Chapter4:MarketEfficiency,MarketFailure,andGovernment

CoreEconomics2ndedi>onbyGeraldW.Stone©2011WorthPublishers▪CoreEconomics

▪StoneSlides By: Debbie Evercloud

©2011WorthPublishers▪CoreEconomics▪Stone

•  MarketsandEfficiency•  MarketFailures

•  GovernmentInterven>on

•  PaulA.Samuelson

ChapterOutline

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•  Attheendofthischapter,thestudentwillbeableto:– Understandhowmarketsallocateresources– Definethecondi>onsneededformarketstobeefficient

– Understandhowmarketsimposedisciplineonproducersandconsumers

– Understandandbeabletousetheconceptsofconsumerandproducersurplus

LearningObjec>ves

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•  Attheendofthischapter,thestudentwillbeableto:– Understandwhatmarketfailureis,andwhenitoccurs

– Describethedifferenttypesofmarketfailure– Understandthehistoryofthechanginglandscapebetweenfreemarketsandgovernmentinterven>on

LearningObjec>ves

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EfficientMarkets

•  Requirementsforanefficientmarket:– Accurateinforma>onisavailable

– Propertyrightsareprotected– Contractobliga>onsareenforced– Noexternalcostsorbenefits– Compe>>vemarketsprevail

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Compe>>veMarkets

•  Inamarketsystem,resourcesareallocatedaccordingtotheinterac>onofsupplyanddemand.

•  Throughthepricemechanism,marketsra>onscarceresourcestotheirmosthighlyvalueduses.

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ConsumerandProducerSurplus

Measuresofthegainsfromtrade:!Consumersurplus!Producersurplus

S

D

P

Q

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ConsumerandProducerSurplus

•  Consumersurplusisthedifferencebetweentheamountaconsumerwouldbewillingtopayandtheactualprice.– Someonewhoreceivesalotofconsumersurplusmightfeelthatheorshefound“abargain.”

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ConsumerandProducerSurplus

•  Producersurplusisthedifferencebetweentheactualpriceandtheminimumpricethefirmrequiresinordertosupplythegood.– Afirmreceivingalotofproducersurplusmightconsiderthemselvestobeselling“atamarketpremium.”

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ConsumerandProducerSurplus

•  Measuresofproducerandconsumersurplushelpusdeterminetheamountofnetbenefitcreatedbyamarket.

•  Thisdetermina>onusuallyrestsonconsidera>onsofefficiency,ratherthanfairness.

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EfficientMarkets

•  Ifamarketra>onsefficiently,itwillallocategoodstothosewhovaluethemthemost.

•  Marketfailurereferstothoseinstancesinwhichthealloca>ondoesnotachievethebestpossibleoutcome,fromsociety’spointofview.

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MarketsandEfficiency

•  Marketsareefficientmechanismsforalloca>ngresources.

•  Efficientmarketsrequire– Propertyrights– Contracts– Minimumofspillovers– Compe>>on– Accurateinforma>onmadewidelyavailable

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MarketFailure

•  Whentheefficientmarketrequirementsarenotmet,marketfailureoccurs.Weconsidereachoftheseinturn.– Asymmetricinforma>on

– Publicgoods– Externali>es– Commonpropertyresources

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AsymmetricInforma>on

•  Asymmetricinforma>onoccurswhenonepartytoatransac>onknowsmorethandoestheother.

•  Someotherwiseefficienttradesmaybeprevented.

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AdverseSelec>on

•  Adverseselec=onoccurswhenproductsofdifferentquali>esaresoldatthesamepricebecauseofasymmetricinforma>on.– Thisisapparentininsurancemarkets.

– Deduc>blesandco-paymentsarea\rac>vetolow-riskindividuals.

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ProblemswithPropertyRights

•  Therearetwogeneralinstancesofmarketfailurecausedbypropertyrightissues:– Publicgoods– Commonpropertyresources

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PublicGoods

•  Publicgoodsarenon-exclusive,andtheyariseinsitua>onsofnon-rivalry.

•  Thismeansthattheycanbeconsumedbyonepersonwithoutdiminishingwhatisle]forothers.

•  Andiftheyareprovidedforoneperson,otherscanenjoythemaswell.

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PublicGoods

•  Publicgoodsgiverisetothefreeriderproblem.Onitsown,thefreemarketwillnotprovideenoughofthesegoods.

•  Examples:– Weatherforecasts

–  Lighthouses–  Na>onaldefense–  GPSsatellites– Mosquitoeradica>on–  Immuniza>on

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CommonPropertyResources

•  The“tragedyofthecommons”ariseswhenanopen-accessresourceisoverused.– Oceanfisheriesareanexample.Becausenoone“owns”thestockofoceanfish,thereisnotanincen>vetopreserveitsvalue.

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CommonPropertyResources

•  The“tragedyofthean>commons”ariseswhenoneownerofaresourcecanblockdevelopmentofagoodthatwouldhavebenefitstomany,suchasanairport.

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ContractEnforcement

•  Whenthereisnolegalsystempresenttoguaranteetheexecu>onofacontract,thenthescopeofcommercialtransac>onswillbelimited.

•  Whencorrup>onprevailsinthepoli>calstructure,businesseswillinvestless.

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Externali>es

•  Whenexternali>esarepresent,thefreemarketwilloverproduceorunderproducethegoodinques>on.

•  Governmentinterven>onmayberequiredtocorrectthemarketfailure.

•  Oneofthetoolsusedbygovernmentcouldbethemarketitself,asinthecaseoftradingpermitsforpollu>onemissions.

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MonopolyPower

•  An>trustlegisla>onisemployedtocreateacompe>>veenvironmentwhenmonopolis>cprac>cesthreatentoestablishnon-compe>>veprices.

•  Theaimofsuchlegisla>onistocreateamoreefficientoutcome.

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MarketFailures

•  Whenmarketsfail,theydonottotallycollapse;theysimplyfailtocreatethesociallyop>maloutcome.

•  Asymmetricinforma>on–whenonepartytoatransac>onhasbe\erinforma>onthananother–canleadtomarketfailure.

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MarketFailures

•  Adverseselec>onoccurswhenproductsofdifferentquali>esaresoldatoneprice.

•  Moralhazardoccurswhenaninsurancepolicyorotherarrangementchangestheeconomicincen>vespeoplefaceandsoleadsthemtochangetheirbehaviors.

•  Publicgoodsgiverisetothefreeriderproblem.•  Commonpropertyresourcesaretypicallysubjecttooverexploita>on.

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MarketFailures

•  Marketsrarelyareefficientwhenexternalbenefitsorcostsarepresent.

•  Monopolymarketsresultinpriceshigherthanwhatissociallyop>mal.