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Topic 8: Market v. StateAgenda, Friday 3rd December 2010
A: Alternative Mechanisms for Allocation of (Society’s) Resources
B: Market and Market Failures
C: Private Solutions v. Public Solutions
D: State Failures
E: Market (Failures) v. State (Failures)
A: Alternative Mechanisms for Allocation of
(Society’s) Resources
Alternative Mechanisms
Market (or more realistically Regulated Market), e.g. restaurant meals, mobile phone, …
Command System, e.g. North Korea, within organisations, …
Majority Rule, e.g. voting on alternative tax-and-spend menus, committees, …
Contest, e.g. CAO points, Oscars, mobile telephony licence, beauty contest, …
Alternative Mechanisms
First-Come, First-Served, e.g. tickets (Take That, All-Ireland, Rugby v. NZ, …
Sharing (Equally?), e.g. votes, air, water, household waste collection?, health?, education?, …
Lottery, e.g. raffle, Medicine TCD = 575*, selling a house?, …
Personal Characteristics, e.g. beauty contest, finding partner(s), discrimination, …
Force, e.g. theft, “taxation Is theft”?, …
B: Market and Market Failures
Market: Welfare Theorems
First Fundamental Theorem of Welfare Economics
Second Fundamental Theorem of Welfare Economics
First Welfare Theorem (Efficiency)
Perfect Competition D = SMB (= P) & S = SMC (= PMC =
MC) P = MC (Allocative Efficiency) Perfect Competition + Market →
Pareto Efficiency
Market Equilibrium: Consumer Surplus and Producer Surplus
Price
Equilibriumprice
0 QuantityEquilibriumquantity
A
Supply
C
BDemand
D
Producersurplus
Consumersurplus
E
Second Welfare Theorem (Equity)
Perfect Competition + Lump-Sum Taxes and Subsidies + Market → Any Specific Pareto Efficiency
Perfect Competition + Lump-Sum Taxes and Subsidies + Market → Pareto Optimality
Second Welfare Theorem (Equity)
Existence of Lump Sum Taxes and/or Subsidies?
Lump-Sum → No Distortion (e.g. no distortionary wedges between buying and selling price introduced)
Poll Tax? Window Tax? … (State Pension, Invalidity Pension)
Second Welfare Theorem?
First Welfare Theorem (Efficiency)
Perfect Competition? D = SMB = P? & S = SMC = MC? P = MC? Second Best Theorem! Specific Market Failures:
Externalities, Public Goods, Informational Problems, Market Power, Equity? Distribution?
Externalities
Non-priced by-products Negative Production (e.g. pollution) Positive Production (e.g. orchards
and honey-producing bees) Negative Consumption (e.g. passive
smoking) Positive Consumption (e.g. vaccines
such as flu, MMR?)
Public Goods
Non-rivalry in consumption Non-exclusion in consumption Examples: defence, lighthouse?, … Pure v. Impure Public Goods Public Goods ≈ Positive Externalities
Informational Problems
Adverse Selection (“hidden information”, e.g. second-hand car market is incomplete)
Moral Hazard (“hidden action”, e.g. insurance markets are incomplete)
Principal Agency (different interests → conflict of interests, e.g. shareholders v. board v. managers v. workers, “life”!)
Market Power
Seller: Monopoly, Oligopoly Buyer: Monopsony (→ buy too little)
C: Private Solutions v Public Solutions
Private Solutions
Coase Theorem
Property Rights (State = “Night Watchman” role)
Transactions Costs Negotiations
Efficiency! (Distributional considerations remain)
Public Solutions
State Provision Nationalisation Command & Control Regulation (“exercise of control by a
public agency over economic and social activities”)
Public & Private Solutions
State & Market-Based Solutions (e.g. Tax, Subsidy, Pollution Permits)
State Ownership/Provision facilitated by market mechanisms (e.g. road building, hospital building, … )
Public-Private Partnerships (PPPs)
D: State Failures
Role of State: Public Interest/Finance Perspective
Benevolent Social Planner/Dictator
Examples Stabilization Policy Optimal Taxation
Role of State: Private Interest Perspective
Public Choice (Economic Theory of Regulation)
Politicians (& Self Interest) Bureaucrats (& Self Interest) Regulators, e.g. regulatory capture
Interest Group Perspective Force of Ideas Perspective
E: Market (& Failures) v. State (& Failures)
Examples
Efficiency-Equity Trade-Off
Arthur Okun’s Leaky-Bucket? Equity: Equality of Opportunity v.
Equality of Outcome