Microeconomics Unit 6 Market Failures and the Role of the Government

Unit 6: Market Failures and the Role of the Government Public Goods Why are public goods a market failure? Businesses in the free-market wonÕt provide public goods and service since they canÕt earn profit. If society wants them, the government needs to step in Two Characteristic of Public Goods: 1. Nonexclusion-Cannot exclude benefits of the good. Everyone can use the good, even those that donÕt pay. 2. Shared consumption-One personÕs consumption of a good does not reduce the usefulness to others. Maximizing Rule for Public GoodsPublic goods should be produced as long as the additional benefit to society is greater than the additional cost. Produce where MSB = MSC Negative Externalities Draw a negative externality. Label the free market quantity, optimal quantity, and deadweight loss Price Dead Weight MSC Loss S = MPC Externalities Negative ExternalityA situation that results in external costs on others causing the marginal social cost to be higher than the marginal private cost Positive ExternalityA situation that results in external benefits on others causing the marginal social benefit to be higher than the marginal private benefit Why are externalities a market failure? They cause markets to produce the wrong output Tragedy of the CommonsA lack of property rights causes individuals to uses resources in a way that is contrary to the benefits of society (example- overfishing) Positive Externalities Draw a positive externality. Label the free market quantity, optimal quantity, and deadweight loss Price S=MSC Dead Weight Loss Consumers ignore the social benefits and demand only their marginal private benefit (MPB) Firms ignore the social cost and produce at their marginal private cost (MPC) D=MSB QOptimal Q Free Market Quantity Correcting Externalities Solutions to solve a negative externalityPer unit tax Government regulation decreasing output Solutions to solve a positive externalityPer unit subsidy Government regulation that increases output How does Coase Theorem seek to solve negative externalities? Coase Theorem suggests that establishing property rights and allowing the parties involved to negotiate alternatives leads to a more efficient solution (Ex: businesses buy the right to pollute up to a set limit) D=MPB D=MSB Q Free Market QOptimal Quantity Regulating Monopolies Label a monopoly unregulated, socially optimal, and fair return A= Unregulated Price B= Fair Return C= Soc. Optimal A MC B ATC C MR D Quantity Income Inequality What are transfer payments? Draw and label the Lorenz Curve showing equal Government payments to individuals or distribution of income and the actual distribution businesses designed to meet a specific objective rather than pay for goods or resources. (Ex: Welfare) What is the Gini Coefficient? A statistical measurement of income equality where perfect equality is 0 and perfect inequality is 1. On the graph, it is Area A divided by the sum of areas A and B. What would happen to the Gini Coefficient if the government increased the amount it taxes wealthier citizens and increase transfer payments to the poor? The Gini coefficient would get smaller. Types of Taxes 1. Progressive Tax- takes a larger percent of income from high income groups (takes more percent from rich people). 2. Proportional Tax- takes the same percent of income from all income groups. 3. Regressive Tax- takes a larger percentage from low income groups (takes more percent from poor people). Income Distribution Practice 1. What is the difference between income inequality and wealth inequality? Income looks at how earnings are distributed and wealth inequality looks at how assets are distributed 2. An increase in job training for low-skilled workers would likely ___↓___ income inequality and cause the Gini coefficient to ↓ . Tax Incidence Label the amount consumers and producers pay of tax Price STax S P1 ConsumerÕs portion of tax P D ProducerÕs portion of tax Quantity Who pays more of the tax: 1. If demand is elastic and supply is inelastic? Producers 2. If demand is inelastic and supply is elastic? Consumers 3. If demand is perfectly inelastic? Consumers pay all