Notes Economics of the Public Sector (Stiglitz).docx - Part...

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Part 1 Paper 4 Notes – Economics of the Public Sector (Stiglitz, Rosengard)Chapter 4: Market Failure There needs to be a government to define property rights and enforce contracts (tragedy of the commons, but also tragedy of the anti-commons (Michael Heller of Columbia Law school): excessive private ownership of a community resource that prevents achievement of a desirable outcome for society) Failure of competition Pareto efficiency requires perfect competition In reality, market structures that are prevalent are those of monopoly, oligopoly and monopolistic competition where firms have downward-sloping demand curvesNumber of reasons why competition may be limited: if average costs of production decline as a firm produces more a larger firm will have a competitive advantage natural monopoly: cheaper for a single firm to produce the entire output / firms may engage in strategic behavior to discourage competitionSome imperfections of the market arise out of government actionse.g. government patents (exclusive rights to an invention): important in providing incentives to innovate BUT competition in product market less than perfect Of course, even without patents, the fact that an innovator has some information (knowledge) that is not freely available to others may enable it to establish a dominant market position Imperfect competition increased economic inefficiency If natural monopoly competition not viable BUT even then, a typical monopoly wouldcharge more than a government-run monopoly (private monopoly would seek to maximize profits while government monopoly would only seek to break even)Public goods There are goods which will not be supplied by the market or, if supplied, will be suppliedin insufficient quantity (e.g. public defense, public infrastructure such as a lighthouse etc.)They are non-excludable and non-rivalrous Externalities In many cases, there are spillover effects of one person to another (group of) person(s) which are either negative (negative externalities) or positive (positive externalities) Negative externalities: driving a car not equipped with pollution control device, smokingin public areas, chemical plant that discharges chemicals into a nearby stream, etc. Positive externalities: education, healthcare, research and innovation, etc. The crisis of 2008 made it clear that the financial sector could (and did) impose large externalities on the rest of the economy financial sector accused of “polluting the global economy with toxic mortgages) Whenever such externalities exist, resource allocation provided by market will not be efficient They create a need for government intervention Incomplete markets Whenever private markets fail to provide a good or service even though the cost of providing it is less than what individuals are willing to pay, there is a market failure we refer to as “incomplete markets” Insurance and capital markets: private market does not provide insurance for many important risks that individuals face

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