10.0 The Microeconomy and the Government

10.1.1

Milton Friedman –1962 -Capitalism and Freedom

Potential roles for governmentEnsuring commutative justice – making sure there

are fair rules for the game

Dealing with market power

Dealing with market failure

Plus, what about equity?

10.1.2

Two underlying questions about policy debates

Does economy need help from the gov’t?

Is government intervention part of the solution or a bigger problem unto itself?

10.2.1-10.2.2

Solving externality problems

All you have to do is figure out the marginal external cost, and impose that cost on the private actor

This is called internalizing the externality

Government might choose to

Tax equal to MEC

Limit ouput – no more beyond Ls

Require firms to install scrubbers –reducing MEC

Much easier said than done

Tough to measure MEC

Have to make an educated guess – a proxy

Plus, if there are strict rules, firms may move elsewhere

10.2.3

Market power in labor disputes

Adam Smith – owner may have an advantage over workers

There are fewer, and it is easier for them to collude

10.3.1

Every government has an economic policy

Even if it chooses to not get involved at all,

That is a choice

Sometimes the policies are not the most thoughtful ones

Assume your objectives are

Pareto optimality and equity

Questions to ask:

How well do you think the market system works?

How realistic are the nice assumptions?

How much do you trust government to effectively carry out policy?

Further,

Does gov’t simply become a tool to create or enhance market power?

Can it be a source of constructive solutions, or

Is it a rent-seeking/rent-maintenance structure that must be constrained?

If the web of connections is

so complicated, is wise policy even possible?

Decent, intelligent people disagree on the answers to these questions

10.3.2 Two extreme positions

Laissez-faire – leave markets alone – non-intervention

People who believe in the nice assumptions often espouse this

Intervention – governments can and should get involved to fix problems that arise with the market system

10.4 Distributive Justice

10.4.1

Problems of definition –

tough to get people to agree on a definition of equity

Gov’t can intervene through taxes, spending on various programs, etc.

10.4.2

Problems of implementation

Even if you can reach a consensus on equity,

the policy may have some unexpected effects

Ex. Rent Control-

Shortage becomes a long-term problem

Figure 10.4.1 - Rent Control Case

RENT

Q

Rc

0

Re

D

S

10.4.3

Are equity and efficiency invariably a trade-off?

Not if redistribution of endowments can occur

Most often, interventions in the name of equity occur on an ad hoc (case by case) basis,

and contain many efficiency issues

10.4.4

Do all these problems mean laissez-faire is the way to go?

Not necessarily, but coherent, constructive policy is a challenge

Debate remains over

How well the market economy works,

How well the government works,

and how fair the status quo is

Social and political competition revolves around

these questions

Sometimes it is peaceful, sometimes not,

and sometimes played out both ways

10.5 ReviewStarted with R.C. – individual choice in isolationMoved to complexity, division of labor, and exchangeThen, markets under perfect competition and nice

assumptions – Pareto optimalityRelaxed assumptions - introduced market power and

market failureLastly, examined role of government – laissez-faire vs.

intervention