microeconomics ch 4

8/12/2019 Microeconomics Ch 4

1/36

M i c r o e c o n o m i c

s

Dr. Karim Kobeissi


2/36

Chapter 4: The Role of Government


3/36

Intervene?

The free market is not always able to achieveallocative eciency !ccor"in#ly$ we have a MarketFailure

!n allocative ecient point is where

All resources are allocated to their most efcient use

!ll markets are in e%&ilibri&m

The economy is operating on its production possibility curve.

It is not possible to make someone better o' witho&t makin# someoneelse worse o' ()ociety*s well bein# is ma+imise",

This sit&ation is also calle" Pareto efciency

Market ailure provides governments ith the

reason to intervene in the economy or in


4/36

)ociety*s Goal

To pro"&ce an optimalmi+ of o&tp&t

-ptimal mi+ ofo&tp&t: the most"esirable combinationof o&tp&t attainable&sin# e+istin#

reso&rces$ technolo#y$an" social val&es


5/36

.arket /ail&re

)ociety wants thecombination atpoint 0

The marketmechanism wo&l"lea" &s to point .

Market ailure!an

imperfection in themarket mechanismthat preventsoptimal o&tcomes


6/36

.arket /ail&re

.arket /ail&re can occ&r from any of thefollowin#:

Market Poer

"ne#uity in "ncome Distribution

$%ternalities

Public &oods


7/36

.arket 1ower

Market poer! ! company2s abilityto manip&late price by in3&encin# anitem2s s&pply$ "eman" or bothTh&s$ the rm can restrict s&pply in

or"er to ma+imi5e prots rather thanpro"&ce society*s "esire" mi+ of o&tp&t

Government role: Restrict market power

1romote more competition


8/36

. a r k e t 1 o w e rPrice

Quantity/time

P2

P1

Q1

D

S1(competitive supply)

Q2

S2(restricted supply)


9/36

Income Ine%&ity

Income Ine%&ity:The #ap between in"ivi"&als or ho&sehol"s makin# most of the

income in a #iven co&ntry an" those makin# very little

Government re"istrib&tes income &sin#:

! pro#ressive income ta+ system Collect ta+es from income earners at a pro#ressive ta+ rate

Transfer payments 1rovi"e payments to in"ivi"&als for which no c&rrent #oo"s

an" services are e+chan#e"

1rovi"es a minim&m amo&nt of merit #oo"s Merit good! Goo"s or services (s&ch as e"&cation an"

vaccination, provi"e" free for the benet of the entire societyby a #overnment$ beca&se they wo&l" be &n"er6provi"e" ifleft to the market forces or private enterprise


10/36

7+ternalities 8 )pillovers

$%ternalities !n e+ternality is an e'ect of a p&rchase or

&se "ecision by one set of parties on otherswho "i" not have a choice an" whose

interests were not taken into acco&ntThe "i'erence between the social an"

private costs (benets, of a market activity

When e+ternalities are present$ market

prices are not a vali" meas&re of a#oo"*s val&e to society


11/36

Correctin# for 7+ternalities

1ositive 7+ternality Thir" parties benet

beca&se of a markettransaction

9ot enoh is pro"&ce"

an" sol" at price pbeca&se society*sbenets are #reater thanmarket benets

Government steps in to#enerate benets for

society Government action

ca&ses more to bepro"&ce" by s&bsi"i5in#pro"&ction or p&rchase

1ro"&ct is sol" at pricep;

1rice ofvaccines


12/36


9e#ative 7+ternality Thir" parties are h&rt


Too m&ch is pro"&ce" an"sol" at price p beca&se

society*s costs are #reaterthanmarket costs

Government steps in toshift costs from society tothe pro"&cer an" the b&yer

'ising costs cause the

supply curve to shitlet.

Government action ca&sesless to be pro"&ce" an"sol" at a hi#her price p=

7+ample: poll&tion

1rice ofpoll&tin# #oo"


13/36


9e#ative 7+ternality Thir" parties s&'er


Too m&ch is pro"&ce"

an" sol" at price p=beca&se society*sbenets are less thanmarket benets

Government steps intore"&ce benets for

market Government action

ca&ses less to bepro"&ce" by restrictin#pro"&ction or

purchase 7+ample: ci#arette

1rice


14/36

)&mmary: 7+ternalities

1ositive e+ternality )ociety*s benet > market benet

The market &n"erpro"&ces

The #overnment s&bsi"i5es

9e#ative e+ternality )ociety*s benet market benet$ or

)ociety*s cost > market cost

The market overpro"&ces

The #overnment restricts cons&mption orpro"&ction


15/36


16/36

1&blic Goo"s

Private good! a #oo" or servicewhose cons&mption by one person

e+cl&"es cons&mption by others ! b&r#er

Public good! a #oo" or servicewhose cons&mption by one person"oes not e+cl&"e cons&mption byothers ! p&blic hi#hway


17/36

1&blic Goo"s

The ree(rider dilemma!The free ri"er problem refers to a sit&ation where some

in"ivi"&als in a pop&lation either cons&me more thantheir fair share of a common reso&rce$ or pay less than

their fair share of the cost of a common reso&rce Free rider!

! commonly &se" e+ample of the economic notion ofthe free ri"er problem is fo&n" in national "efense !ll

citi5ens of a co&ntry benet from bein# "efen"e"@however$ in"ivi"&als who eva"e ta+es (free ri"ers, arestill protecte" by the same public resource ofnational "efense$ even thoh they "i" not pay for

their fair share of the reso&rce


18/36


19/36

.acro Instability

The #oal of macro intervention is to fostereconomic #rowth an" to move towar"s amore allocatively ecient position

.ove o&t of ineciency an"8or p&sh the 11C

o&twar" Re"&ce &nemployment

!voi" in3ation )table prices

Increase o&r capacity to pro"&ce 7conomic #rowth

Government &ses macroeconomic policiesin an attempt to meet these #oals


20/36

Growth of Government

When society perceives a problem$ itlooks to #overnment to B+ the problem$

which provi"es E&stication for#overnment intervention in the economy

!s a res&lt$ #overnment has #rown overthe last cent&ry:

-ver F times more employees since FF

! b&"#et H$FFF times lar#er since FF


21/36

Growth of Government


22/36

Government /inances

7ach level of #overnment (fe"eral$ state$an" local, creates a b&"#et of f&n" in3owsan" o&t3ows

In3ows (so&rces of f&n"s, Ta+es (an" fees8&ser char#es,

orrowin#

-&t3ows (&ses of f&n"s, 1&rchases of #oo"s an" services 1ayments for reso&rces &se"

Transfer payments


23/36

)o&rces of Government Growth

.ost of the #rowth is "&e to

transfer payments$ "efense

spen"in#$ an" health pro#rams


24/36

Ta+ation

Ta+es pay for #overnment spen"in#

There is a chan#e in the o&tp&t mi+ as

more #overnment spen"in# absorbs factorsof pro"&ction that co&l" be &se" to pro"&cecons&mer #oo"s

The opportunity cost o ta%ation is

meas&re" by the private6sector o&tp&tsacrice" when #overnment employsscarce factors of pro"&ction


25/36

Ta+ation

The primary f&nction of ta+es is totransfer comman" over reso&rces

(p&rchasin# power, from the privatesector to the p&blic sector


26/36

/e"eral Ta+es


27/36

Income Ta+

Income ta+es: the lar#est sin#leso&rce of #overnment reven&e

It is a pro#ressive ta+ system !s income rises$ the ta+ rate also rises

Compare" to those with lower incomes$

those with hi#her incomes: 1ay more ta+es

1ay a #reater fraction of their income inta+es


28/36

)ocial )ec&rity Ta+

It is a re#ressive ta+ system !s income rises$ the ta+ rate falls

Compare" to those with lower incomes$those with hi#her incomes: 1ay more ta+es

&t pay a smaller fraction of their income in

ta+es


29/36

-ther Ta+es

Corporate ta+es

Js&ally passe" on to the c&stomer in hi#herprices

It is a pro#ressive ta+ system to thecorporation

7+cise ta+es

Impose" on a specic #oo" or service

)ome are impose" to "isco&ra#e pro"&ctionan" cons&mption of these #oo"s


30/36

-ther Ta+es

1roperty ta+ ! maEor so&rce of local ta+es

It is a re#ressive ta+$ since poorer people "evotea lar#er portion of their income to ho&sin# costs

)ales ta+ !nother maEor so&rce of local ta+es

It is also a re#ressive ta+$ since poorer peopleten" to spen" all of their income while richerpeople "o not


31/36

Government /ail&re

Governmentintervention sho&l"move the mi+ ofo&tp&t closer tosociety*s "esire"mi+

&overnmentailure! #overnmentintervention fails toimprove economico&tcomes an" mayworsen o&tcomes


32/36

1erceptions of Waste

1&blic perception is that the #overnmentisn*t pro"&cin# as many services as itco&l" with the reso&rces at its "isposal

This ineciency p&shes the economy insi"ethe 11C

! relate" %&estion is: are we #ivin# &ptoo many private6sector #oo"s in or"erto #et those p&blic services?

Is the opport&nity cost too hi#h?


33/36

Kal&ation of Costs an" enets

!""itional p&blic6sector activity is"esirable only if the benets from

that activity e+cee" its opport&nitycosts of ta+ation Low "o we i"entify the benets?

Low "o we en&merate the costs? Whose val&es sho&l" be &se" to "o this?

1 bli Ch i t C t ! l i


34/36

1&blic Choice: enet6Cost !nalysis

1rivate6sector enets an" costs

&s&ally accr&e to thesame person

.akes it easy tocompare the two an"make a "ecision

Government

enets an" costs &s&allyaccr&e to "i'erent #ro&ps

.akes it more "ic&lt forthe "ecision maker

1olitics enter into the"ecision

The "ecision maker mayhave no stake in theo&tcome

"n the governmentsector) the bene*ciaries

see only the bene*tsand the payers see onlythe costs. The decisionmaker may not seeeither.


35/36

What Does )ociety Want 1ro"&ce"?

Can either the market base" or the state6r&nsystem$ or a combination of the two$ pro"&cethe mi+ of o&tp&t "esire" by society in

#eneral? ! p&re market system will not pro"&ce a"e%&ate

%&antities of some #oo"s

! p&re #overnment system cannot "etermine themi+ of o&tp&t "esire" by b&yers an" sellers

+y trial and error) a combination o the tosystems may arrive at the optimal mi% ogoods produced


36/36

The 7conomy Tomorrow

Ri#ht6si5in# Government The optimal mi+ is 0 G$ G=$ G;$ an" G4

in"icate a wron#6si5e"#overnment$ "&e to poorbenet6cost analysis$politics$ an" b&rea&cracypower #rabs

Improvement is not likelyin the economy tomorrow

microeconomics ch 4

Documents