Download Public Goods, Regulation, and Public Information

ECONOMICS:
EXPLORE & APPLY
by Ayers and Collinge
Chapter 24
“Public Goods, Regulation,
and Public Information”
©2004 Prentice Hall Publishing
Ayers/Collinge, 1/e
1
Learning Objectives
1. Distinguish among private goods, public
goods, externalities, and common property
resources.
2. Explain why the private marketplace fails to
offer public goods in efficient quantities.
3. Identify an optimal amount of highway
congestion and policies to achieve that
amount.
4. Describe why government enacts regulations
and what principles can guide it toward
efficiency.
©2004 Prentice Hall Publishing
Ayers/Collinge, 1/e
2
Learning Objectives
5. Explain the concept of asymmetric
information and how it influences market
outcomes.
6. Apply the analysis of marginal cost and
marginal benefits to explain criminal
behavior.
7. Identify major issues in healthcare and
alternative ways of addressing them.
©2004 Prentice Hall Publishing
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24.1
IDENTIFYING MARKET FAILURES
•
•
•
•
Technology tells what can be done.
Economics tells us what should be done.
Politics tells us what will be done.
Economist face a dilemma, as they are
caught in middle.
– They neither produce goods nor control
public policy.
– They seek to identify when public policy is
needed to meet public goals, and the type of
government actions that are appropriate.
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Identifying Market Failure
o The invisible hand of the marketplace and
competition lead profit-seeking producers to
offer consumers an efficient variety of goods
and services, which are produced at least cost,
and in efficient quantities.
o Efficiency is the market’s great success, and is
the reason market economies have been able to
improve living standards over time.
o However, there are also instances of market
failure, in which markets do not bring about
economic efficiency.
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Identifying Market Failure
 The two reasons for market failure are…
 The lack of competition.
 Public goods.
 Private goods are excludable, and rival, meaning
that people can be excluded from consuming
the good and any one person’s consumption
diminishes the amount that is available for
others.
 Public goods are nonexcludable and nonrival,
meaning that people cannot be excluded from
consuming the goods, nor does consumption
reduce the amount available for others.
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Identifying Market Failure
Impurities in public goods often involve
congestion, which occurs when the
addition of one more user reduces the
availability of the good for all other users.
Congestion violates the assumption of
nonrivalry needed for a pure public good.
Local public goods provide an economic
justification for local and regional
governments.
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Identifying Market Failure
Sometimes the ownership of something is
common property, meaning that it is
shared.
Shared ownership occurs most frequently
with natural resources, leading to the
term common property.
A common property resource generates
contention over who gets to use it.
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Identifying Market Failure
Zero
Complete
Pure
private
goods
(pencil)
Private
goods with
externalities
(cigars)
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Pure
public
goods
(sunlight)
Common
property
resources
(ocean fish)
Impure and
local public
goods
(stoplight)
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Identifying Market Failure
At other times the production or
consumption of private goods leads to
cost or benefits to third parties.
Such spillover effects onto third parties
are termed externalities.
Negative externalities impose external
cost on others.
Positive externalities confer external
benefits.
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The Production of Public Goods
Private goods are consumed and paid for by the
individual.
Public goods, on the other hand, are consumed
simultaneously by everyone, regardless of who
pays.
The value of a public good is the sum of its
values to all consumers.
The efficient quantity of a public good is
achieved when marginal cost equals marginal
benefit.
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The Production of Public Goods
For private goods, you receive something in
exchange for your money.
With public goods, the amount you consume
seems unaffected by how much you spend.
The result is a free-rider problem, in which
everyone has the incentive to let others pay the
cost of providing the public good.
Public goods, being nonexcludable, will not be
produced unless the government gets involved.
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The Value of Public Goods
The value of a public
good is the sum of its
value to each person,
because everyone
consumes the same
amount.
$5 Worth
to everyone
else
$21
$9
Worth
to Bob
$12
$12 Worth to
Ana
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The Efficient Quantity
of a Public Good
Just as with private goods,
the efficient quantity of a
public good occurs when the
marginal benefit of another
unit just equals its marginal
cost.
Social
Surplus
Marginal cost
Marginal benefit
Efficient
Quantity
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24.2
PUBLIC OPTIONS
Government has no choice but to produce
pure public goods itself.
For impure public goods, it is possible for
government to to use regulation, or price
incentives to guide the marketplace
towards efficiency.
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PUBLIC OPTIONS
Government policy alternatives are of
three general sorts:
Government can price the good.
Government can produce the good.
Government can regulate the good.
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Congestion On The Highway
Congestion without government action
The individualPeak
driver
does not
Demand
perceive the full marginal social
cost of getting on the highway –
only their private marginal cost.
The result is too many cars on
the highway during peak hours.
Marginal
social cost
Efficient goal
•
Market choice
•
•
Congestion point
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Marginal cost
to driver
Vehicles per mile
Too much
congestion
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Congestion On The Highway
Congestion WITH government action
Revenue
Government
The
optimal
is obtained
toll
canwould
reduce
byincrease
Peak
Demand
highway usage
marginal
multiplying
cost
theuntil
number
to an
it intersects
efficient
of
amount by
demand
vehicles
at
subject
the
assessing
efficient
to theatoll
quantity.
tollby
on
each
the
amount
driver during
of the toll
times
perof peak
demand.
vehicle.
Marginal
social cost
Marginal cost
to driver
•
Optimal
Toll
Government
revenue from toll
•
•
Vehicles per mile
Reduced
congestion
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Government Production
The government uses cost-benefit
analysis to estimate and compare the cost
and benefits of alternative courses of
action.
Cost benefit analysis is often complex
because of intangibles, which have no
market price.
For example when analyzing speed limits,
the value of a statistical life, the expectation
of a life saved or lost as a result of
government action, is an intangible.
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Regulation and the
Specificity Principle
o Regulation occurs whenever government acts to
influence the specifications of goods and services or
the manner in which they are produced.
o In determining the type and amount of regulations
to apply, policy makers should be aware of the
regulation’s administrative and compliance cost.
o The marginal benefit of additional regulation
should equal its marginal cost.
o The specificity principle says to target the problem
in as precise and narrow a manner as possible.
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Regulation and the
Specificity Principle


There are often political reasons that run
counter to the specificity principle.
Therefore there are really two goals:
1. To avoid a shortage.
2. To avoid hurting the poor.

The specificity principle would suggest
two separate policies, such as:
1. A single market-clearing price that adjust as
needed to prevent shortages.
2. Financial aid on the basis of income needs.
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Applying the Specificity Principle
APPLYING THE SPECIFICITY PRINCIPLE TO AVOID WATER SHORTAGES
Many
A marginal-cost
cities choose
price
to set the
price
clearsofthe
tapmarket,
water on
which
the basis
of
avoids
average
persistent
cost in order
water to
avoid
shortages.
revenue in excess of that
needed to cover costs.
A single price cannot satisfy
both objectives.
Water shortage from
average-cost price
Marginal cost
Marginal
cost-price
•
Excess
Revenue
Average Price
(average cost)
©2004 Prentice Hall Publishing
•
•
Demand
Sustainable Quantity
Quantity Demanded
Tap Water
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24.3
IMPERFECT INFORMATION
• Imperfect information occurs when we do
not fully understand the choices available
to us, or the consequences of those
choices.
• In the laissez-faire marketplace, there are
always the unscrupulous willing to take
advantage of the naïve.
• In these situations government can and
does look for ways to help.
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Asymmetric Information
When one person has access to more
information than another on a subject of
mutual interest, they are said to possess
asymmetric information.
Asymmetric information provides at least part
of the explanation for another for another
phenomenon – cronyism.
Cronyism occurs when employers hire friends,
relatives, fellow church members, and so forth.
Fair or not cronyism offers a way to circumvent
asymmetric information.
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Protecting Life and Limb Workplace Safety
The search for profit motivates firms to implement
numerous safety measures, even when no
regulation forces them to do so.
If the cost of not implementing these safety
measures exceeds the cost of the safety measures,
the profit-maximizing firm will undertake the
safety measures.
Safety measures should be undertaken so long as
the marginal benefits exceeds their marginal cost.
If firms do not undertake an efficient number of
safety measures, there is a role for government
regulators.
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Workplace Safety
Efficiency goal
Marginal cost
Market equilibrium
•
•
Market
quantity
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Market
demand
Efficient
quantity
With perfect
information, this
would be demand
Marginal
social benefit
Quantity of safety
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Public Safety –
Crime and Punishment
Imperfect information is at the heart of
criminal activity and the fight against it.
Criminals seek to hide their activities,
while authorities seek to uncover them.
Technology can provide information that
assist in uncovering crime, but can also
help the criminals themselves.
The cost of crime and crime prevention
takes many forms.
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Public Safety –
Crime and Punishment
 From an economic perspective, a criminal would
consider the relative monetary and non-monetary
returns and weigh them against expected returns,
when considering a life of crime.
 Because there is uncertainty attached to the
outcome of criminal activity, the economic model of
crime states that criminals make decisions based on
the expected marginal benefits and the expected
marginal cost of criminal activity.
 Expected punishment = Punishment for the crime x
Probability of being caught and convicted
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Economics of Crime
$
Rational, but
not efficient
•
Expected
marginal cost
to criminal
Increasing the cost
or lowering the
benefits reduce the
amount of crime.
Expected marginal
benefit to criminal
Quantity chosen
by the rational
criminal
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Quantity of crime
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24.4 EXPLORE & APPLY
Healthcare – Can the Ills be Cured?
Sources of medical spending
Out of
pocket
15%
Private
Insurance
34%
Medicare
17%
Medicaid
related
16%
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Other
public
12%
Other
private
6%
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Healthcare – Can the Ills be Cured?
Uses of medical spending
Hospital
care
32%
Physician
and clinical
services
22%
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Other
spending
24%
Program
Administration
and net cost
6%
Prescription
drugs
9%
Nursing
home care
7%
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Moral Hazard and Price Surprises
Price to
uninsured
Price surprise
to the
unexpected
uninsured
Price to
insurer
•
•
Moral hazard results
when insurance lowers
the price of healthcare
for the recipient, thus
increasing the quantity
of services demanded
beyond what is efficient.
Demand for
• healthcare
Actual Quantity
Quantity
quantity
demanded if
Efficient
no insurance
Effect of
quantity
moral hazard
32
Co-insurance
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Terms Along the Way
market failure
private good
public goods
congestion
local public good
common property
resource
externality
external cost
©2004 Prentice Hall Publishing
external benefits
free-rider problem
cost-benefit analysis
regulation
specificity principle
imperfect
information
asymmetric
information
Ayers/Collinge, 1/e
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Test Yourself
1. The distinction between impure and pure
public goods is that impure public goods:
a. are rival.
b. are excludable, but not rival.
c. are sometimes either excludable, or rival.
d. must be paid for through taxation, while
pure public goods cost nothing.
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Test Yourself
2.
a.
b.
c.
d.
The value of a public good
is indicated by its demand curve.
cannot be know even in principle.
is the sum of its value to all consumers.
equals the sum of all taxes paid that are
spent on the good.
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Test Yourself
3. The free-rider problem is associated
with
a. downtown bus terminal.
b. pure private goods.
c. the poverty problem.
d. public goods.
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Test Yourself
4. Intangibles
a. are easily measured.
b. is another name for the free-rider
problem.
c. are irrelevant to decision making.
d. are included in cost-benefit analysis.
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Test Yourself
5. In assessing cost and benefits, the value
of a statistical life is
a. ignored.
b. assumed to be zero.
c. infinite.
d. based on people’s willingness to accept
risk.
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Test Yourself
6. Of the following, the most likely
explanation for cronyism is
a. asymmetric information.
b. the free-rider problem.
c. common-property resources.
d. the specificity principle.
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The End!
Next Chapter 25
“Externalities and
Common Property
Resources"
©2004 Prentice Hall Publishing
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