Unit 8. Market Failures

IES Lluís de Requesens (Molins de Rei)Batxillerat SocialEconomics (CLIL) – Innovació en Llengües EstrangeresJordi Franch Parella

Market Failures- It is claimed that markets fail sometimes and that the government can correct the failure:1) Externalities2) Public Goods3) Monopolies4) Inequality5) Crises1), 2) and 3) refer to a misallocation of resources.4) refers to an unqual distribution of resources5) refers to a lack of stabilization

Externalities

Externalities are effects on others not contemplated within the price

With a negative externality the social cost is greater than the private cost and the market overproduces (pollution)

With a positive externality the social benefit is bigger than the private benefit and the market underproduces

Externalities exist because of a lack of clear property rights

Public Goods

Public goods are non excludable (consumers cannot be prevented from consuming) and non diminishable (the consumption of A does not reduce the consumption of B)

Public goods suffer from the free rider problem and are usually provided by the public sector and not the private sector

Inequality

What should the government do about economic inequality? Economic analysis alone cannot give us the

answer The question is a normative one and not

positive The richest fifth of the families earns

about ten times as much as the poorest fifth

Policies to help the poor include: welfare, subsidies and in-kind transfers, minimum wages

Inequality

According to Utilitarianism (Jeremy Bentham and John Stuart Mill), the government should choose policies to maximize total utility of everyone Utilitarians would choose the distribution of

income to maximize the sum the utility of every one in the society (an additional € for the poor involves more utility than an additional € for the rich)

Inequality

According to social-democracy (John Rawls), the government should choose policies deemed to be just (evaluated by an impartial observer behind the “veil of ignorance”) Public policy based on the maximin criterion

(to maximize the utility of the worst-off person in society)

This idea considers the redistribution of income as a form of social insurance

Inequality

According to libertarianism (Murray Rothbard), the government should preserve private property, enforce voluntary agreements and punish crime, but should not redistribute income

Libertarians argue that equality of opportunity is much more important than equality of income (formal equality but not material equality)

Crises

The world is suffering now a global crisis. Is the free market to blame? Or are the Central Banks and the policymakers to blame?

Interest rates are artificially low, but saving is not high. What are the effects?

The creation of money out of thin air is increasing. What are the effects?

Commercial and saving banks have increased the credit without the backing of saving. What are the effects?

Crisis- Housing Bubble: Who is to blame?- Creation of money: Who is to blame?