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Markets and the Role of Government
• Government intervention and social objectives
• The objective of social efficiency– marginal social benefits and costs
• MSB > MSC → produce (or consume) more
• MSC > MSB → produce (or consume) less
– socially efficient output where MSB = MSC
• Equity– concepts of fairness
• Trade-offs between equity and efficiency
O
MC = S
DP
MSC
Co
sts
and
ben
efits
Quantity
External cost
Q1Q2
Social optimum
External costs in production
Types of Market Failure
• Externalities
– External costs of production MSC > MC
– External benefits of production MSC < MC
O
MSC
DP
Q1
External benefit
Co
sts
and
ben
efits
Quantity
MC = S
Q2Social optimum
External benefits in production
O
MC = S
DP
Q1Q2
Cos
ts a
nd b
enef
its (
£)
Quantity
MSC
External cost
(a ) External costs
O
DP
Q2Q1
Cos
ts a
nd b
enef
its (
£)
Quantity
MSCMC = S
External benefit
(b) External benefits
External costs and benefits in production
Types of Market Failure
• Externalities
– External costs of production MSC > MC
– External benefits of production MSC < MC
– External costs of consumption MSB < MB
Q2
(MB)MU = D
O
DP
Co
sts
and
ben
efits
Quantity
External cost
MSB
Q1
External costs in consumption
Social optimum
Types of Market Failure
• Externalities
– External costs of production MSC > MC
– External benefits of production MSC < MC
– External costs of consumption MSB < MB
– External benefits of consumption MSB > MB
Q2
(MB)MU = D
O
DP
Q1
Co
sts
and
ben
efits
Quantity
External benefit
MSB
External benefits in consumption
Social optimum
O
MB
PP
Cos
ts a
nd b
enef
its (
£)
Car miles
MSB
External cost
O
MB
PP
Q1
Cos
ts a
nd b
enef
its (
£)
Rail miles
Q2
MSB
External benefit
(a ) External costs (b) External benefits
External costs and benefits in consumption
Q1Q2
O
P1
MC1
MC = MSC
Q1
MRAR = MSB
Q2
P2 = MSB
= MSC
£
QMonopoly output Perfectly competitive output
A monopolist producing less than the social optimum
Types of Market Failure
• Market power
– lack of social efficiency
– deadweight welfare loss under monopoly
O
£
Q
Ppc
Qpc
AR = D
Consumersurplus
Producersurplus
Deadweight loss under monopolyMC
(= S under perfect competition)
(a) Industry equilibrium under perfect competition(a) Industry equilibrium under perfect competition
a
MRO
£
Q
Ppc
Qpc
AR = D
a
Qpc
Pm
bConsumer
surplus
Producersurplus
Deadweightwelfare loss
MC(= S under perfect competition)
(b) Industry equilibrium under monopoly(b) Industry equilibrium under monopoly
Deadweight loss under monopoly
O
£
Q
Ppc
Qpc
AR = D
Consumersurplus
Producersurplus
MC(= S under perfect competition)
(a) Industry equilibrium under perfect competition(a) Industry equilibrium under perfect competition
a
Perfectcompetition
Deadweight loss under monopoly
MRO
£
Q
Ppc
Qpc
AR = D
a
Qpc
Pm
bConsumer
surplus
Producersurplus
Deadweightwelfare loss
MC(= S under perfect competition)
(b) Industry equilibrium under monopoly(b) Industry equilibrium under monopoly
Monopoly
Deadweight loss under monopoly
Types of Market Failure
• Ignorance and uncertainty
– by consumers
– by firms
• Immobility of factors and time lags
• Protecting people’s interests
– dependants
– merit goods
O
MC = S
DP
MSC
Co
sts
and
ben
efits
Quantity
External cost
Q1Q2
Social optimum
Using taxes to correct a market distortion
Q2
MC
Q1O
P
Co
sts
and
ben
efits
Quantity
Optimum tax = MSC – MC
MC = SMSC
D
Using taxes to correct a market distortion
O
MSC
DP
Q1
External benefit
Co
sts
and
ben
efits
Quantity
MC = S
Q2Social optimum
Using subsidies to correct a market distortion
MC
O
P
Q2Q1
Co
sts
and
ben
efits
Quantity
Optimum subsidy
= MC – MSC
MSCMC = S
D
Using subsidies to correct a market distortion
Government Intervention in the Market
• Taxes and subsidies (cont.)
– to correct for monopoly
• use of lump-sum taxes plus subsidies
– advantages of taxes and subsidies
• can vary the rate according to the size of the market distortion
– disadvantages of taxes and subsidies
• infeasible to use different tax and subsidy rates
• lack of knowledge
Government Intervention in the Market
• Changes in property rights
– the problem of limited property rights
– extending property rights
– limitations of this solution
• Laws prohibiting behaviour that imposes external costs
– advantages of legal restrictions
– disadvantages of legal restrictions
• Regulatory bodies
Government Intervention in the Market
• Price controls– high minimum prices
– low maximum prices
• Provision of information
• Direct provision of goods and services– justification
• social justice
• large positive externalities
• dependants
• ignorance
The Case for Laissez-faire
• Drawbacks of government intervention
– shortages and surpluses
– poor information
– bureaucracy and inefficiency
– lack of market incentives
– shifts in government policy
– voters’ ignorance
– unrepresentative government
– lack of freedom for the individual
The Case for Laissez-faire
• Advantages of the free market– automatic adjustments
– dynamic advantages of capitalism
– high degree of competition even under monopoly/oligopoly• possible market contestability
• competition from other closely related industries
• threat of competition from abroad
• countervailing powers
• competition for corporate control
• Judging the arguments
Firms and Social Responsibility
• The classical view on social responsibility
– managers solely responsible to shareholders
– justification and criticisms of this view
• The socio-economic view
– a stakeholding society
– corporate social responsibility
– environmental scanning
Firms and Social Responsibility
• The virtue matrix– a framework for analysing corporate social
responsibility
– the civil foundation• laws and regulation
• social and moral norms
– the frontier• socially beneficial and potentially profitable activities
• socially beneficial but unprofitable activities
The Virtue Matrix:generating corporate social responsibility
Response tosocial norms
Response tolaws and
regulations
Socially beneficial and
potentially profitable
Socially beneficial and unprofitable
CIVIL FOUNDATION
THE'FRONTIER'
Firms and Social Responsibility
• The virtue matrix– a framework for analysing corporate social
responsibility
– the civil foundation• laws and regulation
• social and moral norms
– the frontier• socially beneficial and potentially profitable activities
• socially beneficial but unprofitable activities
– development of corporate social responsibility over time
The Virtue Matrix:generating corporate social responsibility
Response tosocial norms
Response tolaws and
regulations
Socially beneficial and
potentially profitable
Socially beneficial and unprofitable
CIVIL FOUNDATION
THE'FRONTIER'
Firms and Social Responsibility
• The virtue matrix– a framework for analysing corporate social
responsibility
– the civil foundation• laws and regulation
• social and moral norms
– the frontier• socially beneficial and potentially profitable activities
• socially beneficial but unprofitable activities
– development of corporate social responsibility over time
– globalisation and corporate social responsibility