12 the market mechanism: shortcomings and remedies when she was good she was very, very good, but...
TRANSCRIPT
12The Market Mechanism:
Shortcomings and Remedies
When she was good
She was very, very good,
But when she was bad
She was horrid.
HENRY WADSWORTH LONGFELLOW
● What Does the Market Do Poorly?
● Efficient Resource Allocation: A Review
● Externalities: Getting the Prices Wrong
● Provision of Public Goods
● Allocation of Resources Between Present and Future
● Market Failure and Government Failure
● What Does the Market Do Poorly?
● Efficient Resource Allocation: A Review
● Externalities: Getting the Prices Wrong
● Provision of Public Goods
● Allocation of Resources Between Present and Future
● Market Failure and Government Failure
ContentsContents
Copyright© 2003 South-Western/Thomson Publishing. All rights reserved.
● The Cost Disease of the Service Sector
● Some Other Sources of Market Failure
● The Market System on Balance
● Epilogue: The Unforgiving Market, Its Gift of Abundance, and Its Dangerous Friends
● The Cost Disease of the Service Sector
● Some Other Sources of Market Failure
● The Market System on Balance
● Epilogue: The Unforgiving Market, Its Gift of Abundance, and Its Dangerous Friends
Contents (continued)Contents (continued)
Copyright© 2003 South-Western/Thomson Publishing. All rights reserved.
Copyright© 2003 South-Western/Thomson Publishing. All rights reserved.
What Does the Market Do Poorly? What Does the Market Do Poorly?
● Deals poorly with the side effects of many economic activities
● Cannot readily provide public goods, such as national defense
● May do a poor job of allocating resources between the present and the future
● Deals poorly with the side effects of many economic activities
● Cannot readily provide public goods, such as national defense
● May do a poor job of allocating resources between the present and the future
Copyright© 2003 South-Western/Thomson Publishing. All rights reserved.
What Does the Market Do Poorly?What Does the Market Do Poorly?
● Makes public and personal services increasingly expensive
● Not all market failures are considered in this chapter--other chapters consider: ♦ Business fluctuations
♦ Inequitable income distribution
♦ Monopoly power
● Makes public and personal services increasingly expensive
● Not all market failures are considered in this chapter--other chapters consider: ♦ Business fluctuations
♦ Inequitable income distribution
♦ Monopoly power
Copyright© 2003 South-Western/Thomson Publishing. All rights reserved.
Efficient Resource Allocation: A ReviewEfficient Resource Allocation: A Review
● An efficient allocation of resources requires that price equal marginal cost for each commodity (P = MC).
● An efficient allocation of resources requires that price equal marginal cost for each commodity (P = MC).
FIGURE 12-1 The Economy’s PPF for the Production of Two Goods
FIGURE 12-1 The Economy’s PPF for the Production of Two Goods
Copyright© 2003 South-Western/Thomson Publishing. All rights reserved.
Nu
mb
er o
f B
ackp
acks
P
rod
uce
d
Number of Jeans Produced
A
C
100 80 60 40 20 0
2
4
6
8
10
K
B
Copyright© 2003 South-Western/Thomson Publishing. All rights reserved.
● Beneficial externality = an incidental benefit of an economic activity
● Detrimental externality = an incidental cost of an economic activity
● Beneficial externality = an incidental benefit of an economic activity
● Detrimental externality = an incidental cost of an economic activity
Externalities: Getting the Prices WrongExternalities: Getting the Prices Wrong
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● Externalities and Inefficiency♦ Detrimental externalities marginal social
cost > marginal private cost■Too much is produced
♦ Beneficial externalities marginal social cost > marginal private cost ■Too little output is produced
● Externalities and Inefficiency♦ Detrimental externalities marginal social
cost > marginal private cost■Too much is produced
♦ Beneficial externalities marginal social cost > marginal private cost ■Too little output is produced
Externalities: Getting the Prices WrongExternalities: Getting the Prices Wrong
FIGURE 12-2 Equilibrium of a Firm with Detrimental Externality
FIGURE 12-2 Equilibrium of a Firm with Detrimental Externality
Copyright© 2003 South-Western/Thomson Publishing. All rights reserved.
Marginal private cost
Marginal revenue
Marginal social cost
B A
100
Mar
gin
al C
os
t an
d R
eve
nu
e
Thousands of Tons of Paper per Year
35 0
FIGURE 12-3 Externalities, Market Equil., & Resource Allocation
FIGURE 12-3 Externalities, Market Equil., & Resource Allocation
Copyright© 2003 South-Western/Thomson Publishing. All rights reserved.
Electricity Output in Kilowatt-Hours
Tu
lip O
utp
ut
in D
oze
ns
0
K
B
E
T
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Externalities: Getting the Prices Wrong Externalities: Getting the Prices Wrong
● Externalities are Everywhere♦ These problems are found throughout the
economy.
♦ Both market economies and centrally-planned economies wrestle with externality problems.
● Externalities are Everywhere♦ These problems are found throughout the
economy.
♦ Both market economies and centrally-planned economies wrestle with externality problems.
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Externalities: Getting the Prices WrongExternalities: Getting the Prices Wrong
● Government Policy and Externalities♦ Governments can promote efficiency by
moving private costs closer to social costs.
♦ They can do this by taxing in the case of detrimental externalities and subsidizing in the case of beneficial externalities.
● Government Policy and Externalities♦ Governments can promote efficiency by
moving private costs closer to social costs.
♦ They can do this by taxing in the case of detrimental externalities and subsidizing in the case of beneficial externalities.
Copyright© 2003 South-Western/Thomson Publishing. All rights reserved.
Provision of Public GoodsProvision of Public Goods
● A good is public when:♦ it is not depleted by repeated use.
♦ people cannot be excluded from access to it.
● The market tends to underprovide public goods.
● A good is public when:♦ it is not depleted by repeated use.
♦ people cannot be excluded from access to it.
● The market tends to underprovide public goods.
Copyright© 2003 South-Western/Thomson Publishing. All rights reserved.
● It is usually not possible to charge a price for a pure public good because people cannot be excluded from enjoying its benefits.
● It may also be undesirable to charge a price for it because that would discourage some people from benefiting, even though using a public good does not deplete its supply.
● It is usually not possible to charge a price for a pure public good because people cannot be excluded from enjoying its benefits.
● It may also be undesirable to charge a price for it because that would discourage some people from benefiting, even though using a public good does not deplete its supply.
Provision of Public GoodsProvision of Public Goods
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● Conclusion: If public goods are to be produced, the government must do it.
● Conclusion: If public goods are to be produced, the government must do it.
Provision of Public GoodsProvision of Public Goods
Copyright© 2003 South-Western/Thomson Publishing. All rights reserved.
● A production possibilities frontier can be used to analyze the allocation of resources between the present and the future.
● A production possibilities frontier can be used to analyze the allocation of resources between the present and the future.
Allocation of Resources Between Present and FutureAllocation of Resources Between Present and Future
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Allocation of Resources Between Present and FutureAllocation of Resources Between Present and Future
● The Role of the Interest Rate♦ Allocate resources between present and future
♦ Represents the opportunity cost of money
● The Role of the Interest Rate♦ Allocate resources between present and future
♦ Represents the opportunity cost of money
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Allocation of Resources Between Present and FutureAllocation of Resources Between Present and Future
● How Does It Work in Practice?♦ Since interest rates are manipulated for many
purposes, there is little reason to think that they represent a good evaluation of the future.
♦ The market tends to devote too many resources to immediate consumption since today’s population may not be good judges of future needs.
● How Does It Work in Practice?♦ Since interest rates are manipulated for many
purposes, there is little reason to think that they represent a good evaluation of the future.
♦ The market tends to devote too many resources to immediate consumption since today’s population may not be good judges of future needs.
Copyright© 2003 South-Western/Thomson Publishing. All rights reserved.
Allocation of Resources Between Present and FutureAllocation of Resources Between Present and Future
● How Does It Work in Practice?♦ The inherent risk of investment projects means
that investment for the future may fall short of the socially optimal amount.
♦ It may not be in society’s best interests to allow the market to make irreversible decisions about the future.
● How Does It Work in Practice?♦ The inherent risk of investment projects means
that investment for the future may fall short of the socially optimal amount.
♦ It may not be in society’s best interests to allow the market to make irreversible decisions about the future.
Copyright© 2003 South-Western/Thomson Publishing. All rights reserved.
Market Failure and Government FailureMarket Failure and Government Failure
● The market has many failures, but remember that it has many strengths as well, and that governments are also subject to failure.
● Some market failures are best left alone and, in some cases, the best action by the government is to reinforce the best aspects of the market, not to replace the market.
● The market has many failures, but remember that it has many strengths as well, and that governments are also subject to failure.
● Some market failures are best left alone and, in some cases, the best action by the government is to reinforce the best aspects of the market, not to replace the market.
Copyright© 2003 South-Western/Thomson Publishing. All rights reserved.
● The service sector includes such huge industries as education and health care.
● Services can be public or private.● Costs for services have risen more rapidly
than other costs.● Although not strictly a market failure, this
often leads to government action that threatens general welfare.
● The service sector includes such huge industries as education and health care.
● Services can be public or private.● Costs for services have risen more rapidly
than other costs.● Although not strictly a market failure, this
often leads to government action that threatens general welfare.
The Cost Disease of the Service SectorThe Cost Disease of the Service Sector
FIGURE 12-4 Real per-Capita Health-Care Expenditures
FIGURE 12-4 Real per-Capita Health-Care Expenditures
Copyright© 2003 South-Western/Thomson Publishing. All rights reserved.
6
5
4
3
2
Norway
Spain
Italy
Irela
nd
Japan
United S
tate
s
Austria
France
United K
ingdom
Austra
lia
Germ
any
Canad
a
Nether
lands
Ave
rag
e A
nn
ual
Gro
wth
Rat
es (
per
cen
tag
e)
1
0
FIGURE 12-5 Real per-Pupil Education Costs
FIGURE 12-5 Real per-Pupil Education Costs
Copyright© 2003 South-Western/Thomson Publishing. All rights reserved.
– 1.55
United Kingdom
4.32
Germany
2.72
United States
9.67
France
3.42
Canada
7.25
Japan
Ave
rag
e A
nn
ual
Gro
wth
Rat
es
12%
10
8
6
4
2
0
– 2
– 4
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The Cost Disease of the Service SectorThe Cost Disease of the Service Sector
● Why Are Some Personal Services Getting Worse but Costing More?♦ The “cost disease” of personal services stems
from their labor-intensive nature.
♦ Competition forces wages in the service sector to grow as rapidly as wages in manufacturing.
● Why Are Some Personal Services Getting Worse but Costing More?♦ The “cost disease” of personal services stems
from their labor-intensive nature.
♦ Competition forces wages in the service sector to grow as rapidly as wages in manufacturing.
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The Cost Disease of the Service SectorThe Cost Disease of the Service Sector
● Why Are Some Personal Services Getting Worse but Costing More?♦ Productivity grows more rapidly in
manufacturing than services.
♦ If wage growth cannot be accommodated by productivity growth, prices must rise.
● Why Are Some Personal Services Getting Worse but Costing More?♦ Productivity grows more rapidly in
manufacturing than services.
♦ If wage growth cannot be accommodated by productivity growth, prices must rise.
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The Cost Disease of the Service SectorThe Cost Disease of the Service Sector
● A Future of More Goods, but Fewer Services: Is It Inevitable?♦ As the society becomes richer, it becomes
more difficult, not less, to provide services such as health care, teaching, and the performing arts.
♦ If we value services sufficiently, we can have more and better services--at some sacrifice in the growth rate of manufactured goods.
● A Future of More Goods, but Fewer Services: Is It Inevitable?♦ As the society becomes richer, it becomes
more difficult, not less, to provide services such as health care, teaching, and the performing arts.
♦ If we value services sufficiently, we can have more and better services--at some sacrifice in the growth rate of manufactured goods.
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The Cost Disease of the Service SectorThe Cost Disease of the Service Sector
● Government May Make the Problem Worse♦ The market does give the appropriate price
signals, but government is likely to misunderstand these signals and to make decisions that do not promote the public interest most effectively.
● Government May Make the Problem Worse♦ The market does give the appropriate price
signals, but government is likely to misunderstand these signals and to make decisions that do not promote the public interest most effectively.
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The Cost Disease of the Service SectorThe Cost Disease of the Service Sector
● Government May Make the Problem Worse♦ This problem is not a market failure, but
government attempts to deal with it may distort the market in inefficient ways.
● Government May Make the Problem Worse♦ This problem is not a market failure, but
government attempts to deal with it may distort the market in inefficient ways.
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The Cost Disease of the Service SectorThe Cost Disease of the Service Sector
● Government May Make the Problem Worse♦ In many cases, price controls are proposed for
sectors of the economy affected by the cost disease.
♦ But price controls can, at best, only eliminate the symptoms of the disease, and they often create problems--sometimes more serious than the disease itself.
● Government May Make the Problem Worse♦ In many cases, price controls are proposed for
sectors of the economy affected by the cost disease.
♦ But price controls can, at best, only eliminate the symptoms of the disease, and they often create problems--sometimes more serious than the disease itself.
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● Imperfect information
● Rent-seeking behavior
● Moral hazard
● Imperfect information
● Rent-seeking behavior
● Moral hazard
Some Other Sources of Market FailureSome Other Sources of Market Failure
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● While the market mechanism is virtually irreplaceable, the public interest, nevertheless, requires considerable modifications in the way it works.
● While the market mechanism is virtually irreplaceable, the public interest, nevertheless, requires considerable modifications in the way it works.
The Market System on BalanceThe Market System on Balance
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Epilogue: The Unforgiving MarketEpilogue: The Unforgiving Market
● The market system produces growth and prosperity as no other system has been able to do.
● At the same time, it allocates its rewards in ways that many people believe to be unjust.
● The market system produces growth and prosperity as no other system has been able to do.
● At the same time, it allocates its rewards in ways that many people believe to be unjust.
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Epilogue: The Unforgiving MarketEpilogue: The Unforgiving Market
● Sometimes the proposals of alleged friends of the free market are just as dangerous to its long-term health as are the attacks of its enemies.
● Sometimes the proposals of alleged friends of the free market are just as dangerous to its long-term health as are the attacks of its enemies.