Chapter 7 Market Failures

Chapter 7 Market Failures - CHAPTER 7 Market Failures:...

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CHAPTER 7 Market Failures: External Costs and Benefits In its broadest definitional sense, collective action is the enactment and enforcement of law. The justification for all collective action, for government, lies in its ability to make men better off. This is where any discussion of the bases for collective action must begin. James Buchanan ow much should government involve itself in the marketplace? How much does business want government involvement.” These questions touch on one of the most important economic issues of our time: the division of responsibility between the public and private sectors. In general, economic principles would suggest that government undertake only functions that it can perform more efficiently than the market. As we will see, businesses are not always opposed to government involvement in the economy. Indeed, many businesses have incentives to try to make sure that government is more involved in the economy than is “efficient.” Economics provides a method for evaluating the relative efficiency of government and the marketplace. It enables the United States to identify which goods and services the market will fail to produce altogether, and which it will produce inefficiently. We saw in an earlier chapter that such market failures have three sources: monopoly power, external costs, and external benefits. Now, using the principles and graphic analyses developed in earlier chapters, we will take a closer look at external costs and benefits and at government attempts to capture them and correct market failures. (See later chapters on monopoly and monopsony power .) External Costs and Benefits, Again In a competitive market, producers must minimize their production costs in order to lower their prices, increase their production levels, and improve the quality of their products. Consumers must demonstrate how much they will pay for a product, and in what amount they will buy it. In a competitive market, production will move toward the intersection of the market supply and demand curves -- Q 1 in Figure 7.1. At that point the marginal cost of the last unit produced will equal its marginal benefit to consumers. To the extent that the market moves toward equilibrium in supply and demand, it is efficient in a very special sense. As long as the marginal benefit of anything people do is greater than the marginal cost, people are presumed to be better off if quantity increases. In Figure 7.1, for each loaf of bread up to Q 1 , the marginal benefit of consumption (as H
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Chapter 7 Market Failures: External Costs And Benefits 2 shown by the demand curve) exceeds the marginal cost of production (as shown by the supply curve). Because the marginal cost of a loaf of bread is the value of the most attractive alternative forgone, people must be getting more value out of each of those loaves than they could from any alternative good. By producing exactly Q 1 loaves—no more and no less—the market extracts the possible surplus or excess benefits from production (see shaded area on the graph) and divides them among buyers and sellers. In
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This note was uploaded on 04/10/2011 for the course BUSI 1100 taught by Professor Staff during the Spring '11 term at North Texas.

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Chapter 7 Market Failures - CHAPTER 7 Market Failures:...

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