MARKET FAILURE AND

GOVERNMENT FAILURE

MARKET FAILURE

1.	Market power. The possession of substantial market power by a single, or small group of market participants, creates conditions under which prices deviate from marginal costs, an allocatively inefficient outcome. Similarly we might encounter market power in the supply of labor, through unionization, implying that the price of labor will differ from the value of its marginal product.

2.	Lack of information. Any inability of relevant market participants to access relevant information at reasonable cost prevents them from acting in an economically rational fashion.

3.	Public goods. Goods that are non-rival in consumption and for which the marginal cost of supply is zero will not be produced in efficient quantities by a private market.

4.	Externalities. Outcomes based on private costs and private benefits, are inefficient when social costs and social benefits are economically significant.

MARKET POWER

.

Natural Monopoly

Anti-Trust Policy

four firm concentration ratio,

Herfindahl Hirschman index

Labor Unions

LACK OF INFORMATION

PUBLIC GOODS

Excludability

free rider problem

Diminishability

.

EXTERNALITIES

Government regulatory activity to counter pollution can be of several kinds:

•	it can ban the polluting process entirely;

•	it can establish minimum compliance standards for the manufacturer to meet;

•	it can offer subsidies to the manufacturer to reduce pollution;

•	it can charge the manufacturer a fee per unit of pollution emitted.

GOVERNMENT FAILURE

Great nations are never impoverished by private, though they sometimes are by public, prodigality and misconduct. The whole, or almost the whole, public revenue is in most countries employed in maintaining unproductive hands. Such are the people who compose a numerous and splendid court, a great ecclesiastical establishment, great fleets and armies, who in time of peace produce nothing, and in time of war acquire nothing which can compensate the expense of maintaining them, even while the war lasts. Such people, as they themselves produce nothing, are all maintained by the produce of other men's labor.

Sources of Government Failure

We turn now to look at some of the specific sources of government failure.

Availability of information

The Capture of Regulators

Collective Action

Rent-seeking Behavior

Pork-barreling

Agency Inertia

Dead-Weight Loss and Taxes

GOVERNMENT AND REDISTRIBUTION

A large part of government spending, particularly in industrialized countries, consists of redistributive expenditures.

transfer payments

in-kind

In the cross-section of countries of Western Europe and the United States subsidized housing and social security payments taken together represent between 38% and 60% of total government expenditure.

SOURCES OR VARIATION OF INCOME

1.	Natural talent and ability. Ability is not equally distributed at birth. Some people have characteristics (intelligence, strength, stature) that are going to be more productive and therefore more rewarded than others.

2.	Acquired skills. The earning power of congenital characteristics is qualified by the skills and experience acquired during education and working life. Economists generally regard this as the accumulation of human capital (investment in oneself) made by education and foregone earnings.

3.	Effort. Inasmuch as effort is a determinant of productivity it should have an effect on earnings. Employers should hire the hard-worker and pay him more than a time-server. The ability to do this is conditioned on the ability of employers to pay different rates for the same job description, which is often organizationally difficult, or in some cases legally prohibited.

4.	Inherited wealth. In almost all of the countries for which we have good statistics, wealth is distributed less equally than income. Much of this is due to inheritance whereby blocs of wealth, represented by productive physical and financial assets, are passed from generation to generation. It is also important to note that human capital and inherited wealth are highly correlated. More affluent parents are more able to invest in the human capital of their offspring.

5.	Accumulated savings. Not all physical and financial assets are inherited. One's stock of productive assets is also a function of savings and consumption decisions made over a lifetime. The more one foregoes in one time period the greater will be the capital to be consumed in a later one.

6.	Related supply and demand considerations. Finally income has a lot to do with factors over which we have little control. The value of a worker's marginal product, for example, is a function of the supply and demand, and therefore the price, of the product that he makes. Consider a coal miner. His income would rise should the world oil supply be restricted, but it might fall were a technology for cheap solar energy devised.

Justifications for Redistributive Policy

What then are the cases that might be made for government intervention to amend or correct the income distribution determined by the market? Some of the most familiar are discussed below.

Utilitarianism

Altruism

Social contract

The Increase of Social Productivity

Social Control

Shared Growth

The Democratic Process

Conclusion

QUESTIONS FOR DISCUSSION

1. Evaluate the arguments for and against the use of government power to curb monopolies.

2. How has the need to regulate "natural monopolies" changed in recent years?

3. Why are concentration ratios not thought of as good indices of the level of industry-wide competition? What may be a better approach?

4. How does lack of information impede the operation of a market system? How can a government act to correct this?

5. Define public goods. Are pure public goods an important category? Give some examples. Is information a pure public good.

6. Why may government action be required to correct externality problems like pollution? Which type of system, planned or market, would you expect to lead to most pollution?

7. Why is the government not a "benevolent, cost social guardian?"

8. Give some reasons why redistribution via both cash and in-kind is the fastest growing governmental activity.