Slide 1Copyright © Pearson Education, Inc.Chapter 3, Section 3

Essential QuestionEssential Question

• What role should government play in a free market economy?

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ObjectivesObjectives

1. Identify examples of public goods.

2. Analyze market failures.

3. Evaluate how the government allocates some resources by managing externalities.

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Key TermsKey Terms• free rider: someone who would not be willing to pay for

a certain good or service but who would get the benefits of it anyway if it were provided as a public good

• market failure: a situation in which the free market, operating on its own, does not distribute resources efficiently (need government intervention)

• externality: an economic side effect of a good or service that generates benefits or costs to someone other than the person deciding how much to produce or consume (pollution, living next to a park)

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Key Terms , cont.Key Terms , cont.• public good: a shared good or service for which it would be

inefficient or impractical to make consumers pay individually and to exclude those who did not pay

• non-rival good: a good or service that can be used by any number of consumers without reducing the benefits to any single consumer (public goods are non-rival; think of riding the train)

• public sector: the part of the economy that involves the transactions of the government

• private sector: the part of the economy that involves the transactions of individuals and businesses

• infrastructure: the basic facilities that are necessary for a society to function or grow – like roads, ports, canals, public transit (usually a public good)

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New Park: Who Should Pay For It?New Park: Who Should Pay For It?• Uptown is going to build a new park that is a

gorgeous place that provides recreation services– What benefit does the park provide to you? What are the

costs/tradeoffs of using the park?

– How much would you pay to use the park?

– If you are using the park, can other people use it as well?

– 100 people have paid to build the park. Will the 101st person still be able to use the park?

• Will people be upset if they are not allowed to use a park in their neighborhood

– How would the first 100 people who paid feel about this?

– Will any of the surrounding homes or businesses benefit from the new park?

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Market FailuresMarket Failures

• Market Failures are where the free market does not distribute resources efficiently or charge the right price for a good or service

• Some examples of market failures are:– Free-Rider Problem– Public Goods– Externalities (especially Negative

Externalities)

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Free RidersFree Riders

• One issue associated with public goods is known as the “free-rider problem.”

• Free riders are people who are not willing to pay for a particular good or service but would benefit from it if it were offered as a public good.– Fire/Police Services, Parks, Beaches, Street

Lights, Roads are all good examples of the free-rider problem

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Public GoodsPublic Goods

• A public good is a shared good or service for which it would be inefficient or impractical to make consumers pay individually and to exclude those who do not pay.– Free markets will not provide these goods or

services on their own– Public goods are a market failure– Free-Rider problem often makes it hard to

charge consumers for using the public good

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Public Goods, cont.Public Goods, cont.• Public goods can be used by any number of consumers

without reducing the benefits to any single consumer.– These are called

non-rival goods

- This adds to the free-rider problem

- Think of a park, road,street sign, fire dept

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ExternalitiesExternalities• Public goods involve externalities, which may be

either positive or negative.– Externality is a benefit or a cost that is not

captured in the price– We will explore externalities more when we talk about

supply and demand

• Positive Externalities– Represent the beneficial side effects of public goods– Allow someone who did not purchase a good to enjoy

part of the benefits of that good– Examples:

• a new park would increase the value of homes nearby, but homeowners did not pay for the park

• A new road or highway might bring more people to a town, which will help local businesses grow, but the local businesses did not pay for the road

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Externalities, cont’d.Externalities, cont’d.• Negative Externalities

– Represent the negative/cost side effects of public goods

– Cause part of the cost of producing a good or service to be paid for by someone other than the producer.

– Example: • A coal-fired power plant produces electricity, but

also has the negative externality of polluting the air. The power company does not pay for the cost of pollution, the neighbors “pay for this cost” by breathing polluted air

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Externalities, cont’d.Externalities, cont’d.A town is considering building a new bridge to help local farmers get their products to the market. Why would the construction of the bridge be considered a positive externality some people and a negative externality by others?

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Market FailuresMarket Failures

• Checkpoint: Road construction is a public good. Explain how road construction is a market failure?

– Free-Rider Problem: If I paid for a road on my street, my neighbors could still use it

– Externalities: Roads might bring more traffic and pollution to an area (negative) or more stores and businesses to an area (positive)

– Public Good: Roads are shared and it is inefficient/impractical to charge people to use the road

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Role of Government:Costs and BenefitsRole of Government:Costs and Benefits

• Since the free market doesn’t provide public goods, government must provide public goods

• The government will only pay for the cost of a public good if:– The benefit to each

individual is less than the cost that each individual would have to pay if it were provided privately (by the free market).

– The total benefits to society are greater than the total cost.

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Role of Government:Regulation and ExternalitiesRole of Government:Regulation and Externalities

• Understanding externalities helps us see more roles that the government plays in the U.S. economy.– The government may take action to create

positive externalities, such as improving education.

– The government aims to limit negative externalities like pollution, such as the Clean Air Act or smog control on cars