ECO 101 Ch.9 Governing the Market

8/13/2019 ECO 101 Ch.9 Governing the Market

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Ch.9 Governing the marketDr.Agim Mamuti


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The McGraw-Hill Companies, 2009

Governing the market

By the end of this section, you should understand:

Horizontal equity and vertical equity

EfficiencyExternalities and public goods

Moral hazard and adverse selection

Direct and indirect taxes

Competition policy


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Equity and efficiency

Equity is where income is distributed in a

way that is considered to be fair or just.

Economic efficiency is thus achieved when

each good is produced at the minimum cost

and where individual people and firms get

the maximum benefit from their resources.


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Horizontal and vertical equity

Horizontal equityis the identical treatment

of identical people.

Vertical equityis the different treatment of

different people in order to reduce the

consequences of these innate differences.


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Vilfredo Paretos definition of

efficiency

For given tastes, inputs and technology, an

allocation is efficient if no one can then be

made better off without making at least one

other person worse off


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Market failure

Market failure (or a distortion in the market)

exists if societys marginal cost of making a

good/service does not equal societys

marginal benefit from consuming that

good/service


7/13 The McGraw-Hill Companies, 2009

Market failure (contd)

There are four principal sources of market

failure:

Taxation

Imperfect competition

Externalities

Other missing markets



Externalities

Costs or benefits of production or consumption experiencedby society but not by the producers or consumers themselves.

Sometimes referred to as spillover or third-party costs or

benefits.

When people use their cars, other people suffer from their

exhaust, the added congestion, the noise, etc. These

negative externalities make the marginal social benefit of

using cars less than the marginal private benefit (i.e.

marginal utility).

There is a category of goods where the positive

externalities are so great. They are calledpublic goods.

Examples include public lights, public services such as the

police and army, etc.



Free rider problem

A free rider arises when no one is willing to

contribute to the cause!

A free rider knowing he/she cannot be

excluded from consuming a good/service,

has no incentive to buy it



Other missing markets

Information is not always free to acquire!

People often know more about their ownbehaviour than others can easily find.

Fear that people will exploit thisinformational advantage may then preventmarkets from developing.

This can lead to:

Moral hazardexploits inside information to take advantage of theother party to the contract

Adverse selectionuse of inside information to accept or reject acontract. Those accepting are no longer an average sample of the

population



How to tax fairly

In taking proportionately more from the rich than from

the poor, income tax reflects the principle of ability to

pay based on vertical equity.

Taxationcan either been seen as:

Progressive tax. A tax whose average rate with respect to

income rises as income rises.

Regressive tax. A tax whose average rate with respect toincome falls as income rises.

Proportional tax.A tax whose average rate with respect to

income stays the same as income rises.



Competition policy

Competition policy tries to promoteefficiency through competition between

firms.

Competition Commission examines whethera monopoly, or potential monopoly, is

against the public interest.



Merger policy

Competition policy also scrutinizes the formation of

large new companies.

A mergeris the union of two companies wherethey think they will do better by amalgamating.

Mergers can be: Horizontal Vertical

Conglomerate

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ECO 101 Ch.9 Governing the Market