intro to economics - government i

8/8/2019 Intro to Economics - government I

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Government I

Ch 3

Dr. Katherine Sauer

Citizens Guide to Economics

ECO 1040


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There are 3 main roles of a good government:

1. make markets possible

2. deal market failures

- externalities

- public goods

4. do some wealth redistribution


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1. Good Governments Make Markets Possible

In order for markets to function, someone needs to

set the rules

provide infrastructure

develop institutions

define/protect property rights

provide justice system


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2. Good Governments Deal with Market Failure

In some cases, markets do not workwell.

Market exchanges make involvedparties better off.

However, sometimes a third party is affected.(externalities)

ex: driving your car produces CO2 emissions

Additionally, sometimes a good/service is importantbutis not profitable to provide. (public goods)

ex: basic research

A. Externalities


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In the eastern part of the Pacific Ocean, there is a

floating garbage patch that is twice the size ofTexas.

https://reader010.{domain}/reader010/html5/0530/5b0d9aac08494/5b


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Plastic

Consumers get the benefit of buying things that contain

plastic, and they have to pay for that benefit.

Producers get the benefit of selling an item that people

want, and they incur the costs of producing it.

But,

there are *extra costs* to society as a whole.


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When you drive your car, you are emitting carbon dioxide,

a known greenhouse gas, into the air.

http://www.boxoid.org/?p=86


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Gasoline

Consumers get the benefit of driving their cars, and they

have to pay for the cost of gasoline.

Producers get the benefit of producing/selling gasoline,

and they have to incur the cost of producing it.

But,

there are *extra costs* to society as a whole.


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When you get a college education, you are likely to be a

more conscientious, productive member of society.


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Education

Consumers (students) get benefits like a higher futuresalary and an increase in skills and experience, and must

pay the cost in the form of tuition.

Producers (colleges) get benefits like selling a servicethat consumers want but also must incur the costs of

production.

But,

there are *extra benefits* to society as a whole.


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Historic buildings allow a glimpse into the past.

http://www.downtowndenver.com/Business/DevelopmentandPlanning/denverunionstation/tabid/316/Default.aspx


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Historic Buildings

The owner of the building gets the benefit from owningthe building, and incurs the cost of renovation / upkeep.

But,

there are *extra benefits* to society as a whole.


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The Market Outcome

Recall:The Demand curve represents the value (benefit) to

consumers.

The Supply curve represents the production cost.

In reality, sometimes the total benefits are not reflected in

the demand curve and the total costs are not reflected in the

supply curve.

When there are extra benefits or costs to society, the

market will fail to provide the optimal quantity of the good.


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Externalities are the uncompensated impact of ones

actions on the well-being of a bystander or society as a

whole.ex: factory emissions, barking dogs, flu shots,

flower gardens


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Externalities can be positive or negative.

Positive externalities mean that the third party has in

some way benefited.

Negative externalities mean that the third party has in

some way been harmed.


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An externality isNOTthe same thing as an unintendedconsequence or perverse incentive.


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When a party engages in an activity that harms/benefits

themselves directly, that is notpart of the externality.

ex: You smoke cigarettes. (benefit to you)

- You pay for cigarettes. (cost to you, not an externality)

- You spend money on gum and mouthwash. (cost to you,

not an externality)

- You will probably face some health issues in the future.(cost to you, not an externality)

-You smoke around a non-smoker and it bothers them.

(negative externality)

-You eventually end up with Medicare paying your healthcosts. (negative externality)

-You die younger than a non-smoker and stop drawing

Social Security. (positive externality)


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When someone purposely intends to cause benefit orharm with an action, it is not an externality.

ex: theft

ex: giving to charity


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Negative Externality Example: pollution from the

production of coal-fired electricity

- you pay for electricity and get its benefits

- the power plant incurs production costs and

receives payment for the electricity it sells

- pollution from the power plant harms the

environment and bothers people

Thesocial costof coal-fired electricity is greaterthan theprivate costof coal-fired electricity.

social cost = production costs + externality costs


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Positive Externality Example: K-12 education (in many

nations it is not free)

- student pays for education and gets its benefits

- school incurs production costs and receives

payment for services

- society as a whole benefits by having more

educated residents

Thesocial benefits of education are greaterthan theprivate benefits of education.

social benefit = private benefit + externality benefit


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B. Government responses to externalities

If the market ignores externalities, then perhaps there is

reason for the government to step in.

Two common types of government responses to

externalities:

1. command and control

2. market based


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1. Command and Control = regulate the behaviordirectly

Ex: laws against dumping untreated water into

rivers

Ex: must attend school until you are 16


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2. market based = provide incentives so people/firmschoose to change behavior

Ex: gasoline tax

Ex: flu shot subsidies

Market based solutions allow the externality to be

internalized.

- alter the incentives so that people/firms take

the external effects of an action into account


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C. Private Solutions (non-government solutions)

We do not necessarily need government involvement tocorrect externalities

Types of private solutions

1. moral codesex: the Golden Rule

2. nonprofits and charities

ex: Sierra Club, University Alumni Foundation

3. self-interest / contracts


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How well does the private sector do when dealing withexternalities?

Depends on

- how well property rights are defined

- ease of bargaining- transaction costs


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The Coase Theorem: If property rights are well-

defined and if private parties can bargain costlessly,

then the private market will solve the externalityproblem.

Explain:

The parties involved in the externality have an incentiveto come to an agreement on their own.

The solution will be the same, regardless of who starts

with the property right.

In order for a private solution to be reached, transaction

costs have to be low.


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D. Public Goods

a. Types of Goods

When classifying types of goods in the economy, two

characteristics should be examined.

excludability: the property of a good whereby a

person can be prevented from using it

rivalry in consumption: the property of a goodwhereby one persons use diminishes other

peoples use


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Using these two characteristics, goods can be divided

into four categories:

1.private goods: goods that are both excludable

and rival in consumption

2.public goods: goods that are neither excludable

nor rival in consumption

3. common resources: goods that are rival in

consumption but not excludable

4. If a good is excludable but not rival in

consumption, it is an example of a natural

monopoly.


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The boundary between the categories is sometimes fuzzy.

- often a matter of degree


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Rival in consumption?

Yes No

Excludable?

YesPrivate Goods

ice-cream cones

clothingcongested toll roads

Natural Monopoliesfire protection

cable TVuncongested toll roads

NoCommon Resources

fish in the oceanthe environmentcongested nontoll roads

Public Goodsnational defenseknowledgeuncongested nontoll roads


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E. Public Good Example: a citys fireworks display

It is not excludablebecause it would be nearlyimpossible to keep others from viewing it.

It is not rival in consumption because one persons

enjoyment does not preclude others from enjoying the

fireworks.

Other examples: flood control, mosquito control,

basic research, national defense, tornado siren


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F. The Free-Rider Problem

Because they are non-ex

cludable,public goods sufferfrom the free-riderproblem.

- people can enjoy the benefit of the good

without having to pay the cost


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Firework example: It would be difficult to sell tickets

to the fireworks show because it is not excludable.

Thus, some individuals would get a benefit from the

show without paying for it.

More than likely, private individuals or firms will not

produce the fireworks show because it would not be

profitable.


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If thesocial value of the fireworks show is greaterthan

the costof producing it, it would be efficient for thefireworks show to be produced.

The local government can sponsor the show and charge

each of its citizens with part of the cost (in the form ofa tax).

If the tax is less than the value of the fireworks display

to each individual, everyone is better off.


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Very important note:

Just because the governmentprovides a good, doesntmean it is a public good!

Ex: public education

Education itself is excludable.Education is non-rival to a degree, then is rival.

Education is not a true public good!

Because there are positive externalities associated with

education, our government chooses to provide it. The

market can and does provide education on its own.


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G. Difficult Job of CostBenefit Analysis

To decide whether or not it should fund a public good,

the government must conduct a study of the total

benefits and costs of the good.

- cost-benefit analysis

It is oftenstraightforwardto estimate the cost of

providing a good or service.

It is very difficultto measure thebenefits of a public

good or service.


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Ex: Should a traffic light be installed at a particular

intersection?

Cost

- light costs $30,000 to $140,000

Benefit- stop lights decrease chance of death in a

particular intersection by 1%

Do the benefits outweigh the costs?


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4. Governments need to do some wealth redistribution.

In order to make markets possible, deal with

externalities, and provide public goods, governments

need to raise money.


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Summary:

Governments are needed to make markets possible.

Externalites are uncompensated impacts on society.Markets may not deal with externalities on their own.

Public goods are non-rival and non-excludable so

suffer from the free-rider problem. Governments maychoose to provide public goods.


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What did you learn today?

Please explain 2 concepts from todays class.

intro to economics - government i

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