11

CircularCircular Flow Flow

22

Technical efficiency:Technical efficiency: maximum maximum value of output from a resource value of output from a resource basebaseEconomic efficiency:Economic efficiency: when one when one person cannot be made better off person cannot be made better off without making someone else without making someone else worse off.worse off.

Markets Can Fail Markets Can Fail Government Can Government Can HelpHelp

33

The Government’s RoleThe Government’s Role

Imperfect Information Externalities Public Goods Lack of Competition Business Cycles

Correct for:

44

False informationAsymmetric information

Either the buyer or the seller has better information: he knows his situation best … and the other guy flees

Dealing with information problemsPrivate solutions: Brand names,

franchises, and product warranties Public solutions: Government may require

full and correct disclosure. (Food labels, stock prospectuses, etc.)

Poor Information Poor Information Inefficiency Inefficiency

55

Externalities: External BenefitsExternalities: External BenefitsSomeone outside a transaction Someone outside a transaction benefits from the transaction ... and benefits from the transaction ... and doesn’t paydoesn’t pay

–Buyers will demand less than the Buyers will demand less than the socially optimal amount. socially optimal amount.

–Sellers will produce less than the Sellers will produce less than the socially optimal amount. socially optimal amount.

–Examples: Mowing your lawn, Examples: Mowing your lawn, painting your house, painting your house, getting educated.getting educated.

66

Externalities: External CostsExternalities: External CostsSomeone outside a transaction incurs Someone outside a transaction incurs costs because of it ... but isn’t paidcosts because of it ... but isn’t paid

– If buyers don’t bear all the costs of If buyers don’t bear all the costs of their purchase, they buy too much.their purchase, they buy too much.

– If producers don’t bear all the costs If producers don’t bear all the costs of production, they produce too of production, they produce too much.much.

–Examples: A nightclub next door to Examples: A nightclub next door to your house, pollution by a your house, pollution by a manufacturer.manufacturer.

77

Consumption by one person does not diminish the quantity or quality available to others.Public goods can be jointly consumed

Individuals can simultaneously enjoy consumption of same product or service.

Public goods are non-excludableConsumption of the good cannot be restricted to just those who pay for it.

No one has a private property right to the good.

• Everybody has incentive to be a free rider

• When everyone free rides, too little (or none) is produced.

Public GoodsPublic Goods

88

•National defense•Public radio and television stations•Clean air•Unpolluted ground water

•Markets may develop ways of providing some public goods

•use advertising to support radio and television … but then you’re “paying” by listening to the ads.

Examples of Public GoodsExamples of Public Goods

99

Lack of CompetitionLack of CompetitionSellers may gain by restricting output and Sellers may gain by restricting output and raising priceraising price– Earn more by doing less.Earn more by doing less.

– Too little is produced.Too little is produced.

Monopoly:Monopoly: only one produceronly one producer

–Example: utility companiesExample: utility companies

Oligopoly:Oligopoly: only a few producers (who may only a few producers (who may operate jointly as a monopolist through a operate jointly as a monopolist through a cartel or otherwise collude).cartel or otherwise collude).

–Example: OPECExample: OPEC

Monopsony:Monopsony: only one buyer only one buyer

1010

Public Choice AnalysisPublic Choice Analysis•Gov’t actions result from self-interested behaviors of voters and politicians.

•Gov’t may intervene to benefit specific individuals or groups who do not like a market outcome.

•This is rent-seeking—the use of resources to transfer wealth from one individual to another without increasing output.

Gov’t intervention may not intend efficiency gains.

Gov’t intervention may result in efficiency losses.

1111

Microeconomic PolicyMicroeconomic Policy

Government Government provides public goodsprovides public goods to to avoid the free rider problem in the avoid the free rider problem in the private production of certain goods.private production of certain goods.

Government Government taxes or subsidizestaxes or subsidizes activities that create externalities.activities that create externalities.

Government Government ensures competitive ensures competitive marketsmarkets where possible and where possible and regulatesregulates noncompetitive industries in the public noncompetitive industries in the public interest.interest.

But there’s problem of But there’s problem of regulatory captureregulatory capture. .

1212

Macroeconomic PolicyMacroeconomic PolicyMonetary PolicyMonetary Policy

–Policies that influence Policies that influence money and creditmoney and credit (money supply and interest rates). (money supply and interest rates).

– In the U.S., the Federal Reserve Board In the U.S., the Federal Reserve Board (“(“the Fedthe Fed”) is responsible for this.”) is responsible for this.

Fiscal PolicyFiscal Policy

–Policies that control government Policies that control government spending and taxationspending and taxation. .

– In the U.S. federal government, In the U.S. federal government, CongressCongress enacts these policies and the enacts these policies and the PresidentPresident signs them into law. signs them into law.

1313

Federal, State, and Federal, State, and Local Government Local Government Expenditures for Expenditures for

Goods and Goods and ServicesServices

1414

U.S. U.S. Federal Federal Budget Budget DeficitsDeficits

1515

Economic SystemsEconomic Systems