Topic 8: Market v. StateAgenda, Friday 3rd December 2010

A: Alternative Mechanisms for Allocation of (Society’s) Resources

B: Market and Market Failures

C: Private Solutions v. Public Solutions

D: State Failures

E: Market (Failures) v. State (Failures)

A: Alternative Mechanisms for Allocation of

(Society’s) Resources

Alternative Mechanisms

Market (or more realistically Regulated Market), e.g. restaurant meals, mobile phone, …

Command System, e.g. North Korea, within organisations, …

Majority Rule, e.g. voting on alternative tax-and-spend menus, committees, …

Contest, e.g. CAO points, Oscars, mobile telephony licence, beauty contest, …

Alternative Mechanisms

First-Come, First-Served, e.g. tickets (Take That, All-Ireland, Rugby v. NZ, …

Sharing (Equally?), e.g. votes, air, water, household waste collection?, health?, education?, …

Lottery, e.g. raffle, Medicine TCD = 575*, selling a house?, …

Personal Characteristics, e.g. beauty contest, finding partner(s), discrimination, …

Force, e.g. theft, “taxation Is theft”?, …

B: Market and Market Failures

Market: Welfare Theorems

First Fundamental Theorem of Welfare Economics

Second Fundamental Theorem of Welfare Economics

First Welfare Theorem (Efficiency)

Perfect Competition D = SMB (= P) & S = SMC (= PMC =

MC) P = MC (Allocative Efficiency) Perfect Competition + Market →

Pareto Efficiency

Market Equilibrium: Consumer Surplus and Producer Surplus

Price

Equilibriumprice

0 QuantityEquilibriumquantity

A

Supply

C

BDemand

D

Producersurplus

Consumersurplus

E

Second Welfare Theorem (Equity)

Perfect Competition + Lump-Sum Taxes and Subsidies + Market → Any Specific Pareto Efficiency

Perfect Competition + Lump-Sum Taxes and Subsidies + Market → Pareto Optimality

Second Welfare Theorem (Equity)

Existence of Lump Sum Taxes and/or Subsidies?

Lump-Sum → No Distortion (e.g. no distortionary wedges between buying and selling price introduced)

Poll Tax? Window Tax? … (State Pension, Invalidity Pension)

Second Welfare Theorem?

First Welfare Theorem (Efficiency)

Perfect Competition? D = SMB = P? & S = SMC = MC? P = MC? Second Best Theorem! Specific Market Failures:

Externalities, Public Goods, Informational Problems, Market Power, Equity? Distribution?

Externalities

Non-priced by-products Negative Production (e.g. pollution) Positive Production (e.g. orchards

and honey-producing bees) Negative Consumption (e.g. passive

smoking) Positive Consumption (e.g. vaccines

such as flu, MMR?)

Public Goods

Non-rivalry in consumption Non-exclusion in consumption Examples: defence, lighthouse?, … Pure v. Impure Public Goods Public Goods ≈ Positive Externalities

Informational Problems

Adverse Selection (“hidden information”, e.g. second-hand car market is incomplete)

Moral Hazard (“hidden action”, e.g. insurance markets are incomplete)

Principal Agency (different interests → conflict of interests, e.g. shareholders v. board v. managers v. workers, “life”!)

Market Power

Seller: Monopoly, Oligopoly Buyer: Monopsony (→ buy too little)

C: Private Solutions v Public Solutions

Private Solutions

Coase Theorem

Property Rights (State = “Night Watchman” role)

Transactions Costs Negotiations

Efficiency! (Distributional considerations remain)

Public Solutions

State Provision Nationalisation Command & Control Regulation (“exercise of control by a

public agency over economic and social activities”)

Public & Private Solutions

State & Market-Based Solutions (e.g. Tax, Subsidy, Pollution Permits)

State Ownership/Provision facilitated by market mechanisms (e.g. road building, hospital building, … )

Public-Private Partnerships (PPPs)

D: State Failures

Role of State: Public Interest/Finance Perspective

Benevolent Social Planner/Dictator

Examples Stabilization Policy Optimal Taxation

Role of State: Private Interest Perspective

Public Choice (Economic Theory of Regulation)

Politicians (& Self Interest) Bureaucrats (& Self Interest) Regulators, e.g. regulatory capture

Interest Group Perspective Force of Ideas Perspective

E: Market (& Failures) v. State (& Failures)

Examples

Efficiency-Equity Trade-Off

Arthur Okun’s Leaky-Bucket? Equity: Equality of Opportunity v.

Equality of Outcome