Download Lecture Week 12

Government Goals & Policy



1.
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
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 lowincome 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 programs
 Employment Insurance program
 Welfare 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 resources
 Taxes create deadweight loss
 Taxes 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
Ensure economy wide stability & growth
Macro economic policy
3.
Economic Functions of Government
4.

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.
Market Failure: Public
Goods
1) Nonrival
 Consumption by one person does not
decrease consumption by another.
Television show
2) Nonexcludable
 It
is impossible, or extremely costly, to
prevent someone from benefiting from the
good once it is produced.
National
defence
Market Failure: Public Goods

Since people enjoy the benefits without paying, markets
fail to produce public goods
 government provision e.g.fireworks
non excludable  free riders
a
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?
Public Goods

The marginal benefit of a public good to an individual
is the increase in total benefit that results from a oneunit 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.
Marginal benefit$
Benefits of a Public Good
Lisa's Marginal Benefit
10
8
6
4
Marginal benefit$
0
MBL
1 2
3
4
5
Quantity (number of
fireworks displays)
Max's Marginal Benefit
8
6
4
0
MBM
1
2
3
4
5
Quantity (number of fireworks displays)

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.
Benefits of a Public Good
Economy's Marginal Benefit
Marginal benefit $
18
14
10
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.
 MB
0
1
2
3
4
5
Quantity (number of fireworks displays)
Market Failure: Public Goods
Efficient 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.
The Efficient Quantity
of a Public Good
 The
Marginal Benefit & Marginal Cost
MC=MSC
Marginal benefit
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.
MB
Efficient
use of
resources
 MB=MSB
0
1
Quantity (number of fireworks displays
Market Failure: 3.) Externaility

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
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
MPCMSC &/or MPBMSB, then markets will
fail to achieve efficiency
Market Failure:
External Benefits
S
E1
Price of Flu Shots
P2
P1
With external benefits:
1) More shots are
given
at a higher price
2) Demand shifts to D2
Without external benefits
registered:
1) Too few influenza shots
are given
2) Demand = D1
E
D2
D1
Q1
Q2
Quantity of Flu Shots per Year
Too little is produced, price too low when external benefits are not
accounted for in the market
Market Failure: External Costs
Price of Steel per Tonne
MSC
P2
MPC
Internalize external cost:
1) Steel mill pays the
the cost of pollution
2) Supply shifts to S2
E1
P1
E
A
Private costs only
1) Residents incur cost
of pollution
2) Supply = S1
MSB
Q2
Q1
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
Public Policy: Tax = External Cost
S2 MC (including externalities)
Price of Good X per Unit
Supply of Good X
when costs =
social cost
S1 = MC (excluding externalities)
Tax=External Cost
P2
of Pollution
P1
Supply of Good X
when costs include
only internal costs
D
Q2
Q1
Quantity of Good X per Time Period
In the case of a negative externality, the efficient amount of production is
achieved through a tax=external costs
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.
Cost and benefit of waste
(dollars per tonne)
Public Policy: 3.) Emission
Charges
MSC
15
At an
emission
level of
15MTonnes
MSC($15) >
MB($7)
10
7
Efficient price $10
per tonne at efficient qn of
10M Tonnes/yr
0
5
10
15
MB
20
Emissions (millions of tonnes per year)
External Costs: Public Policy:
Marketable Permits
4)Tradable Pollution Rights
 Trading pollution rights in
essence creates a new scarce
resource - pollution permits.
 The price will be set by the
forces of demand and
supply.
 The firms that can reduce
pollution only at high cost
will be willing to pay the
most for pollution permits,
others will reduce pollution
for less cost.
P
r
i
c
e
of
P
o
l
l
t
i
o
n$
Supply Pollution
Permits
D Pollution
Permits
Qn
(pollution
Optimal Amount of
Pollution
Society’s
MSC & MSB
of
Pollution
Abatement
MSC
15
Optimal
(social)
amount of
pollution
10
7
Efficient Price
0
MSB
20
40
60
80
Amount of pollution abatement %