Macroeconomics: Crash Course Adriene: Hi I'm Adriene Hill, welcome back to Crash Course Economics. As you may remember from our first video, economics can be divided into two parts: microeconomics and macroeconomics. Since macroeconomics is the one that's most often in the news, that's where we're gonna start. We'll get to microeconomics, which is also super important in future episodes, but what is macroeconomics again? Mr. Clifford: (monotone) It's the study of economic aggregates revealed through national income accounting, which is then- Adriene: Okay okay, when you explain it like that it sounds boring but it is not boring! Macroeconomics is about booms and busts, will you get a job when you graduate, should the government cut taxes? Mr. Clifford: In theory, lowering marginal tax rates would actually increase- Adriene: No no no! Remember, the goal of learning economics is to become a better decision maker, and part of that is learning how the whole economy works. So let's learn about the whole economy. [Intro] So, macroeconomics is the study of the entire economy. Macroeconomists study the big stuff, like economic output, unemployment, inflation, interest rates, and government policies. Now when it comes to fields of study, macroeconomics is a relatively new subject. It wasn't until the Great Depression in the 1930's that economists fully appreciated the need for a systematic way to measure the overall economy, and that we might need theories to guide policies and fix potential problems. A hundred years ago there was no comprehensive data on economic activity, so there was no macroeconomics. Today, economic data is plentiful, but that doesn't mean that economists agree about where the economy is, where it's going, or what should be done to help. Macroeconomists make predictions based on data, theoretical models and historical trends, but in the end they're just predictions. If you ask three economists the same question, you're likely to get three different answers, but how, you ask, can the dismal "science" be so subjective? Well, economics is not a traditional science because it is nearly impossible to control all the different variables. Like all the social sciences, economics is studying people, and it turns out that sometimes people are unpredictable. Stan Muller: I challenge all of you to a tournament of champions in Flappy Bird! Adriene: Who saw that coming? That doesn't mean that economics is all guesswork. For example, right now in early 2015, the economy of Greece is, well it's not, it's not good. But how can we tell, and is it gonna get better? Is it gonna get worse? What should be done about it? These are all questions that macroeconomists try to answer, but for this video, we're gonna focus on the question "How can we tell?" Mr. Clifford: Well in general, policy makers have three economic goals: they want to keep the economy growing over time, they want to limit unemployment, and they want to keep prices stable. Now for the most part when these three things happen, the citizens are happy, politicians get reelected, and economists get raises. There are three specific measurements that economists analyze to see if a country is achieving each goal. They're the Gross Domestic Product, unemployment rate, and the inflation rate. The most important measure of an economy is Gross Domestic Product or GDP. GDP is the value of all final goods and services produced within a country's border in a specific period of time, usually a year. Now there are some details worth mentioning. GDP doesn't include every transaction that's in the economy. For example, if you buy a used domestic car, it doesn't count towards GDP because nothing new was produced. Now that same logic applies to buying financial assets like stocks, or when one company buys another company, for example when Google bought YouTube. Those don't count towards GDP because no new good or service was produced. Also, GDP often doesn't include illegal activity, since drug dealers don't usually report their sales to the government, or non-traditional economic activity like household production. For example, if a plumber charges someone $100 to fix their hot water heater, that counts towards GDP, when he fixes his own water heater, that doesn't count towards GDP. Here's a list of countries organized by GDP. Notice that GDP is measured in dollars, not in the raw number of things produced. If we analyzed just the raw number, then a country that produced five million thumbtacks would look like they're doing just as well as a country that
Transcript
Macroeconomics: Crash Course Adriene: Hi I'm Adriene Hill, welcome back to Crash Course Economics. As you may remember from our first video, economics can be divided into two parts: microeconomics and macroeconomics. Since macroeconomics is the one that's most often in the news, that's where we're gonna start. We'll get to microeconomics, which is also super important in future episodes, but what is macroeconomics again? Mr. Clifford: (monotone) It's the study of economic aggregates revealed through national income accounting, which is then- Adriene: Okay okay, when you explain it like that it sounds boring but it is not boring! Macroeconomics is about booms and busts, will you get a job when you graduate, should the government cut taxes? Mr. Clifford: In theory, lowering marginal tax rates would actually increase- Adriene: No no no! Remember, the goal of learning economics is to become a better decision maker, and part of that is learning how the whole economy works. So let's learn about the whole economy. [Intro] So, macroeconomics is the study of the entire economy. Macroeconomists study the big stuff, like economic output, unemployment, inflation, interest rates, and government policies. Now when it comes to fields of study, macroeconomics is a relatively new subject. It wasn't until the Great Depression in the 1930's that economists fully appreciated the need for a systematic way to measure the overall economy, and that we might need theories to guide policies and fix potential problems. A hundred years ago there was no comprehensive data on economic activity, so there was no macroeconomics. Today, economic data is plentiful, but that doesn't mean that economists agree about where the economy is, where it's going, or what should be done to help. Macroeconomists make predictions based on data, theoretical models and historical trends, but in the end they're just predictions. If you ask three economists the same question, you're likely to get three different answers, but how, you ask, can the dismal "science" be so subjective? Well, economics is not a traditional science because it is nearly impossible to control all the different variables. Like all the social sciences, economics is studying people, and it turns out that sometimes people are unpredictable. Stan Muller: I challenge all of you to a tournament of champions in Flappy Bird! Adriene: Who saw that coming? That doesn't mean that economics is all guesswork. For example, right now in early 2015, the economy of Greece is, well it's not, it's not good. But how can we tell, and is it gonna get better? Is it gonna get worse? What should be done about it? These are all questions that macroeconomists try to answer, but for this video, we're gonna focus on the question "How can we tell?" Mr. Clifford: Well in general, policy makers have three economic goals: they want to keep the economy growing over time, they want to limit unemployment, and they want to keep prices stable. Now for the most part when these three things happen, the citizens are happy, politicians get reelected, and economists get raises. There are three specific measurements that economists analyze to see if a country is achieving each goal. They're the Gross Domestic Product, unemployment rate, and the inflation rate. The most important measure of an economy is Gross Domestic Product or GDP. GDP is the value of all final goods and services produced within a country's border in a specific period of time, usually a year. Now there are some details worth mentioning. GDP doesn't include every transaction that's in the economy. For example, if you buy a used domestic car, it doesn't count towards GDP because nothing new was produced. Now that same logic applies to buying financial assets like stocks, or when one company buys another company, for example when Google bought YouTube. Those don't count towards GDP because no new good or service was produced. Also, GDP often doesn't include illegal activity, since drug dealers don't usually report their sales to the government, or non-traditional economic activity like household production. For example, if a plumber charges someone $100 to fix their hot water heater, that counts towards GDP, when he fixes his own water heater, that doesn't count towards GDP. Here's a list of countries organized by GDP. Notice that GDP is measured in dollars, not in the raw number of things produced. If we analyzed just the raw number, then a country that produced five million thumbtacks would look like they're doing just as well as a country that
produced five million cars, but there's also a problem with using the dollar value of stuff produced: it's inflation. If two countries produce the same amount of cars, but one has higher prices, then that country's going to have a higher nominal GDP, or GDP not adjusted for inflation. To get a more accurate idea of the health of the economy, economists look at Real GDP, which is GDP adjusted for inflation. Just what "adjusted for inflation" means is really important, but too big of a topic to discuss right now. We'll get to it. Adriene: So what does the Real GDP in Greece tell us about its economy? In 2013, the Greek Real GDP was around 242 billion dollars, but that number doesn't really mean anything until you compare it to previous years. In 2012, it was 250 billion dollars, in 2011, it was 288 billion, and in 2010 it was 300 billion. In fact, starting in 2008, Greece has had six years of decreasing GDP, and the data reveals that this recession is just as deep and prolonged as the Great Depression in the United States in the 1930's. Now, I just used the term recession, which a lot of people use incorrectly. A recession is not just when the economy's bad, officially it's when two successive quarters or six months show a decrease in Real GDP. Even though the economy in Greece is still struggling, it climbed out of its recession in 2014, experiencing a slight increase in GDP. A depression, on the other hand, doesn't have a technical definition, but it's a severe recession, when the economy's really really bad. It's worth noting though that GDP can be a little problematic. I mean not all countries measure GDP in the same way, and in recent years some European Union countries have started experimenting with counting underground markets, like the sex trade and drug trade as part of the total. In fact, GDP isn't even that old an idea. According to Robert Froyen, during the Great Depression, economic decisions were made "on the basis of such sketchy data as stock price indices, freight car loadings, and incomplete indices of industrial production. The fact was that comprehensive measures of national income and output did not exist at the time. The depression, and with it the growing role of government in the economy, emphasized the need for such measures and led to the development of a comprehensive set of national income accounts." So GDP was invented to account for national income, and it may not necessarily provide a complete picture of a country's economy, but for the moment it's what we've got. So that's economic growth, or at least one way to look at economic growth. now, for the next big issue for macroeconomists: unemployment. Anyway, the major goal of unemployment policy is to limit unemployment, and that's measured by - you guessed it - the unemployment rate. In Greece, unemployment is over 25%. Mr Clifford: The unemployment rate is calculated by taking the number of people that are unemployed and dividing by the number of people in the labor force, times 100. Now this percentage represents the number of people that are actively looking for a job but just can't find one. First, the labor force only includes people that are of legal working age and working or actively looking for work, so little kids don't count and neither do people who aren't able to work or who just choose not to work. So what about someone who's been looking for a job but just gives up? Well, they're no longer part of the labor force, and they're no longer considered unemployed. These are called discouraged workers. The unemployment rate also doesn't take into account people that are underemployed. A worker with a five hour a week part time job is considered fully employed even if they're looking for a better job. In both of these cases, the official unemployment rate underestimates the problems in the labor market. A common misconception is that the goal is to have 0% unemployment, but it turns out there's types of unemployment that'll exist even when the economy's going strong. Economists would point out that there's three types of unemployment, or three reasons why people would be unemployed. First is frictional unemployment. This is when people are temporarily unemployed or between jobs. So if you quit your job and look for a new one, or if you're just entering the labor force, then you're frictionally unemployed. The second is called structural unemployment. Workers are out of work because there's no demand for that specific type of labor. This would be like a VCR repair person, but it also includes technological unemployment, where workers are replaced by machines. Now both frictional and structural unemployment will always exist; the goal is not to have 0% unemployment. I mean, 0% is not even possible. We're always going to have people between jobs or people fired because machines do it better. So the goal is to have no cyclical unemployment. This is unemployment due to a recession. It's when people stop buying stuff, so businesses lay off their workers and since workers have lower incomes, they stop buying stuff which means more people lose their jobs. An economy is considered to be at full employment when there's only frictional and structural unemployment. This is called the natural rate of unemployment. This natural rate differs slightly between countries, in the United States it's usually between 4 to 6 percent unemployment.
Now as you might expect the GDP growth rate and the unemployment rate are inversely related. That means that when GDP is rising, the unemployment rate is falling, when GDP is falling, the unemployment rate is rising. Adriene: And that's exactly what happened in the United States during the Great Depression. in the 1930's, droughts, bank failures, and counterproductive policies caused GDP to fall, and unemployment peaked at 25 percent. Let's move on to the third economic goal: stable prices. While I might like the idea of the stuff I buy getting cheaper across the board, falling prices are not really a good thing. Average prices in Greece have fallen about two percent recently, and during the 1930's, the inflation rate in the US was negative ten percent, but how can cheaper stuff be bad for the economy? Mr. Clifford: Well the goal is to keep prices stable, mainly to avoid rapid inflation, or rising prices, but we also want to avoid excessive deflation which is falling prices. Inflation is measured by tracking the prices of a set amount of commonly purchased items, or what economists call a market basket. The inflation rate is the percent change in the price of that basket over time. Too much inflation is bad because it decreases the purchasing power of money; it means you can buy less stuff with the same amount of money, which has all sorts of negative effects on the economy. Business costs increase as workers demand higher wages and interest rates increase, so it's harder to buy loans, so people buy less cars and houses. Deflation on the other hand, seems like it would be a good thing but most economists see falling prices as a bad thing. Falling prices actually discourage people from spending since they might expect prices to fall more in the future. Less spending in the economy means GDP is gonna decrease and unemployment's gonna increase, and that just becomes a vicious cycle. So severe recessions are often accompanied by deflation because the demand for goods and services falls, but when the economy starts to improve again, we often see an increase in prices. Adriene: Throughout history, economies have expanded and contracted. It's called the business cycle. Let's go to the Thought Bubble. If we imagine the economy as a car, then GDP, employment and inflation are the gauges. A car can cruise along at 65 miles per hour without overheating. Safe cruising speed is like full employment; unemployment is low, prices are stable and people are happy. But if we drive that car too fast for too long, it'll overheat, and in the economy, significant spending increases GDP causing an expansion. Unemployment falls and factories start producing at full capacity to keep up with demand. Since the amount of products that can be produced is limited, people start to outbid each other, resulting in inflation. Eventually, production costs increase as workers demand higher wages and the economy starts to slow down. Businesses lay off a few workers, those unemployed workers spend less causing the businesses that produce the good that they would otherwise be buying to lay off more workers. This is a contraction, the economy is going to slow. Eventually things stabilize, production costs fall since resources are sitting idle, and the economy starts to expand again. This process of booms and busts is called the business cycle. To understand why these fluctuations might occur, let's take this car analogy just a little further and look at the engine. Much like the four cylinder engine that powers the Volkswagen of growth, an economy has four components that make up GDP. Each represents a different group that can purchase things in the economy. They're consumer spending, business spending which is called investment, government spending, and net exports which is basically spending by other countries. If any one of these components loses power, the economy will slow down, but not all of them are created equal. Most economies rely heavily on consumer spending. For example, in the US, consumers account for about 70% of GDP, but other countries might rely more heavily on exports. The point is, changes in these four components change the speed of the economy. Thanks Thought Bubble. So when I'm driving my car on the highway, I use cruise control to regulate my speed. So why don't we have cruise control for the economy? Well many economists think that the government should play a role in speeding up or slowing down the economy. For example, when there's a recession, the government can increase spending or cut taxes so consumers have more money to spend. Proponents of this policy argue that it would get the economy back to full employment, but it has its drawback: debt, which some economists hate while others argue isn't very much of a drawback at all. Stupid economic policy, always resisting simplistic explanations. We're gonna save the debate over how to fix the economy for future videos, but for now it's important for you to have a general understanding of how the
economy works and how it's measured. After all, whether you're driving a Namco in Greece, a Kia in Korea or a Ford in the US, your livelihood and your future will be shaped by what happens in the economy. So wear your seat belt. By which I mean try to save a little once in a while, OK? So we've really just touched on these three major indicators of economic health, and while they can be useful in providing a broad overview of a nation's economy, reality is, as usual, a little more nuanced than that. Mr. Clifford: Next week, we're gonna go under the hood and look at the greasy, dirty details of how economists calculate growth, and tune up thee economy, and rev up their economic engines and drive around the drag racing tr-- Adriene: OK, I think that's enough with the cars, Thanks for watching, we'll see you next week. Mr. Clifford: Thanks for watching Crash Course Economics. It was made with the help of all of these nice people. Now, if you want to help keep Crash Course free for everyone forever, please consider subscribing over at Patreon. It's a voluntary subscription platform that allows you to pay whatever you want per month to make Crash Course exist, and it also increases GDP. Thanks for watching, DFTBA.
1. Complete viewing guide with the transcript 2. Complete the article with the questions at the bottom of the page
Hey guys!! We just wanted to wrap up out study of microeconomics by briefly hitting on market failures. Here is the order you should go through this lesson.
1. Read the ‘market failures transcript’ and answer the video guide that goes with it. This will explain to you what market failures are
2. Read and answer the ‘externalities’ handout. This explains to you in more detail about the market failure of externalities.
3. Read and answer the ‘public good’ handout. This explains to you in more detail about the market failure of public goods
4. Complete the market failures worksheet.
Transcript:
The Federal Reserve Bank of St. Louis presents The Economic Lowdown, Episode 17:
Public Goods.
Do you ever stop to think about how you use certain goods in different ways? For
example, when you’re at a pizza party, the host orders and pays for a large amount of
pizza, so you and your friends eat as much as you’d like without paying a dime. Even if
your buddies take the pizza off your plate, you can just grab another slice free of charge.
However, when you go out to dinner at a restaurant, you don’t eat quite as much, do
you? First of all, you need to stay within your budget. You can’t order everything on the
menu if you have no money, no matter how hungry you are. And if somebody else eats
your dinner, you can’t eat it.
While these concepts may seem obvious, they are essential to understanding the
distinction between public and private goods.
Let’s pretend it’s your lucky day and you get to buy your dream car. You head to your
local dealership and find exactly what you want. You can’t just drive the car off the lot,
though. You have to pay the dealer first. If you can’t pay, you can’t have the car. But you
can, and you do, and you drive off. Your new car is yours, and it’s a private good. I know
that may seem obvious, but “private good” is actually a technical economics term. For a
good to be a private good, it must meet two conditions: It must be excludable and rival.
When a good is excludable, the supplier of the good can keep nonbuyers from obtaining
that good. So, in the case of the car, if you did not pay for it, the dealer would not have
given you the keys and ownership title—you would be excluded from owning it.
When a good is rival, one person’s consumption—or use—interferes with another’s
ability to consume it. If you drive your new car to the mall on the north side of town, I
can’t take it to the movie theater on the south side. The car is “rival.” One person driving
it keeps another person from driving it. So, cars are private goods because they are
excludable and rival.
Explain what makes a good a private good.
In contrast, public goods are not limited in these ways.
For a good to be classified as a public good, it must meet two conditions: It must be
non-excludable and nonrival. A good is nonexcludable if the supplier of the good cannot
prevent those who don’t pay it from consuming or using it. A good is nonrival if one
person’s consumption does not hinder anyone else’s consumption of the good. That is,
everyone gets to use it freely. So, I can consume as much of the good as I like and you
can consume as much as you like. Even if we wanted to, we couldn’t hog it. Additionally
a public good may not necessarily be a physical good that you can hold in your hands.
Nonexcludable and nonrival services are also considered “public goods.”
Explain what makes a good a public good.
National security is an example of a public good. We all benefit from this government
service with hardly a second thought. We pay our taxes to the government, and the
government uses part of those funds to defend the country from foreign and domestic
threats. National security is nonexcludable because there is no way of withholding
protection from those who don’t pay taxes. If a missile were heading for the country, the
military would shoot it down to save everyone in its path, regardless of who did and
didn’t pay their taxes. National defense is nonrival because one person’s use of it does
hinder anyone else’s consumption. For example, as the population grows, more people
benefit from national security, but the level of protection for those already benefiting
remains the same.
Provide an additional example of a public good.
It’s important to note that there are different meanings of the term “public.” The
economic definition of “public” differs from the common use of the word “public” in
everyday language. For a good to be a public good, it must be nonexcludable and
nonrival.
So, for example, public transportation is not a public good. It is excludable, because the
transit company won’t give you a ride if you don’t pay the fare. It’s also rival because
public transportation has limits. At busy times, a train or bus might have to leave
passengers behind because of lack of space. So, public transportation isn’t a public
good because it is not nonexcludable and nonrival.
A public pool is another example. While it may or may not be nonexcludable, in that you
may or may not have to pay to get in, it is rival. If too many people try to use, it can
become overcrowded. Everyone’s level of enjoyment may suffer and some people will
be left out. So, a public pool is not a public good.
Now, let’s put you to the test. Fireworks shows are a staple of American celebrations.
Are fireworks shows a public good or a private good? Well, it depends on the situation.
In many areas, local governments use tax money to pay for fireworks shows for their
citizens. First, such fireworks display are nonexcludable. It’s just not possible to stop
non-taxpayers from enjoying them simply by looking up to the sky. Second, the
fireworks remain just as beautiful regardless of how many people are looking at them.
That makes them nonrival as well. So, in general, tax-funded fireworks displays are
public goods.
In some cases, however, you may have to pay to see a fireworks display. For example, in
a large, fenced-in area such as an amusement park, only paying customers at the park
have the best views. While you could possibly stand outside the park and watch for free,
you likely wouldn’t see everything the show has to offer, especially if your sight line is
obstructed by a roller coaster. In this case, the fireworks display is not technically a
public good. Although it may possibly be considered nonrival, it is excludable. People
must pay for the best views.
Why does the government usually supply public goods instead of private companies?
For starters, the free rider problem. Free riders are the consumers who don’t pay in
order to consume the public good. Since public goods are free, most consumers
become free riders because they have no incentive to pay the supplier. After all,
consumers have a budget, so they won’t likely pay for a good if they can get for free.
While there may be people who recognize the importance of a public good and have
enough money to donate voluntarily, they form the exception to the rule. In general,
people will not pay willingly for a public good.
Summarize the free rider problem.
If a private business supplied a public good, most people would consume the product
for free. Since it is nonexcludable and nonrival, consumers can already get the full
benefits without paying anything. They won’t likely donate much, if any, of their
hard-earned cash. Hence, the company won’t make much money. That’s why private
firms won’t produce public goods; there’s no reward. Firms instead spend their time and
resources producing private goods because people do have to pay for those, allowing
the firm to sell them for a profit.
When a private market fails to produce a good at the level society wants, or doesn’t
produce it at all, economists call this a market failure.
Explain how public goods can lead to market failures.
Think back to the fireworks example. A business looking to make money would likely
not offer a fireworks display if it can’t exclude people from watching it. It needs to make
a profit to stay in business. So, the private market fails to provide as many fireworks
displays as society wants.
Because the private market is profit-driven, it produces only those goods for which it
can hope to earn a profit. That is, it will not produce public goods.
So how do we get public goods? The government steps in. Unlike a private firm, the
government has no profit motive. And the government reduces the free rider problem by
collecting taxes from consumers to help fund public goods. You could think of it this
way: The government simply returns the public’s own money to them in the form of
public goods.
Streetlights are another example of public goods. They’re nonexcludable because
anyone can use the lighting even if they don’t pay for it, and they’re nonrival because
they shine just as brightly regardless of how many people stand or drive under them.
While society has a clear need for lighting for motorists and pedestrians, the free rider
problem prevents the private market from providing such goods. Private firms don’t
provide streetlights because there’s no way to exclude people who don’t pay for them.
So, the government provides streetlights and pays for them with taxes.
Each of us benefits from the use of public goods every day—often without even thinking
about it. But they are necessary for a well-functioning economy and society in general.
So the next time you read about national security, take in a fireworks show, or drive
down a well-lit road at night, stop for a second to think about what your life would be
missing without public goods.
Market Failures Worksheet Directions: Identify the market failure for each scenario. Then, create and explain a regulatory or market-based solution to the failure.
Scenario 1: Parks are a great source of recreation and exercise, they’re family-friendly and raise property values. However, because they are free, no corporation wants to build a new one in Econville.
Market failure: Solution:
Scenario 2: Cigarettes affect more people than the smoker. Others around them could experience a health problems and the society pays more for health care. The price of cigarettes doesn’t reflect this.
Market failure: Solution:
Scenario 3: A lumber company plants trees throughout Oregon. Not only does this guarantee they’ll have trees to harvest decades later, but it helps clean the air and prevents soil erosion in the forests.
Market failure: Solution:
Transcript What do pollution, education, and your neighbor's dog have in common? No, that's not a trick question. All three are actually examples of economic transactions that include externalities. When markets are functioning well, all the costs and benefits of a transaction for a good or service are absorbed by the buyer and seller. For example, when you buy a doughnut at the store, it's reasonable to assume all the costs and benefits of the transaction are contained between the seller and you, the buyer. However, sometimes, costs or benefits may spill over to a third party not directly involved in the transaction. These spillover costs and benefits are called externalities. A negative externality occurs when a cost spills over. A positive externality occurs when a benefit spills over. So, externalities occur when some of the costs or benefits of a transaction fall on someone other than the producer or the consumer. Define externality Negative Externalities Imagine there's a factory in your town that produces widgets, a good that benefits consumers all over the world. The smokestacks at the factory, however, belch out pollution 24/7. From an economic perspective, the firm is shifting some of its cost of production to society. How? Well, in its production process the firm uses clean air-a resource it does not pay for-and returns polluted air to the atmosphere, which creates a potential health risk to anyone who breathes it. If the firm were paying the full cost of production, it would return clean air to the atmosphere. Instead, if society wants clean air, society must pay to clean it. So, in this case, pollution represents the shifting of some of the cost of production to society, a negative externality. And, because the firm isn't paying the full cost of producing widgets, the price charged for widgets is artificially low. Consumers will buy more widgets at the artificially low price than at a price that reflects their full production cost. So, ultimately, more widgets are produced than would be the case if all costs were included. And since more widgets are being produced, more air is being polluted.
Come up with an additional example of negative externalities. Correcting Negative Externalities Government can play a role in reducing negative externalities by taxing goods when their production generates spillover costs. This taxation effectively increases the cost of producing such goods. The higher cost, then, better reflects the true cost of production because it includes the spillover costs of, say, pollution. So, such taxation attempts to make the producer pay for the full cost of production. The use of such a tax is called internalizing the externality. For example, let's assume the cost of producing the widgets noted earlier is two dollars per unit, but an additional 20 cents per unit had been shifted to society as a negative externality in the form of dirty air. The government could place a 20 cent tax on each widget produced to ensure that the firm pays the actual cost of production-which is now two dollars and twenty cents, including the cost of the negative externality. As a result of the higher cost of production, the firm will reduce its production of widgets thus reducing the level of pollution. How can taxes help correct negative externalities? Positive Externalities When you complete high school, you'll reap the benefits of your education in the form of better job opportunities, higher productivity, and higher income. A technical degree or college education will further enhance those benefits. Although you might think you are the only one who benefits from your education, that isn't the case. The many benefits of your education spill over to society in general. In other words, you can generate positive externalities. For example, a well-educated society is more likely to make good decisions when electing leaders. Also, regions with a more-educated population tend to have lower crime rates. In addition, more education leads to higher worker productivity and higher living standards for society in general. Although education has many spillover benefits, providers of education do not receive all the revenue they would earn if the full benefits of the transaction were internalized. To state it differently, producers
of education are not fully compensated for the benefits that spill over to society. As a result, producers of education will likely under produce education. Come up with an additional example of a positive externality Encouraging Positive Externalities Government can play a role in encouraging positive externalities by providing subsidies for goods or services that generate spillover benefits. A government subsidy is a payment that effectively lowers the cost of producing a given good or service. Such subsidies provide an incentive for firms to increase the production of goods that provide positive externalities. And, because the spillover benefits go to society, government subsidies are a way for society to share in the cost of generating positive externalities. After all, society pays the taxes that fund the subsidies. Regarding education, because the government subsidizes public education, a greater quantity of education is produced and consumed and society reaps the spillover benefits. How can governments encourage positive externalities? Which One Is It? An externality is determined positive or negative based on whether costs or benefits spill over. Imagine this scenario: Your neighbor buys a dog, feeds the dog, and pays all of the expenses to care for the dog. In other words, your neighbor is bearing the explicit costs of dog ownership. Your neighbor also receives benefits from the dog, such as companionship and home security. But, what if the dog spends most of the night barking outside of your bedroom window, depriving you of valuable sleep? In this case, you would be bearing some of the costs of your neighbor's dog ownership-and that would be a negative externality for you. You could call your neighbor and try to reach an agreement. But, if that weren't successful, you might call the police, who may fine your neighbor. You could think of that as a type of corrective tax. On the other hand, let's assume your neighbor's dog doesn't keep you awake at night. Instead, Fido is perfectly quiet and only barks when suspicious looking strangers come
near your homes. Now the dog is providing you with the benefit of home security without you having to share in the cost of the dog-you receive a positive externality. You might choose to "subsidize" Fido by taking care of the dog when your neighbor is away or by giving the dog a treat from time to time. To summarize, the costs and benefits of transactions for goods and services are often contained between the producers and consumers, but sometimes costs and benefits spill over to third parties. A negative externality exists when a cost spills over to a third party. A positive externality exists when a benefit spills over to a third-party. Government can discourage negative externalities by taxing goods and services that generate spillover costs. Government can encourage positive externalities by subsidizing goods and services that generate spillover benefits. Overall, explain how externalities represent market failures. Be sure to show that you understand the definition of a market failure.
Market Failures, Taxes and Subsidies: Crash Course Economics #21
Jacob: I’m Jacob Clifford
Adriene: and I’m Adriene Hill and welcome to Crash Course Economics.
Jacob: In the last few videos we’ve said a lot of nice things about how competitive markets allocate resources. You know,
they do a pretty good job.
Adriene: But nobody’s perfect. Sometimes markets get it wrong. Sometimes they fail. Sometimes the byproducts of
production make people sick. Today we are going to talk about those market failures, and how economists address them.
[Theme Music] In 2105, a story made the rounds online about a University of Maryland professor and an extra credit
question: "Select whether you want 2 points or 6 points added onto your final paper grade. But there’s a small catch...if
more than 10% of the class selects 6 points, then no one gets any points." So, what would you do? The question alludes
to one of the biggest problems with free markets: sometimes people have a personal incentive to do something that is
against the collective interests of the group. Obviously, everyone wants at least some extra credit, but there is also an
incentive to get even more points. In this situation, the professor reported that too many people chose 6 points and no
one got extra credit. Let's say that your local government sent a similar proposition to every household in your city,
“Select whether you want to pay $20 or $100 to fund the local fire department, but there’s a small catch: if more than
50% of citizens choose $20 there's not going to be enough money to have a fire department.” This is the free rider
problem. Free riders are people who benefit without paying. They are not necessarily evil, let’s face it, you probably know
someone that's illegally downloaded Game of Thrones, but they're responding to incentives -- why pay more, if I can get it
for less? If too many people think like this, then we're all worse off and we're going to end up not getting the things we
want like fire protection or a satisfying ending to Game of Thrones. So how do most cities get around the problem that
some people will benefit even if they don’t pay. The city doesn’t ask for money, they demand money in the form of taxes.
The reasoning is that fire protection is so essential that people shouldn’t be allowed to opt out.
Jacob: So things that are for our collective well being, like fire protection, schools, and national defense are often funded
by the government. When markets alone fail to provide enough of these things, that's called market failures. These are
often called public goods, but the technical definition of a public good is anything that has two characteristics:
non-exclusion and non-rivalry. Non-exclusion is the idea that you can't exclude people that don’t pay. For example, it's
impossible to limit the benefits of national defense to only people that pay their taxes. People who pay no federal taxes
still get the benefit of protection from bombs, and people who pay a lot of federal taxes don’t get extra protection.
Non-rivalry is the idea that one person’s consumption of the good doesn’t ruin it for other people. So, public parks are a
great example. You can use it today, I can use it tomorrow; it can be shared. Ideally. If a good or service meets these two
criteria it's unlikely that private firms will produce it, no matter how essential it is. Street lights and organizations that
track and prevent the spread of diseases are pretty important, and if the government doesn’t step in, we probably won’t
get them.
Adriene: The incentive to do what's best for you, rather than what's best for everyone is the root cause of something
economists call the Tragedy of the Commons. This is the idea that common goods that everyone has access to are often
misused and exploited. It explains the cause of most of our environmental problems like air pollution, deforestation, the
killing of endangered species, and overfishing. In many places in the world, there are more fish being pulled out of rivers,
lakes, and oceans than are being born. This is not just bad for the fish; it’s bad for the people doing the fishing. As these
resources are depleted, fishermen find themselves without a job. So why aren’t they conserving? Allowing fish to
reproduce and generate more resources in the future? Well, look at the incentives. If a few environmentally conscious
fishermen decide to give the fish time to spawn, then some other fisherman will harvest them instead. If you can’t
prevent other people from exploiting the resource, then you have an incentive to exploit it yourself and take as much as
you can, as quickly as you can. But, with everyone following that logic, the finite resource gets pillaged. The tragedy of
the commons explains why fish stocks get depleted, the rainforest get cut down, and why endangered species get hunted
for their hides or horns. There is an entire subfield of economics focused on address and solving these issues, it is called
environmental economics.
Jacob: The problem here is that unregulated markets sometimes don’t produce the outcome that society wants.
Remember, sometimes markets misallocate resources because they don't have the right price signals. There is no better
example of this than what economists call externalities. Externalities are situations when there's an external costs or
external benefits that accrue to other people or society as a whole. When other people are made worse off that's called a
negative externality. When other people are made better off that is called a positive externality. Let’s go to the Thought
Bubble. Let’s look at a TV factory that pollutes a river with toxic chemicals. This is definitely a negative externality. The
factory has internal costs: it has to pay its workers, buy raw materials, pay for energy; and it uses those costs to determine
how many TVs to produce. But there are also external costs associated with polluting the waterways, like dead fish,
contaminated drinking water, and people getting sick. Those external costs are paid by people downstream, and they are
likely to be ignored by the factory owner. The free market assumes that all the costs associated with producing TVs are
accounted for within the price of those TVs, but, in this case, the market is wrong. The end result is a market failure
because the factory is producing too many TVs. As for positive externalities. Think about education. More education is
great for you. You'll likely generate more income and it makes you more interesting to talk to at parties. But there are also
external benefits of your education. Everyone is actually better off. With more education you're more likely be a positive
and productive member of society. And if you earn a higher income, that means more tax revenue. Now in both cases,
negative and positive externalities, economists often look to the government to step in and solve the problem. For
example, the government could tax the TV factory or subsidize education. In fact, externalities are the justification for
almost everything the government does. When politicians, tax cigarettes, fund education, subsidize fuel efficient cars, or
regulate financial markets, it's because they are convinced that free markets alone are not adjusting for externalities.
Adriene: Thanks Thought Bubble. We’ve tried to explain the problem of externalities, now let’s talk about the solutions.
When the government tries to fix externalities they can use regulatory policies or market-based policies. Regulatory
policies are simply rules established by government decree. Some people complain about regulation. They say, “the
government can’t tell me what to do.” But let's be honest, it can. The government also spends a ton of time and money
telling you what you can’t do. Don’t drive too fast. Don’t build a house in Yellowstone. Don’t kill anybody. It seems like
the government probably should regulate some stuff. The question is, “how much should they regulate?” Even people
who adamantly oppose government regulation probably agree that nuclear weapons and nerve gas shouldn't be on the
shelves at Target. Let’s go back to the TV factory example. To help solve the pollution externality, the government could
ban the use of certain types of chemicals or set a production quota to limit the production of TVs or regulate what can be
dumped in the river. In the US, the Environmental Protection Agency (EPA) has pushed for laws to control pollution, and
these regulations have worked. Regulation can also create positive externalities. In some cases, the external benefits are
perceived to be so high that the government essentially takes over the market. Consider education. Most countries have
compulsory education which requires citizens to be educated up to a specific age and the government pays for schools
through taxes. If the government didn’t get involved, all education would be provided by private schools that would
charge tuition; there might not be enough affordable schools to educate young people. The government funds education
because they think that the external benefits, like literate, well-informed, erudite citizens, are so high it's worth forcing
everyone to pay.
Jacob: Another way that governments try to solve externalities is with market-based policies. These are policies designed
to manipulate markets, prices, and incentives to correct for market failures. The best examples are taxes and subsidies. A
tax on the production of TVs or on the chemicals the factory is using will decrease production and limit pollution. Federal
grants that help subsidize college education will increase the amount of education people buy. In general, economists
tend to prefer market-based policies. Take cigarettes. Cigarettes generate high external costs on society. There's second
hand smoke and there's higher healthcare costs for everyone, due to smoking related illnesses. The government could
force cigarettes companies to produce less, or just shut them down entirely, but instead they tax cigarettes. The tax drives
up the price, consumers buy fewer cigarettes, and this addresses the negative externality. Now, this market-based
approach has one key advantage over the regulatory approach. Instead of spending money on enforcing regulations, the
government is earning tax revenue that can be used for purposes. In real life, though, governments often use both
policies. In the US, the government taxes cigarette producers and regulates where people can smoke. It also restricts how
tobacco companies can advertise, and supports anti-smoking campaigns designed to convince people to quit smoking.
Seriously, you should stop smoking. Market-based approaches to reduce negative externalities are also used to fight
climate change. Many economists argue that taxes on carbon-based fuels like coal, oil, and gas are a more effective way
to deal with air pollution.
Adriene: One oft-discussed market-based policy is emissions trading or “cap and trade.” The government issues pollution
permits and if your factory doesn’t hold one of those permits, it can’t pollute. But companies can buy or sell those
permits. This sets up incentives to go green: if you can produce without pollution, you can make money by selling your
permits. But if you operate a dirty plant, you have to pay for those extra permits. As controversial as cap and trade can be
among American politicians, it’s interesting to note that it's already been used successfully in the US. A cap and trade
program to reduce acid rain pollution -- it worked! It cut sulfur dioxide emissions. According to a 2003 report from the
Office of Management and Budget, “the Acid Rain Program accounted for the largest quantified human health benefits of
any major federal regulatory program implemented in the last 10 years, with benefits exceeding costs by more than 40:1.”
Remember that extra credit question? What if the world’s largest economies were given a similar proposition: “Select
whether you want to decrease your pollution by 5% or 30%, with a small catch; if more than 50% of counties choose only
5% then climate change will make Earth unlivable." That simplifies the issue, but it does illustrate why it's so hard to
address climate change. Individual countries might work to reduce carbon dioxide emissions, but they can’t prevent other
countries from polluting. It’s the Tragedy of the Commons. In an unregulated global economy, where producers want to
make products as cheaply as possible, there's an incentive to ignore international environment to get ahead. Global issues
like climate change, human rights abuses, and nuclear proliferation can't be effectively addressed if countries don’t work
together. But that requires a lot of trust and a lot of commitment.
Jacob: So markets aren't perfect. There are many cases when the government should get involved, and there's even some
situations when the government should just take control. Adriene: The question isn’t “which is better: free markets or
government?” The question is “how can they work together to make our lives better?” Thanks for watching, we’ll see
you next week. Crash Course Economics is made with the help of all these fine people. You can support Crash Course at
Patreon, a voluntary subscription service where your support helps keep Crash Course free for everyone, forever. And you
get great rewards. Thanks for watching, and DFTBA!
Crash Course Market Failure - Viewing Guide Directions: Answer questions using the crash course transcript. 1. What did a University of Maryland professor ask about an extra credit question? 2. What would you do in this situation? 3. How does the above question allude to one of the biggest problems with free markets? 4. What did the University of Maryland professor report? 5. How can the University of Maryland “experiment” apply to your local government? 6. What are free riders? 7. How do most cities get around the free rider problem? What is the reasoning? 8. What is market failure? 9. What is the technical definition of a public good? Explain. 10. What is the Tragedy of the Commons? 11. What does the Tragedy of the Commons explain? 12. What is environmental economics?
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13. What are externalities? 14. What is a negative externality? Provide an example. 15. What is a positive externality? Provide an example. 16. What are two things the government can use to fix externalities? 17. What are regulatory policies? How can the government use regulatory policies in the TV factory example? 18. How can regulation create positive externalities? 19. What are market-based policies? How can the government use market-based policies in the TV factory example? 20. Do economists tend to prefer regulatory policies or market-based policies? 21. What is one key advantage market-based policies have over regulatory policies? 22. How are market-based approaches being used to fight climate change? 23. What is “cap and trade”? 24. When did a cap and trade program work?
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Directions at bottom of article.
U.S. Jobless Claims Soar to Once-Unthinkable Record 6.65 Million By Katia Dmitrieva Source: Bloomburg April 2, 2020, 5:32 AM PDT Updated on April 2, 2020, 9:50 AM PDT
● Filings totaled 10 million in two weeks, spanning industries
● Jobless rate of 20% ‘not unthinkable’ as shutdowns multiple
The number of Americans applying for unemployment benefits soared to a record 6.65 million last
week, a level unimaginable just a month ago.
As states shut down commerce to prevent the deadly coronavirus from spreading, the weekly claims
data have been among the first detailed figures to show the devastating economic hit, highlighting the
extent to which U.S. businesses and workers are reeling from the global health crisis.
The figures also may add to pressure on the federal government to ensure that aid payments and
loans under the $2 trillion stimulus package flow quickly to people and businesses.
“I never thought I’d see such a print in my lifetime as economist,” said Thomas Costerg at Pictet
Wealth Management, who had the highest forecast in the Bloomberg survey, at 6.5 million. Claims are
likely to stay elevated as more states announce stay-at-home orders, and it would be “not
unthinkable” to see a 20% unemployment rate, more than double the high that followed the last
