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CHAPTER 14 - REGULATION, PUBLIC GOODS, AND BENEFIT-COST ANALYSIS Opening Case: R&D for a new drug typically costs $200m. Burroughs Wellcome Co. developed AZT for treatment of AIDS. Initial costs for patients were $5,000-$8,000 per year, making AZT one of the most expensive drugs ever sold, bringing protests of "price gouging" and calls for government intervention. Issues: What is government's role in regulating drugs and ensuring public safety? Part of the high cost of developing drugs ($200m) can be traced to the lengthy FDA approval process. What is the government's role in regulating prices for drugs (or wages, rents, concert tickets, farm price supports, etc.)? What are the legitimate functions of government? What is the optimal size of government in a "mixed" economy? Three categories of government's role in the economy: 1. Macroeconomic - Using fiscal (Congress) and monetary policy (Federal Reserve) to achieve macroeconomic goals of stabilizing the economy and promoting low unemployment, full output, stable prices, stabilize the business cycles, prevent recessions, etc. 2. Microeconomic - Provide public goods (national defense, FBI, police protection, fire departments, roads and highways, court system, patents, etc.) and regulate the economy (FDA, FTC, DOJ, EPA, NTSB, FAA, DOA, zoning, etc.). 3. Distributive - Redistribute income to reduce income inequality, improve the welfare of the poor, provide medical care (Medicare, Medicaid, VA hospitals), provide retirement income (Social Security). In this chapter we focus on the microeconomic role of government to: 1) improve upon potential market failures, inefficient production or consumption and 2) provide the "optimal" amount of public goods and services that cannot be "provided" by the private sector. Actually in most cases, the goods or services can easily be produced by the private sector, the problem is what??? Lighthouse example, most are owned and operated by the government because a privately owned lighthouse may have a hard time collecting money from ships. All ships benefit from a lighthouse, but what would be the problem be if voluntary contributions were used to attempt finance the operation of the lighthouse? However, in 19th century England, many lighthouses were privately owned, and fees were collected from the owners of nearby ports and not from the ship owners. If port owners didn't pay, the lighthouse owner would turn off the lights, and ships would avoid that port. Or the owner of the port would build a lighthouse to attract ships. In this chapter we cover: a) regulation and b) cost-benefit analysis to evaluate public programs. I. MARKET FAILURES AND REGULATION ECN 469: Managerial Economics-CH 14 Professor Mark J. Perry 1
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1. Market Failure Due to Monopoly Compared to efficient perfectly competitive markets, monopolies are inefficient and result in higher prices, lower output and dead-weight losses to the economy. Consumers lose more than monopolies gain, and total welfare falls. See p. 445, Figure 11.3, for graphical analysis of DWL. Empirical
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