reasons for government intervention in the market

Reasons for

Government Intervention

in the Market

Reasons for

Government Intervention

in the Market

Markets and the Role of GovernmentMarkets and the Role of Government

• Government intervention and social objectives

• The objective of social efficiency– marginal social benefits and costs

• MSB > MSC produce (or consume) more

• MSC > MSB produce (or consume) less

– socially efficient output where MSB = MSC

• Equity– concepts of fairness

• Trade-offs between equity and efficiency

• Government intervention and social objectives

• The objective of social efficiency– marginal social benefits and costs

• MSB > MSC produce (or consume) more

• MSC > MSB produce (or consume) less

– socially efficient output where MSB = MSC

• Equity– concepts of fairness

• Trade-offs between equity and efficiency

Types of Market FailureTypes of Market Failure

• Externalities

– External costs of production MSC > MC

• Externalities

– External costs of production MSC > MC

Q1

External costs in productionExternal costs in production

O

MC = S

DP

Co

sts

and

be

nef

its

Quantity

O

MC = S

DP

MSC

Co

sts

and

be

nef

its

Quantity

External cost

Q1Q2

Social optimum

External costs in productionExternal costs in production

Types of Market FailureTypes of Market Failure

• Externalities

– External costs of production MSC > MC

– External benefits of production MSC < MC

• Externalities

– External costs of production MSC > MC

– External benefits of production MSC < MC

External benefits in productionExternal benefits in production

O

DP

MC = S

Q1

Co

sts

and

be

nef

its

Quantity

O

MSC

DP

Q1

External benefit

Co

sts

and

be

nef

its

Quantity

MC = S

Q2Social optimum

External benefits in productionExternal benefits in production

O

MC = S

DP

Q1Q2

Cos

ts a

nd b

enef

its (

£)

Quantity

MSC

External cost

(a ) External costs

O

DP

Q2Q1

Cos

ts a

nd b

enef

its (

£)

Quantity

MSCMC = S

External benefit

(b) External benefits

External costs and benefits in productionExternal costs and benefits in production

Types of Market FailureTypes of Market Failure

• Externalities

– External costs of production MSC > MC

– External benefits of production MSC < MC

– External costs of consumption MSB < MB

• Externalities

– External costs of production MSC > MC

– External benefits of production MSC < MC

– External costs of consumption MSB < MB

Q1

(MB)MU = D

External costs in consumptionExternal costs in consumption

O

DP

Co

sts

and

be

nef

its

Quantity

Q2

(MB)MU = D

O

DP

Co

sts

and

be

nef

its

Quantity

External cost

MSB

Q1

External costs in consumptionExternal costs in consumption

Social optimum

Types of Market FailureTypes of Market Failure

• Externalities

– External costs of production MSC > MC

– External benefits of production MSC < MC

– External costs of consumption MSB < MB

– External benefits of consumption MSB > MB

• Externalities

– External costs of production MSC > MC

– External benefits of production MSC < MC

– External costs of consumption MSB < MB

– External benefits of consumption MSB > MB

(MB)MU = D

O

DP

Q1

Co

sts

and

be

nef

its

Quantity

External benefits in consumptionExternal benefits in consumption

Q2

(MB)MU = D

O

DP

Q1

Co

sts

and

be

nef

its

Quantity

External benefit

MSB

External benefits in consumptionExternal benefits in consumption

Social optimum

O

MB

PP

Cos

ts a

nd b

enef

its (

£)

Car miles

MSB

External cost

O

MB

PP

Q1

Cos

ts a

nd b

enef

its (

£)

Rail miles

Q2

MSB

External benefit

(a ) External costs (b) External benefits

External costs and benefits in consumptionExternal costs and benefits in consumption

Q1Q2

Types of Market FailureTypes of Market Failure

• Public goods

– non-rivalry

– non-excludability and the free-rider problem

• Public goods

– non-rivalry

– non-excludability and the free-rider problem

Types of Market FailureTypes of Market Failure

• Market power

– lack of social efficiency

• Market power

– lack of social efficiency

MC1

Q1

MC

MRAR

A monopolist producing less than the social optimumA monopolist producing less than the social optimum

O

P1

£

Monopoly output

Q

O

P1

MC1

MC = MSC

Q1

MRAR = MSB

Q2

P2 = MSB

= MSC

£

QMonopoly output Perfectly competitive output

A monopolist producing less than the social optimumA monopolist producing less than the social optimum

Types of Market FailureTypes of Market Failure

• Market power

– lack of social efficiency

– deadweight welfare loss under monopoly

• Market power

– lack of social efficiency

– deadweight welfare loss under monopoly

O

£

Q

Ppc

Qpc

AR = D

Consumersurplus

Producersurplus

Deadweight loss under monopolyDeadweight loss under monopolyMC

(= S under perfect competition)

(a) Industry equilibrium under perfect competition(a) Industry equilibrium under perfect competition

a

MRO

£

Q

Ppc

Qpc

AR = D

a

Qpc

Pm

bConsumer

surplus

Producersurplus

Deadweightwelfare loss

MC(= S under perfect competition)

(b) Industry equilibrium under monopoly(b) Industry equilibrium under monopoly

Deadweight loss under monopolyDeadweight loss under monopoly

O

£

Q

Ppc

Qpc

AR = D

Consumersurplus

Producersurplus

MC(= S under perfect competition)

(a) Industry equilibrium under perfect competition(a) Industry equilibrium under perfect competition

a

Perfectcompetition

Deadweight loss under monopolyDeadweight loss under monopoly

MRO

£

Q

Ppc

Qpc

AR = D

a

Qpc

Pm

bConsumer

surplus

Producersurplus

Deadweightwelfare loss

MC(= S under perfect competition)

(b) Industry equilibrium under monopoly(b) Industry equilibrium under monopoly

Monopoly

Deadweight loss under monopolyDeadweight loss under monopoly

Types of Market FailureTypes of Market Failure

• Ignorance and uncertainty

– by consumers

– by firms

• Immobility of factors and time lags

• Protecting people’s interests

– dependants

– merit goods

• Ignorance and uncertainty

– by consumers

– by firms

• Immobility of factors and time lags

• Protecting people’s interests

– dependants

– merit goods

Government Intervention in the MarketGovernment Intervention in the Market

• Taxes and subsidies

– to correct externalities

• Taxes and subsidies

– to correct externalities

Q1O

MC = S

DP

Co

sts

and

be

nef

its

Quantity

Using taxes to correct a market distortionUsing taxes to correct a market distortion

O

MC = S

DP

MSC

Co

sts

and

be

nef

its

Quantity

External cost

Q1Q2

Social optimum

Using taxes to correct a market distortionUsing taxes to correct a market distortion

Q2

MC

Q1O

P

Co

sts

and

be

nef

its

Quantity

Optimum tax = MSC – MC

MC = SMSC

D

Using taxes to correct a market distortionUsing taxes to correct a market distortion

O

DP

MC = S

Q1

Co

sts

and

be

nef

its

Quantity

Using subsidies to correct a market distortionUsing subsidies to correct a market distortion

O

MSC

DP

Q1

External benefit

Co

sts

and

be

nef

its

Quantity

MC = S

Q2Social optimum

Using subsidies to correct a market distortionUsing subsidies to correct a market distortion

MC

O

P

Q2Q1

Co

sts

and

be

nef

its

Quantity

Optimum subsidy

= MC – MSC

MSCMC = S

D

Using subsidies to correct a market distortionUsing subsidies to correct a market distortion

Government Intervention in the MarketGovernment Intervention in the Market

• Taxes and subsidies (cont.)

– to correct for monopoly

• use of lump-sum taxes plus subsidies

– advantages of taxes and subsidies

• can vary the rate according to the size of the market distortion

– disadvantages of taxes and subsidies

• infeasible to use different tax and subsidy rates

• lack of knowledge

• Taxes and subsidies (cont.)

– to correct for monopoly

• use of lump-sum taxes plus subsidies

– advantages of taxes and subsidies

• can vary the rate according to the size of the market distortion

– disadvantages of taxes and subsidies

• infeasible to use different tax and subsidy rates

• lack of knowledge

Government Intervention in the MarketGovernment Intervention in the Market

• Changes in property rights

– the problem of limited property rights

– extending property rights

– limitations of this solution

• Laws prohibiting behaviour that imposes external costs

– advantages of legal restrictions

– disadvantages of legal restrictions

• Regulatory bodies

• Changes in property rights

– the problem of limited property rights

– extending property rights

– limitations of this solution

• Laws prohibiting behaviour that imposes external costs

– advantages of legal restrictions

– disadvantages of legal restrictions

• Regulatory bodies

Government Intervention in the MarketGovernment Intervention in the Market

• Price controls– high minimum prices

– low maximum prices

• Provision of information

• Direct provision of goods and services– justification

• social justice

• large positive externalities

• dependants

• ignorance

• Price controls– high minimum prices

– low maximum prices

• Provision of information

• Direct provision of goods and services– justification

• social justice

• large positive externalities

• dependants

• ignorance

The Case for Laissez-faireThe Case for Laissez-faire

• Drawbacks of government intervention

– shortages and surpluses

– poor information

– bureaucracy and inefficiency

– lack of market incentives

– shifts in government policy

– voters’ ignorance

– unrepresentative government

– lack of freedom for the individual

• Drawbacks of government intervention

– shortages and surpluses

– poor information

– bureaucracy and inefficiency

– lack of market incentives

– shifts in government policy

– voters’ ignorance

– unrepresentative government

– lack of freedom for the individual

The Case for Laissez-faireThe Case for Laissez-faire

• Advantages of the free market– automatic adjustments

– dynamic advantages of capitalism

– high degree of competition even under monopoly/oligopoly

• possible market contestability

• competition from other closely related industries

• threat of competition from abroad

• countervailing powers

• competition for corporate control

• Judging the arguments

• Advantages of the free market– automatic adjustments

– dynamic advantages of capitalism

– high degree of competition even under monopoly/oligopoly

• possible market contestability

• competition from other closely related industries

• threat of competition from abroad

• countervailing powers

• competition for corporate control

• Judging the arguments

Firms and Social ResponsibilityFirms and Social Responsibility

• The classical view on social responsibility

– managers solely responsible to shareholders

– justification and criticisms of this view

• The socio-economic view

– a stakeholding society

– corporate social responsibility

– environmental scanning

• The classical view on social responsibility

– managers solely responsible to shareholders

– justification and criticisms of this view

• The socio-economic view

– a stakeholding society

– corporate social responsibility

– environmental scanning

Firms and Social ResponsibilityFirms and Social Responsibility

• The virtue matrix– a framework for analysing corporate social

responsibility

– the civil foundation• laws and regulation

• social and moral norms

– the frontier• socially beneficial and potentially profitable activities

• socially beneficial but unprofitable activities

• The virtue matrix– a framework for analysing corporate social

responsibility

– the civil foundation• laws and regulation

• social and moral norms

– the frontier• socially beneficial and potentially profitable activities

• socially beneficial but unprofitable activities

The Virtue Matrix:generating corporate social responsibility

The Virtue Matrix:generating corporate social responsibility

Response tosocial normsResponse tosocial norms

Response tolaws and

regulations

Response tolaws and

regulations

Socially beneficial and

potentially profitable

Socially beneficial and unprofitable

CIVIL FOUNDATION

THE'FRONTIER'

Firms and Social ResponsibilityFirms and Social Responsibility

• The virtue matrix– a framework for analysing corporate social

responsibility

– the civil foundation• laws and regulation

• social and moral norms

– the frontier• socially beneficial and potentially profitable activities

• socially beneficial but unprofitable activities

– development of corporate social responsibility over time

• The virtue matrix– a framework for analysing corporate social

responsibility

– the civil foundation• laws and regulation

• social and moral norms

– the frontier• socially beneficial and potentially profitable activities

• socially beneficial but unprofitable activities

– development of corporate social responsibility over time

The Virtue Matrix:generating corporate social responsibility

The Virtue Matrix:generating corporate social responsibility

Response tosocial normsResponse tosocial norms

Response tolaws and

regulations

Response tolaws and

regulations

Socially beneficial and

potentially profitable

Socially beneficial and unprofitable

CIVIL FOUNDATION

THE'FRONTIER'

Firms and Social ResponsibilityFirms and Social Responsibility

• The virtue matrix– a framework for analysing corporate social

responsibility

– the civil foundation• laws and regulation

• social and moral norms

– the frontier• socially beneficial and potentially profitable activities

• socially beneficial but unprofitable activities

– development of corporate social responsibility over time

– globalisation and corporate social responsibility

• The virtue matrix– a framework for analysing corporate social

responsibility

– the civil foundation• laws and regulation

• social and moral norms

– the frontier• socially beneficial and potentially profitable activities

• socially beneficial but unprofitable activities

– development of corporate social responsibility over time

– globalisation and corporate social responsibility

Firms and Social ResponsibilityFirms and Social Responsibility

• Economic performance and social responsibility

– possible costs to the firm

– possible benefits to the firm

• improved economic performance

• enhancing the brand

• attracting and retaining employees

• access to capital

• Economic performance and social responsibility

– possible costs to the firm

– possible benefits to the firm

• improved economic performance

• enhancing the brand

• attracting and retaining employees

• access to capital