes among
legislators to gain passage of
certain projects.
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In 2006, Rep. Don Young (R-AK) and Sen. Ted Stevens (RAK) amended the National Appropriation bill to use
federal funding for a bridge in Ketchikan, Alaska. Dubbed
the “Bridge to Nowhere,” it became a national symbol of
“pork-barrel” spending. The bridge would connect the
town of Ketchikan (population 8,900) with the island of
Gravina (population 50) at a cost to federal taxpayers of
$320 million, by way of three separate earmarks in the
2006 highway funding bill.
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Friedman’s Government Failures
SHORT-TERM
THINKING
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The idea that politicians
are rational in seeking to
maximize their potential for
re-election by giving
something for nothing; and
do not think further than
the next election. This may
result in actions having
short-term benefits, but
higher costs in the long
run.
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Friedman’s Government Failures
CROWDING
OUT
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A reduction in private
consumption or investment from
increased governments spending.
If the increase in spending is
financed by a tax increase, the
tax increase would tend to
reduce private consumption. If
the increase in spending is not
accompanied by a tax increase,
government borrowing to
finance the increased
government spending would
increase interest rates, leading
to a reduction in private
investment.
Friedman’s Government Failures
DEADWEIGHT
LOSS
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The term "deadweight
loss" can be applied to
any inefficient allocation
of resources caused by
government interference.
Lost production and
investment due to
government taxation and
crowding out are primary
examples.
Friedman’s Government Failures
BUREAUCRATIC
CAPTURE
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Regulatory or bureaucratic
capture is a term used to refer
to situations in which a
government regulatory agency
created to act in the public
interest instead acts in favor
of the industry it is charged
with regulating. Regulatory
capture is a form of
government failure, as it can
act as an encouragement for
large firms to produce
negative externalities.
Milton Friedman
SOLUTION TO MARKET FAILURE:
inDIRECT GOVERNMENT INTERVENTION
GOVERNMENT AS REpairman
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Reagan’s
First Inaugural Address
1980
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Bill Gates and Creative
Capitalism
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Friedman and Galbraith
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