Microeconomics Chapter 13

Market Failure

A condition wherein private markets do not produce an economically efficient allocation of resources.

Private Good

A good and service that can be consumed by only one person at a time. It is also possible to exclude non-buyers from consuming the goods.

Public Good

A public good has two characteristics. First, it is difficult or impossible to exclude non-buyers from consuming the good. Second, consumers can consume a public good without interfering with others' consumption of the same good.

Common Resource

A resource that can be consumed by only one producer or consumer at a time and is found in environments in which it is difficult to exclude nonpaying users.

Explain why it is difficult for governments to solve the asteroid defense problem.

Asteroid defense is a global good in the sense that every country in the world would benefit from not having its citizens annihilated. But it suffers from the free rider problem: even countries that do not contribute to an asteroid defense system would be able to use it. Thus, it is hard to convince individual countries to pony up. You heard the congressman! Ask Russia to pay for it!

Explain why the efficient amount of production in a competitive market with external benefits is greater than the equilibrium market quantity.

Compare the marginal social benefits with the producer's marginal cost at the equilibrium market quantity. The benefits, derived from the marginal social benefit curve, are higher than the supplier's costs at that point, derived from the supply curve. The market should produce more of this good - and keep producing as long as the social benefit exceeds the cost. When that is no longer true, the market will be at the efficient quantity.

Social Benefit

External benefits plus private benefits.

Social Cost

External costs plus private costs.

Using concepts from the first part of this chapter, why might some cities buy trees and give them to residents to plant?

Homeowners who plant trees do not receive all the benefits of the increased numbers of trees. If there are external benefits, the city is justified in subsidizing or providing trees for less than their costs.

For a product with external costs, the social cost curve lies above the market supply curve. Explain why that is the case.

If one curve lies above another, then the marginal costs depicted in the higher curve exceed the marginal costs depicted in the lower curve at any given quantity of production. So in order to depict social costs that are in excess of the private costs incurred by the producer, the social cost curve must lie above the market supply curve.

If the marginal cost is zero, how much of a good should be produced? Or how many customers should be allowed or encouraged to consume the good? Why?

If there is no marginal cost of producing additional quantities, and if consumers derive any marginal benefit from the good at all, then the allocatively efficient quantity of production is "as much as possible" and as many consumers as possible should consume the good.

In Nashville, Tennessee it costs $68 per ton of trash if that trash is taken to the thermal energy plant and burned. It costs $31 per ton of trash to ship it to a nearby landfill and to dump it. Does it make sense to take any trash to the thermal energy plant?

It depends on the marginal benefits from each option. If burning trash produces usable energy, then the extra costs may be justified. Or if landfills are overcrowded and unsightly, it may be worth it to spend more money burning trash. Otherwise, it does not make sense.

Using the concepts we have used to determine that "optimal amount," describe the conditions under which no pollution should be allowed. In other words, when does it make sense to have zero pollution?

It may well make sense in some cases to have zero pollution. If the costs to consumers of each additional amount of pollution (i.e., the marginal benefits of pollution reduction) are greater than the costs of eliminating the pollution, and this is true at all levels of pollution, then the pollution should be eliminated - and we will be better off as a result.

Why are broadcast radio stations like public goods? How are private producers able to provide the stations and earn profits?

Once the radio signal is broadcast, it is difficult to prohibit anyone from receiving the signal. Consumers do not need to pay to consume these goods, and one person's consumption of broadcast radio does not affect any other person's ability to consume the same. The solution that traditional broadcast radio has used is to charge advertisers for time and to use those revenues to cover their costs.

Can you give some examples of situations in which markets may not be efficient?

One answer, based on Chapter 10, is a market with a monopoly supplier. You saw there that monopolists choose to sell a lower quantity than the allocatively efficient quantity. This chapter will highlight many other cases of market conditions that generate quantities other than the allocatively efficient quantity.

Given these facts, what do you think is likely to happen to Atlantic salmon off the coast of Maine if there are no regulations on fishing?

One possible outcome is if a profit-maximizing fishing fleet owned by a single company fishes the area. The fleet knows that it must be careful and manage its catch well, or the fish will soon disappear and the company will go out of business. The second scenario is one in which several smaller companies fish the area. The fleet has been growing and is beginning to catch more than 1,000 tons. Each fishing boat knows that if it does not catch its share, someone else will. In order to protect their current profits, each boat begins to expand its fishing. As they all do that, the salmon begin to disappear.

How can pollution be good? Or is that really what we mean?

Pollution is not necessarily good, but there may be positive amounts of pollution where the costs of getting rid of the pollution are greater than the damages done by the pollution. In those cases, the optimal (or perhaps "good") amount of pollution is a positive amount.

Can you think of examples of goods where excluding non-payers is difficult?

Public radio is a product rife with free riders—people who don't donate to the station, but listen to the programming anyway.

External Benefit

The benefits received by individuals other than the producer or consumer.

Make economic arguments in favor of government subsidies of farm products. Use the economic concepts we have discussed in this chapter.

The challenge here is to identify a market failure. If there is a legitimate economic role for government, it has to be because of external costs or benefits, a market with the characteristics of public goods markets, a common good market, a not-very-competitive market, lack of information and concerns with safety for consumers, or simply a goal of changing the income distribution that results from an otherwise normal market. In this case, the most often stated goals are to help the small farmer - perhaps an effort to redistribute income - and to preserve farming and rural communities as a way of life - perhaps an external benefit of farming. In reality, the programs stem from a dramatic shift in our economy away from agriculture to manufacturing and services. In that shift, millions lost jobs and livelihoods as they were forced to move to cities and new jobs. The subsidy programs are largely a result of the old effort to help make the transition easier. (In fact, the original motivation for farm subsidies was to provide income during the Great Depression.) And they still exist, in part because subsidy recipients are highly motivated to keep them in place and can afford to pay lobbyists and other influencers to make their case to lawmakers.

External Cost

The costs of producing a good or service that are borne by individuals other than the producer or consumer.

Marginal Social Benefit

The marginal benefit of consumption from society's point of view.

Marginal Social Cost

The marginal cost of production from society's point of view.

Fishing, as an industry, is in trouble around the world due to declining fish populations. Some countries are subsidizing their fishing industries in order to assist them. What do you think of that as a policy to aid fishermen?

ubsidizing fishing industries is exactly the wrong thing to do as it encourages more fishing, thereby worsening the fish population problem. The nature of the industry is such that fish are a common resource and production and consumption should be restricted, not encouraged.