market_failure(1) - Lecture 4 Market Failures Commerce 394...

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Lecture 4 Market Failures Commerce 394: Government and Business Keith Head Sauder School of Business September 22, 2015
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Summary of Lecture 3 Key Points Economists (and the educated public) understand that markets (private enterprise) are preferred to state-directed socialism for several reasons Countries with extreme socialist economic systems have performed poorly. Most have abandoned the system. Adam’s Smith “invisible hand” argument is deep and powerful. Economist have formalized this in the First Welfare Theorem. Deviations from competitive equilibrium lead to deadweight loss.
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Lecture 4: Learning Objectives After reading Brander 3.7–3.11 and attending this lecture, students should know how to Diagram the consequences of market interventions: price floors and ceilings, quotas identify examples of each of 4 types of market failure. explain why each type of market failure prevents Pareto efficiency.
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Policy interventions without market failure When the market is in a competitive equilibrium, government policies cause deadweight loss and Pareto inefficiency. We know this because the 1st Welfare theorem told us the competitive equilibrium was the Pareto efficient quantity. At this quantity, Q c , the sum of consumer and producer surplus is maximized. So when policies change the level of output produced and consumed away from Q c we call this a distortion . The result in almost every case is a triangle of deadweight loss: the gains to the winners from moving away from Q c are less than the losses imposed on the losers.
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Graphical exercises Diagram the following policies. Label DWL w/ an “L.” Show the competitive eqbm. price & quantity as P c & Q c . 1. A tax of $ t /unit. Show the seller and buyer’s price as P s and P b . Show Q s = S ( P s ) and Q b = D ( P b ). Label area of tax revenue as T tQ b . 2. Price floor of P > P c . Show quantity bought as Q b and quantity that firms would like to supply as Q s . 3. Price ceiling of ¯ P < P c . Show quantity sold as Q s and the amount consumers would like to buy as Q b . 4. A quota of ¯ Q < Q c . Show the price paid as P b . 5. A production subsidy (or cost rebate) of $ v /unit. Show the seller & buyer’s price as P s & P b . Label area of subsidy expense as R vQ b .
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Four types of market failure Markets can fail to achieve Pareto efficiency as the result of the following 4 issues: 1. Imperfect competition 2. Public goods 3. Externalities 4. Informational market failure To the 4 issues in Brander 3.7, we should also consider “macro” failure, the economy-wide failure to keep workers and capital fully employed (ch. 14).
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Mkt. failure type 1: Imperfect competition
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