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Markets and Government Chapter 7 ECONOMICS Introduction to Economics
Markets and Government
Chapter 7 ECONOMICS
Introduction to Economics
contents
Roles Markets Play
Efficient Allocation of Resources
Roles Government Plays
Public Goods
Problems of Environment
Welfare State
7.1
7.2
7.3
7.4
7.5
7.6
7.1 Roles Markets Play
- one of the most important institutions that have been ever made
market
• from the viewpoint of efficiency, no other system is
superior to market economy system
• but market economy system has its own limits
- no guarantee of equitable distribution
- sometimes instability in employment and price
- it could have some problem in terms of efficiency
- to make up for these limits, government may
intervene → mixed economy system
market economy
system
7.1 Roles Markets Play
– how to divide the roles between markets and
government?
– how to coordinate the roles of markets and
government?
– even though markets are not perfect, we cannot
say government should intervene
– sometimes government intervention could make
the situation worse
• problems in a mixed economymixed
economy
Are Markets Omnipotent?
7.1 Roles Markets Play
- asks whether it is desirable that the logics of the market is applied
to everything
M. Sandel, What Money Can’t Buy?
• some examples
(1) express tickets of amusement parks
(2) substitution of military service
(3) room upgrades at prisons
7.2 Efficient Allocation of Resources
• strictly speaking, efficiency in economics means Pareto efficiency
- cannot make someone better-off without making others
worse-off by reallocation of resources → Pareto efficient
- suppose there are two persons(A, B) and 100kg of rice
and 20 clothes in a certain economy
- initial state of allocation : A has 70kg of rice and 5
clothes, and B has 30kg of rice and 15 clothes
- suppose A wants more clothes while B wants more rice
Pareto efficiency
7.2 Efficient Allocation of Resources
• reallocation : A gives 10kg of rice to B in return for 3 clothes
• new state of allocation after the exchange : A has 60kg of rice and 8 clothes, B has 40kg of rice and 12 clothes
• if both persons come to enjoy higher levels of utility through this exchange, we can say that the initial state of distribution was not Pareto efficient
• if any kind of reallocation from this state cannot make both A and B better-off, this state is Pareto efficient
Pareto efficiency
7.2 Efficient Allocation of Resources
• perfectly competitive markets allocate resources efficiently
• because the conditions for efficient resource allocation are automatically satisfied in perfectly competitive markets
• this is what A. Smith called ‘invisible hand’ of the market
• but, in some case, resource allocation could be inefficient even in the presence of perfect competition → market failure
efficient allocation of
resources
Market Failure
7.2 Efficient Allocation of Resources
• if market failure occurs, resource allocation in the market economy
will be inefficient
• causes of market failure
(1) imperfect competition
- efficiency of the market economy presupposes perfect competition
(2) public goods
- non-rivalry in consumption and non-excludability
- due to these two characteristics, people try to free ride when it comes
to public goods → free-rider problem
시장의 실패 원인
7.2 Efficient Allocation of Resources
(3) externalities
– a certain action causes incidental benefits or damages to others, and no
corresponding compensation is provided or paid → externality
– negative externality
ex) environmental pollution
– positive externality
ex) education and research of basic science
– problem : too much negative externality and too little positive
externality
Market Failure
7.3 Roles Government Plays
• should government intervene in the presence of market failure?
- if market failure occurs, government intervention might be
necessary
- but government intervention is not automatically justified
• government intervention itself can be the cause of
inefficiency
• in some cases, government failure can occur
- government intervention makes the situation worse →
government failure
Causes of Government Failure
7.3 Roles Government Plays
(1) incomplete knowledge and information- due to incomplete knowledge and information, it is difficult to
foresee the consequences of a certain policy
(2) difficult to control the actions of the private sector
(3) constraints in the political process- a good policy can turn into a bad one in the negotiation processes
of politicians
(4) problems of bureaucracy- moral hazard of bureaucrats can occur
Means of Government Intervention
7.3 Roles Government Plays
(1) direct action- production and supply of specific commodities
• public goodsex) national defense service, police service, roads, parks
• merit goods- not a kind of public goods- government thinks it desirable that all the people
consume a certain commodity equally and sufficiently ex) compulsory education, housing service, health care
service
Means of Government Intervention
7.3 Roles Government Plays
(2) provision of incentives
- tax or financial incentives to promote investment
- high taxes on gasoline or diesel oil to reduce their consumption
- has the characteristic that market mechanism is utilized
• can avoid the problem of inefficient resource allocation caused by
direct government intervention
• but no guarantee that the private sector responds to the given
incentives as expected
Means of Government Intervention
7.3 Roles Government Plays
(3) regulation of the private sector
- regulation for the purposes of income redistribution, protection
of consumers, environmental protection, fair trade
- problems of regulation
• basically inflexible and arbitrary
• actual consequences of regulation could be different from what was
expected
• gains could go to special interest groups → capture theory of
regulation
• makes rent seeking activities more rampant
Measures to Cure Government Failure
7.3 Roles Government Plays
• institutional reforms- inefficiency mainly comes from too much bureaucratization,
unclear distribution of roles, insufficiency of check and balance
• provision of appropriate incentives - inflexibility in promotion and pay is the main cause of laziness
• introduction of competition- lack of effective competition leads to the inefficiency of the
government sector
7.4 Public Goods
• free-rider problem- people want to consume public goods, but are reluctant to share
the cost of producing them - closely related to non-excludability of public goods- if markets assume the task of providing public goods markets,
the level of actual provision will be far lower than socially optimal level
• Question: Do people actually try to free-ride in connection with public goods?- according to the results of experiments by behavioral economists,
people do not necessarily free-ride in actuality
7.4 Public Goods
• one more difficulty related to public goods is the difficulty in
figuring out the appropriate level of production
- the appropriate level of production of public goods depend on
the preferences of people
- but people may act strategically and do not reveal true
preferences in order to reduce their tax burdens
- to figure out the appropriate level of public goods, it is necessary
to induce people to reveal their true preferences for public goods
7.5 Problems of Environment
• problems of environment can be understood basically in the framework of ‘The Tragedy of the Commons’- commons used by all people tend to be overused and
become wasteland sooner or later• unclear definition of ownership is the crux of the matter
• economic development and environment - the problems of environmental pollution existed even
before the time of industrial revolution - water and air pollution in the Roman empire (B.C. 1c) - true that the problem became much more serious with
industrialization - ‘zero growth’?
Solution of Environmental Problem
7.5 Problems of Environment
- environmental problems are closely related to externalities• market failure inevitable
- environmental problems tend to get serious to a dangerous level all of a suddenex) ‘The Great Smog’ that broke out in London in October 1952
- conflicts of interest among various groups make it difficult to find rational solutions
• Why is it difficult to solve the problem of environment?
Solution of Environmental Problem
7.5 Problems of Environment
(1) command-and-control• direct control of the amount of effluents, mandatory cleaning
facilities, mandatory adoption of clean technology
(2) market based approach• effluent charge or emission rights system induces the private
sector to clean up voluntarily through price incentives
- policies of environmental protection in Korea are basically command-and-control
• government intervention
Solution of Environmental Problem
7.5 Problems of Environment
- he says that reciprocity is an essential feature of externalities
- government intervention could lead to a worse outcome
- a better solution can be found by voluntary negotiations of
interested parties
- Coase theorem presupposes that transaction cost is nor large
- not a practical solution in actuality
• Coase theorem argues that government intervention in the
presence of externalities is undesirable
7.6 Welfare State
• government plays a central role in the efforts to improve
people’s economic and social welfare → welfare state
• in modern societies, the model of welfare state is closely
related with liberalism
• those who presented the model of welfare state in the early
stages, however, were conservative politicians
• the first example of welfare state could be found in Prussia
(O. von Bismarck)
• welfare state in the modern sense first appeared in Britain in
1948
Core Programs of Welfare State
7.6 Welfare State
• contents of welfare state differ from country to country, but basically consist of the following three core programs
(1) reduction in distributional inequality with the expectation such a decrease will improve social welfare
(2) reduction in economic instability by various social insurance programs
(3) anti-poverty measures : poverty is the most serious threat to social welfare, but its total eradication is a difficult task
Controversy over Welfare State
7.6 Welfare State
• welfare state tries to improve the state of social welfare through redistribution, but persons with conservative belief argue that government’s redistribution efforts cannot be justified on ethical grounds ex) R. Nozick, M. Friedman
• some argues that too much social welfare dampens the vitality of economy
• too much tax burden could also be a problem • but too little social welfare leads to inequitable state of distribution,
and this would also be an important reason for dampening the vitality of economy
THANK YOU
E C O N O M I C S
