chapter4 - ThePublicSector CHAPTER4 (orresource allocations...

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CHAPTER 4 The Public Sector 
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Lessons from a Market Economy The  market mechanism  uses market prices and  sales to signal desired outputs (or resource  allocations). Ideally, the market mechanism should lead to an  optimal mix of output. An  optimal mix of output  is the most desirable  combination of output attainable with existing  resources, technology and social values.
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Market Failure Market failure  occurs when an imperfection in the  market mechanism prevents optimal outcomes. The forces of supply and demand don’t lead to the best  point on the production possibilities curve. There is a basis for government intervention to push  market outcomes closer to the ideal. LO1
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Market Failure All Other Goods (units per time period) Computers (units per time period) Production possibilities M (Market mix) X ( Optimal mix) LO1
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Causes of Market Failure The four specific sources of market failure are: Public goods Externalities Market power Equity LO1
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Public Goods private good  is a good or service whose  consumption by one person excludes consumption by  others. public   good  is a good or service whose  consumption by one person does not exclude  consumption by others. LO1
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The Free-Rider Dilemma The communal nature of public goods may cause  consumers to try for a free ride. free rider  is an individual who reaps direct benefits  from someone else’s purchase (consumption) of a  public good. LO1
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Underproduction of Public Goods Everyone would wait for someone else to pay if  public goods were marketed like private goods. The market tends to underproduce public goods and  overproduce private goods. LO1
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Externalities Externalities   are the costs (or benefits) of a market  activity borne by a third party. The difference between the social and private costs (benefits)  of a market activity. LO1
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Whenever externalities are present, market prices  aren’t a valid measure of a good’s value to society. The market will under-produce goods that yield 
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chapter4 - ThePublicSector CHAPTER4 (orresource allocations...

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