Government Intervention A.S 3.4 INTERNAL 5 CREDITS

Government Intervention

A.S 3.4INTERNAL5 CREDITS

GOVERNMENT INTERVENTION

Providing an explanation of:• Each market failure• Government interventions to correct

each market failure in terms of efficiency or equity

Market failure refers to situations when a market fails to deliver an efficient or equitable outcome

The different market failures relate to:• consumption externalities, • production externalities, • public goods, • imperfect information, • inequitable income distribution

GOVERNMENT INTERVENTION

The different market failures relate to:• consumption externalities, • production externalities, • public goods, • imperfect information, • inequitable income distribution

Government interventions refer to:• subsidies, taxes, regulations, property

rights and government provision (consumption externalities)

• subsidies, taxes, regulations, property rights and government provision (production externalities)

• government provision (public goods)• regulation (imperfect information)• progressive taxes, welfare benefits,

collective provision and minimum wage (inequitable income distribution).

Failure• Task; (In groups)

You are to come up with your best example of a famous international/national FAILURE!!!!!!

It can be;

• A moment in history

•A sporting event

•Report back;•Outline what the failure is,•How the failure occurred (describe the event),•Describe how you would have prevented the

failure!•A conclusion about the incident.

The Invisible HandBACKGROUND

Aim: An economy wants to achieve allocative efficiency! (producing the combination of Goods and Services consumers actually want!)

Adam SmithDescribed how an economy can achieve this!

Markets work correctly when the forces of demand and supply

interact and price systems work to allocate resources!

Note: equilibrium, consumer and producer surpluses are maximised

(no D.W.L)

http://images.google.co.nz/imgres?imgurl=http://upload.wikimedia.org/wikipedia/en/thumb/f/fa/Hand.svg/496px-Hand.svg.png&imgrefurl=http://en.wikipedia.org/wiki/Image:Hand.svg&h=531&w=496&sz=34&hl=en&start=5&tbnid=Z7onekBcr6muNM:&tbnh=132&tbnw=123&prev=/images?q=Hand&gbv=2&hl=en&safe=active

The Invisible HandAdam Smith

Consumer SovereigntyBelief that consumers are the best judge of their own well-being!

No externalities of Public goodsNo side effects imposed on others and private sector provides all goods to consumers!

Perfect informationConsumers and producers should be well informed so they can make sensible decisions about the use of their resources!

Perfect mobilityReallocate resources in order to deal with changes in consumers tastes and preferences and also other factors;

•Geographic mobility•Occupational mobility

Perfect competitionRequirements for a perfect competitor!e.g. price taker etc…

Market failure occurs when the market

system does not work perfectly i.e conditions of the invisible hand

are not met!


Discussion-Market FailuresAdam Smith

Consumer SovereigntyBelief that consumers are the best judge of their own well-being!

No externalities and Public goodsNo side effects imposed on others and private sector provides all goods to consumers!

Perfect informationConsumers and producers should be well informed so they can make sensible decisions about the use of their resources!

Perfect mobilityReallocate resources in order to deal with changes in consumers tastes and preferences and also other factors;

•Geographic mobility•Occupational mobility

Perfect competitionRequirements for a perfect competitor!e.g. price taker etc…


Questions:1. How much does a replacement battery for an iPod cost?2. Exactly how are the Nike jerseys made?

3. Is Telecom a price taker?4. Are there barriers to entry and exit for the airline industry?

5. When you buy a boy racer car with a noisy muffler are you the only one affected by the use of the car?

6. When people consume cigarettes are they the only people affected by it?

7. When you buy a pair of shoes or a hoodie are you being influenced?

8. Is purchasing 3 Big Macs a good consumer decision?

9. Is the market able to convert to a different fuel source other than petrol next week?

10.Do we have the human resources available to start producing cars tomorrow?

Perfect information

Perfect Competition

Externalities/public goods

Consumer Sovereignty

Perfect Mobility

Market has failed!

The market doesnot always give

efficient and fair allocation

of resources

This is a Justification

for Government intervention

Overview

Main aim of an economy is Allocative Efficiency

ConsumerSovereignty Perfect

CompetitionPerfect Mobility

Perfect Information

Externalities public goods

The free market and price systems guides producers to use scarce resources and make the items

consumers want

Market does not always provide resources which are efficient and fair.

Market Failure

This is a Justification

for Government intervention

Roles of the Government

Regulatory Role

Distributive Role

Allocative/ provisional

Role

Stabilisation Role

Regulations and laws

Income distribution

Providing collective or

public goods

Maintain a stable

economy.

e.g. drinking age, WOF’S

for cars

Progressive Taxation,Transfer

payments

Schools, defence, national parks

Control inflation,

Employment levels

Market failure provides justification for intervention. It is the aim of the Government to help price signals carry the correct information. There are four roles the Government can provide

regulatory stabilisation distributive allocative

Taxation

Subsidies

Regulation

The drinking age limit

Public Provision

EXTERNALITIES

Demand

Supply

Affected Affect

ed

Third Party

Externalities Externalities

Buyer Seller

Market Situation

Do we know the risks and effects?

Externalities in Private Goods• Lets start with the effects of:

Alcohol

http://tvnz.co.nz/nigel-latta/s1-ep3-video-6041406

http://tvnz.co.nz/nigel-latta/s1-ep3-video-6041406

Goods can be classified as either private, mixed or public!

Private goods•Rival or Depletable:If one person has the good then it is not available to others

•Excludable by priceCannot enjoy benefits with out paying for the good/service

•No Externalities

•Property rights are clear

Mixed goodsThose goods with externalities. These goods are not produced or consumed in socially desirable quantities.

What are Private Goods?

Definition:Externalities are spill over costs/benefits that are imposed on people other than the buyer and/or seller.

These spill over costs or benefits can be a result of consumption or production.

Externalities

MB

MC

Cos

ts a

nd p

rice

Quantity

P

Q

The private benefits associated with the

consumption of a good or service e.g. catching

a bus saves us from walking

The private costs associated with the

production of a good or service. MC/supply curve for a producer

Unregulated free market equilibrium! Doesn’t account for the spillover

benefits or costs of consumption/production!

MB = MC

Private Market Equilibrium

Alcohol

MB

MC

Cost and price

Quantity

PM

QM

When we take into account the spillover

costs there is MARKET FAILURE. As a result this product is under

priced and over consumed

SMB

Costs get greater as

more is consumed!

What are the spillover costs?

Externalities in Society!!!

• Explain why these could be an issue for the economy of Agnewland. Why should Government intervene?

• Cigarettes

• Synthetic highs

• Marijuana

• Petrol (including diesel)

• Fatty foods

ExampleObesity Epidemic Hits New Zealand

New Zealand is ranked 17th of the world’s most obese populations.

The problem is New Zealanders are eating more calories than they can burn in their increasingly exercise-free lives in front of TV and computers.

Source: The Press 3 March 2007

(a) On GRAPH 1, identify: (i)the market quantity (label it Q1) (ii)the socially desirable quantity (label it QS). (b) From GRAPH 1, identify the letter(s) that show the: (i) deadweight loss area that illustrates this market’s failure (ii)per unit tax required to fully internalise the externality. (c)Explain why QS is a more desirable output level than Q1.

b) i) def

ii) ce or PP2

C) Eg:(I) Consumers of obesity-causing foods don’t (directly) pay the full costs of their consumption, market does not take into account spillovers, junk food is overconsumed and underpriced, at Q1 MSC is greater than MSB, market failure at Q1(E) Qs is more desirable than Q1 because Qs reflects social preferences, achieves allocative efficiency, MSC=MSB, no DWL at Qs, reduces surpluses.

University

MB

MC

Cost and price

Quantity

PM

QM



priced and over consumed

SMB

Benefits get greater as

more is consumed!

What are the spillover Benefits?

University

MB

MC

Cost and price

Quantity

PM

QM

SMB

What benefits?

Private equilibrium problem?

Internalise?

Conclude?

Private market equilibrium

SMC

SPILL O

VER

BENEFIT

P (social)

Q(social)

Social market equilibrium

Mountain biking tracks from forestry production


benefits there is MARKET FAILURE. As a result this product is over priced and under

produced

Positive Externalities of Production

Example!In recent years, a number of movies have been filmed

in New Zealand, including The Lord of the Rings trilogy, The Last Samurai and Whale Rider.

Give 3 examples of Positive Externalities of Production for the movie industry producing in NZ

Draw and appropriately label a new curve that shows the effect of Positive Externalities of Production. Label the social equilibrium quantity QS and the social equilibrium price PS.

Identify and label the per unit subsidy that would be needed to internalise the positive externality.

Private market equilibrium

SMC

SPILL O

VER COST

P (social)

Q(social)

Social market equilibrium

Negative Externality of productionPollution caused by the production of dairy cows



priced and over produced

Equity and Efficiency

• When setting policies to internalise externalities, you may not achieve both!

• Lets explore

Lower the catch limit of recreational fisherman to 2 fish/person/day

Group work presentation!

• Groups of 3-4

• Current policy and action

• Present to the class.

• Winner may have their phone out for 1 period of the class to receive calls, use facebook, do texts, snap chat Tully.

Examples• Must be current!

• Must have clear externalities (be mixed goods)

• Equity and Efficiency?

• EXAMPLES:

Increase rules, regulations around alcohol (tax, age, outlets)

Government should fund Team NZ

Reduce subsidies on University Fees

Increase subsidies on dental care

Equity and Efficiency Debate

Equity (fair)A situation that is considered fair!

e.g. A child pays a lower fair on the bus!

Inequity (unfair)A situation that is considered unfair!

e.g. Rich people can get an education but poor people can’t

Equal (same)A situation where everyone is treated the same

e.g. Everybody gets a medal at the olympics

Unequal (different)A situation where everyone is treated differently

e.g. A child has to go to bed earlier than adults

Equity and Equality Box of Debate

Equity (fair)

Inequity (unfair)

Eq

ual

(s

ame)

Un

equ

al

(dif

fere

nt)

Debate

• Should Maori and Pacific Island students have greater access to scholarships?

• Is it fair that children are supposed to stand up for adults on the bus?

• Is it fair that people under the age of 16 get cheaper movie tickets than adults?

How does this relate to EconomicsMarket Failure (loss of Allocative Efficiency) occurs when unfair situations happen in the Economy in terms of;

•Market income•Purchasing power•Opportunity•Access to resources

Distribution of Income

Economies generate incomes.

How incomes are earned is determined by the market. In a free market (interaction of demand and supply) and our skills and abilities dictate our level of income.

e.g Doctors vs Bus Drivers, Rugby Players vs Lawn Bowls

How the income is spread is called;


Wealth vs Income

Wealth:

Is a stock. How much exists at a certain time!

Income:

Is a flow. Money earned over a period of time!


Lowest 10% of Income earners

2nd

10% of Income earners

3rd 10% of Income earners

4th 10% of Income earners






Highest 10% of Income earners

If all incomes were equal the income

distribution would look like this!


Lowest 10% of Income earners

2nd

10% of Income earners

3rd 10% of Income earners







Highest 10% of Income earners

Less than equal share

More than equal share

People with different skills and abilities are valued differently in the market

Weighting up the stats!

• Market Failure (loss of Allocative Efficiency) occurs when unfair situations happen in the Economy in terms of;

•Market income•Purchasing power•Opportunity•Access to resources

Distribution of IncomeHousehold

income groups

% of income earned by

group

Cumulative % of income

1 0.3 0.3

2 1.7 2

3 4 6

4 6 12

5 8 20

6 10 30

7 12 42

8 16 58

9 17 75

10 25 100

Lowest % of

households

Highest % of

households

We can graph this. This is

called a Lorenz Curve!

Lorenz Curve (Inequality)

10

20

30

40

50

60

70

80

90100

10 20 30 40 50 60 70 80 90 100

Cu

mu

lati

ve %

of

inco

me

Cumulative % of Households

Line of complete equality. 50% of the economies

households earn 50% of the

income

This does not represent the market income. We draw in the Lorenz curve to show this!

more unequal

Line of market income. 90% of the economies

households earn 50% of the

income

10% of the richest people

earn 50% of the economies

income

Line of wealth. This line is more unequal due to

people with high incomes ability

to save (generate wealth).

Redistribution of income?

• Existing tools for redistribution are? Tax

• Top tax bracket is 33c should it go to 38c or should it go to 30c?

• Fair or Unfair?

• Other tools?

Issues Equitable or Inequitable

10

20

30

40

50

60

70

80

90100

10 20 30 40 50 60 70 80 90 100

Cu

mu

lati

ve %

of

inco

me

Cumulative % of Households

• Increase GST to 15%?

• Working for families subsidy?

• Raising the minimum wage?

• Lowering tax to high income earners?

• Lowering welfare payments to the elderly?

Equity and Efficiency Trade off

Fairness (income market)

Economy producing at a high level of activity.

When the Government aims to improve equity in income distribution it will come at a cost of Efficiency. We can use the PPF to draw this!

Efficiency

Equity

Government introduces

Working For Families to

help families with children


Government introduces

Working For Families to help

families with children

Efficiency

Equity

A family with 2 children!Due to the Government supplementing their income there is a less incentive for both parents to be productive!Ie:The difference between earning $60,000/year or earning $38,000/year plus WFF supplement is $8000/year.

The family will not try to solve their financial issues by being

more productive and as a result the economy will lose Efficiency from the Government pushing

for equity


Efficiency

Equity

Country A is highly efficient but has a

very unequal distribution of income

Country B is very equal but is very

inefficient.

Efficiency or Equity policy??????

An increase in the minimum wage

Lowering of Transfer Payments

Progressive tax rates

Providing benefits for single mothers

Removal of the community services cards

Increasing the pension for elderly

Questions

A government can use progressive taxes to redistribute an economies income.

Give 2 other ways the government can redistribute income:

1.

2.

Explain how progressive taxes redistribute incomes.

On the Lorenz curve show the effect of increase the top tax rate.

Explain why some level of income inequality may be equitable.

Answers

1. Community services card, Transfer payments, gold card, Working for families…..

2. Progressive taxes redistribute income through taxing higher income earners a higher average/marginal tax rate per dollar earned. The government redistributes the extra tax revenue to lower income earners…..

3. On board

Answers

4. If people are working longer hours or are more skilled/productive (via qualifications) they may earn more than those with less skills. This creates unequal income

distribution (income inequality)between households, however this is fair as those who are unskilled/less productive are paid lower due to lower contributions to the economy.

Answers

In a market system, incomes are allocated by the forces of supply and

demand (in factor markets) and supply and demand are different in each

market.

(E) If you have skills to produce products that are demanded, you earn income(and if the product demand is high and the number with the skills to produce it is small, you earn a high income).

Because supply and demand are different in different markets, uneven incomes are earned. (Q)

Answers

This could be seen as unfair (inequitable).

E The free market means that only those who work can gain income.

Q Some who cannot work (sick, invalids, retired) will receive no income.

Equity means fairness; equality means the same.

Everyone receiving the same income could be seen as unfair as those who worked longer hours would be no better off than those who did not work.

Q There would be no incentive to work longer hours etc if you were getting the same income as those who worked less / had fewer skills.

Public Goods vs Private Goods!!!

What is the difference?

• Private goods

Excludable

Rival

Depletable


Producers can exclude users through price

Consumers use excludes others from using it.

Once used it cannot be consumed again.

• Public goods

Non-

Excludable

Non-

Rival

Non-

Depletable

Producers cannot exclude users

Consumers use does not exclude others from using it.

Once used it can be consumed again.


Has Zero MARGINAL

COST

Public goods

• Often have positive externalities of production/consumption Examples?

Why provided this good?

Who pays?

Other examples?

What would happen if we turn this into a private

good?

Public Goods

Equity and Efficiency???

Equity and efficiency to providing the community with a Library:

Equity?

Efficiency?

Problem – Free rider

People who refuse to contribute to the cost of providing the good on

the grounds no one can be excluded from using

it!

Firms have very little option when the free rider

problem occurs! It is difficult to charge for the

products use!

Documents

Government Intervention A.S 3.4 INTERNAL 5 CREDITS