Role of Government
Organic View Mechanistic View
• Friedman and the “Classical Liberal” viewpoint. • Market Socialism • Paternalism
Market Failures Welfare Economics
*This lecture draws from H. Rosen’s text: “Public Finance”
• Government’s goal is to guide individuals to accomplish societal goals.” • Social (common) well being matters. not individual well being.
• “Society is a natural organism. Each individual is a part and government is its heart.
• Social goals not important except as a collection of individual goals.Mechanistic View
• Government created by individuals to better achieve individual goals. When is it correct to transfer property from one person to another?
. • Within the mechanistic view there can be differences about how to weigh the benefits for different individuals.
“Government as Referee”
• Government defines and protects property rights.
– It enforces contracts. – Also limits types of “legal” contracts.
• • • • Illegal activities Bankruptcy Anti-trust Safety regulations
• Government provides the legal framework within which all transactions occur. • Government arbitrates disputes (the courts).
– Provide some “public goods.” – When in doubt. “Government failures” might be worse than the “market failures.”
• Skeptical of using government for redistribution. • Government’s primary role is “referee” • Role of Government narrowly defined:
– Define and enforce property rights and support the efficient functioning of markets.Mechanistic View: “Classic Liberal” or “Libertarian”
• Extreme within the mechanistic framework.” – Correct some “market failures. do not interfere.
Mechanistic View: “Social Democratic”
• “Substantial government intervention is required for the good of individuals.” • Supports using government to redistribute wealth.” • Agree with libertarians that government should provide public goods and correct market failures.
. • In addition. It might provide a “social safety net. • Less concerned about “government failure. government should do more.” guaranteeing availability of certain goods or services.
. • The paternalistic view argues that for certain decisions individuals do not maximize their own well being. for questions related to topics such as environmental planning – in particular with long term consequences. 180)
• Even stronger than the “social democratic” view is the “paternalistic” view. p.Mechanistic View: “Paternalism”
(Rosen. • “Merit goods” are defined as goods that ought to be provided even if people do not demand it.
Economic Theory: Welfare Economics
• Introduction • Statement of Welfare theorems (general) • Definitions
– Pareto Optimality – Market failure
• Restatement of theorems (precise) • Interpretations • Caveats
Introduction to Welfare Economics
• Welfare Economics: “The branch of economic theory concerned with the social desirability of alternative economic states.” • “The theory is used to distinguish circumstances under which markets can be expected to perform well” • Welfare economics helps us define some circumstances under which we might want government intervention.
• First theorem of welfare economics: A perfectly competitive market with no “market failures” reaches a “Paretoefficient” allocation. Second theorem of welfare economics: Any Pareto-efficient allocation is consistent with perfect competition (with no market failures). given the correct initial endowments.
“Pareto Optimal” or “Pareto Efficient”
• “An allocation where the only way to make one person better off is to make another person worse off is Pareto Optimal.” • A “Pareto Improvement” is a change that makes one person better off without making anyone else worse off. • If a Pareto improvement is possible. • Example (parking)
. the current allocation is not Pareto efficient.
. • Public Goods
– Non-rival – Non-excludible
Asymmetric Information • Adverse Selection Imperfect Competition • Monopoly. oligopoly.Market Failures
Imperfect Property Rights • Externalities: “An activity of one entity (firm or individual) that affects another entity in a way that is outside the market.
for example). • When a market failure exists.
. This is what we mean by “efficient. there may be a role for government to correct that market failure. • Externalities and public goods might be thought of as specific cases of imperfectly defined property rights.” • The criteria of efficiency ignores normative considerations (equity. • Economists might suggest “creating” a market for the externality (see Fullerton and Stavins).Intuition
• Market maximize total surplus (producer surplus plus consumer surplus).
.First Fundamental Theorem of Welfare
Suppose the following conditions hold: • Households and firms act as price takers • Full set of market for inputs and outputs (property rights are correctly defined) • Full information on the part of all buyers and sellers The first fundamental theorem of welfare states that a competitive market equilibrium is Pareto Efficient.
• Need to find the correct level or value of the non-traded externality… • Looking ahead to the Coase theorem
.Second Fundamental Theorem of Welfare
• Any Pareto efficient allocation is supported by some competitive market allocation.
.Applying views of government
Can the following types of government intervention be justified by the concept of “market failure?” Are they consistent with a mechanistic view of government? •Prohibition of drugs •Prohibition of alcohol (for those under 21) •Prohibition of prostitution •Mandatory air bags for cars •Support for the arts •Mandate that flights be non-smoking or that restaurants reserve non-smoking sections.
Group IA: assignment
Using the language of economics and the criteria for policy evaluation developed in the first two lectures… [Choose only one] • Consider the case to legalize marijuana. • Consider the case to legalize prostitution. Present a detailed proposal either supporting or opposing the legalization of prostitution.
. Present a detailed proposal supporting or opposing the legalization of marijuana.
Group IB: assignment
Using the language of economics and the criteria for policy evaluation developed in the lectures and text. • Consider the case for mandates that flights be non-smoking and that that restaurants reserve non-smoking sections.
. Present a detailed proposal supporting or opposing such mandates.