Bec doms ppt on economic theory, markets, and government
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Transcript of Bec doms ppt on economic theory, markets, and government
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Economic Theory, Markets, and Government
Economic Theory Market Failure The Role of Government
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I. Economic Theory
Elements objectives constraints choices
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objectives
what do we want to do? people: maximize satisfaction firms: max. profits gov't: max. re-election or budget
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constraints
limits on how we achieve objectives physical (PPC) financial (budget constraint) legal (property rights)
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choices
a statement about likely choice law of demand law of supply
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key assumption
people are rational people make best decision give their objectives and
constraints
rational decisions are consistent forward-looking
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rationality
full use all available info when making decisions
bounded limited ability to process information
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rationality & objectives
self-regarding preferences maximize own satisfaction
other-regarding preference max. own and others' satisfaction care what others think
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combine theory with observation simplest theory, consistent with observation (Ockham's razor)
Theory vs. observation
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What if observations do not match theory?
modify theory have we allowed for all constraints? are the objectives correct?
reluctant to change preferences rationality assumption
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II. Market failure
Usually market allocates resources optimally directs resources to best uses market outcome is efficient
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market failure results when market outcome is not efficient too little of good is produced OR too much of good is produced
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When does this happen?
externalities public goods lack of competition
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3rd party gets costs or benefits from good production or consumption OTHER than buyer/seller
Externalities
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External benefit =
positive externality
External cost =
negative externality
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example: flu shot
Flu shot I pay $10 for a flu shot I am less likely to get the flu AND you are less likely to get the flu
external benefit
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So what’s the problem?
My decision to get flu shot based on only MY benefits
underestimate total benefits of shot
too few people get shots markets under-produce goods with external
benefits
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So what’s the solution?
Government subsidy of flu shot
-- price is cheaper
-- more people get flu shots
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Other goods with external benefits
education antilock brakes landscaping
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Example: electricity production
Profits for utility company costs to utility company external costs
-- air pollution
-- water pollution
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So what’s the problem?
Electricity cost reflects production cost not pollution costs
underestimate total costs
electricity is too cheap markets over-produce goods with external
costs
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So what’s the solution?
Government pollution regulation
increase costs of electricity
less power generated
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Other goods with external costs
Cigarette smoking loud music drunk driving
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Public goods
nonexclusive cannot exclude those who do not pay
from getting benefits nonrival
my consuming good does not prevent you from consuming it
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Private good: candy
if I eat it, you cannot
Public good: missile defense shield over CNY
everyone here can use it
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So what’s the problem?
If I buy the shield, you benefit
so I wait, hoping you buy the shield….
nobody buys the shield
free rider problem market alone will fail to produce the
public good
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So what’s the solution?
Gov’t levies taxes to fund production of public good
society better off
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Other public goods:
law enforcement fire protection roads, bridges flood control
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Lack of Competition
What is it? Firm is large or only supplier firm is able to influence price
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With no market power
Perfect competition many firms max output at lowest price
example: dairy farmers
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Monopoly one firm is only supplier
examples: Microsoft (Windows) National Grid (distribution) Pfizer (Lipitor)
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Oligopoly a few firms
examples: automobile companies
GM, Ford, Chrysler cereal companies
General Mills, Post, Kellogg soft drinks
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Cartels
A few firms get together and act like a monopoly
examples OPEC (oil) DeBeer’s (gemstones)
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So what’s the problem?
Firms w/ market power restrict output increasing prices
anti-competitive behavior no incentive to improve quality
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So what’s the solution?
Antitrust laws regulate BEHAVIOR not size
case against Microsoft
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Not all monopolies are bad!
1. Natural monopolies efficient to have only one producer
example: electricity distribution
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2. Gov’t - created monopolies
Use patents to give firm exclusive right to supply allows firm to recoup research costs
example: drug companies
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III. Role of Government
dealing with market failures regulation subsidies/taxes anti-trust laws provision of goods/services
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problems
rent-seeking government failure
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rent-seeking
parties lobby gov’t for laws to protect their interest at expense of others tariffs/quotas tax credits patent/copyright extention
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government failure
law of unintended consequences policies have other effects is the cure worse than the disease?