Chapter 2 Fisher

MICROECONOMIC ANALYSIS: MARKET
EFFICIENCY AND MARKET FAILURE
STATE AND LOCAL PUBLIC FINANCE

RONALD C. FISHER
JOHNNY PATTA
KK PENGELOLAAN PEMBANGUNAN DAN PENGEMBANGAN KEBIJAKAN
SAPPK - ITB
9/2/2009 jpatta@pl.itb.ac.id 1
Create PDF files without this message by purchasing novaPDF printer (http://www.novapdf.com)
INTRODUCTION
• The economic function left to state and local
governments in the United States system is the
allocation function, i.e., the determination of the
amount and mix of local public services to be
offered
• An important issue of microeconomics is when
and why collective action, such as that by
government, may be preferable to separate
economic decisions by individual consumers and
producers
• We’ll examine the basic microeconomic principles of
market operation and economic efficiency, including
why private markets may be efficient, the conditions
under which private markets will not generate
efficiency, the potential distributional concerns from
private provision, and the ways government
involvement generally in an economy may improve
efficiency or resource distribution compared to
private markets.
THE EFFICIENCY OF THE MARKET
• The concept of economic efficiency most often used in economics is
called Pareto efficiency or optimality, which states that an economy
is efficient if it is not possible to make at least one person better of
without making someone else worse off
• Economic efficiency includes includes the idea of technical or
engineering efficiency, requiring that goods be produced at lower
cost, but it also requires that the type and quantity of goods and
services being produced are consistent with society’s desires.
• The test for efficiency is to search for changes to the current
economic situation that can improve the welfare or economic
conditions of some people but not decrease the welfare of any
others
• The efficiency definition only requires that it be possible to make
some consumers better of without hurting anyone and does not
address the issue of how any change actually is to be accomplished.
• If the gain to society from one small change is called
the marginal social benefit and the cost of the
change is the marginal social cost
• If marginal social benefit equals to marginal social
cost, then the economy is efficient because there is
no net gain from any change.
• If marginal social benefit is greater or less than
marginal social cost, the economy is not efficient,
and the proposed change would improve economic
efficiency
THE EFFICIENCY OF THE MARKET (2)
• By welfare, economists mean the utility or
satisfaction consumers receive from
consumption
• Consumer’s utility depends on his or her own
preferences, because each consumer is the
sole judge of his or her own welfare.
• More goods will not improve a consumer’s
welfare if that consumer does not like those
goods.
• The advantages of economic efficiency are
that value judgments about how much society
“cares” for different types of consumers are
not necessary and that no consumer need be
opposed to change to an inefficient economy.
• If a potential economic change must hurt even
one consumer while making all others better
off, by the Paretto definiton that situation is
efficient.
• At the market equilibrium, the marginal cost
of producing one more unit equals the
marginal benefit
• Consumer’s surplus is defined as the
difference between the marginal benefit to
consumers from a unit of the product and the
market price they actually pay
• Producer’s surplus is defined as the difference
between the price charged for the product
and the marginal cost of producing a unit of
the product
• If marginal social cost does not equal marginal
social benefit for the amount of a good or
service provided, then the outcome is not
efficient
THE EFFICIENCY OF THE MARKET (3)
• If output and consumption is restricted to 100 units rather than the
efficient quantity of 200, the welfare loss or welfare foregone by
society can be measured by area DEFG, the sum of producer’s and
consumer’s surplus
• The results in a competitive market when producers act to get the
highest possible profits and consumers act to get the greatest
possible satisfaction are as follows:
1. Marginal cost equals marginal benefit, with both equal to price
2. Price equals the lowest possible production cost and producers earn
normal profits
3. Because price equals both marginal cost and marginal benefit in all
competitive market-that is, PA* = MCA = MBA and PB* = MCB =
MBB, it follows that the relative prices of different products reflect
the relative production costs and relative marginal benefits in
consumption or
PA*/PB* = MCA/MCB = MBA/MBB
WHEN MARKETS ARE NOT EFFICIENT
• One possibility is that the marginal cost faced by

producers does not reflect all the costs to society
from additional production or that an individual
consumer’s marginal benefit does not equal society’s
benefit
• A second possibility is that a lack of competition,
such as if economies of scale are present or entry of
firms is blocked, may prevent the market from
reaching the marginal cost equals marginal benfit
equilibrium
WHEN MARKET ARE NOT EFFICIENT (2)
Externalities
• External effects: if one person’s consumption or one firm’s
production imposes costs or benefits on other consumers or
producers
• Externality exists if one economic agent’s action affects
another agent’s welfare and does so outside of changes in
market prices or quantities
• Externalities create an efficiency problem because the
external costs or benefit usually will not be taken into account
by the consumer or producer causing the external effect
Externalities
• Because each unit of this good purchased by one consumer
generates benefits for others as well, the marginal benefit to
society is greater that to the direct consumers alone
• In that case, the efficient amount of consumption is Q*,
where marginal private cost equals marginal social benefit
• When externalities are present, private choices by consumers
and firms in private markets generally will not provide an
economically efficient result
• Government may be able to intervene and create incentives
so that private choices of consumers and firms will be efficient
in the presence of externalities
Public Goods
• The term public goods is used clasically to refer to goods or services that
exhibit two properties
• Public goods are nonrival, meaning that one additional person can
consume the good without reducing any other consumer’s benefit; once
the good or service is produced, the marginal cost of an additional
consumer is zero
• Public goods often are also said to be nonexcludable, meaning that it is
not possible to exclude consumers who do not pay the price from
consuming the good or service
• If a good is nonrival, the amrginal social cost of adding another consumer
is zero, so efficiency requires a zero price
Public Goods
• The government’s task is to collect revenue to cover the fixed
costs of a service while maintaining the price for each use of
the service equal to zero
• Government can use general taxes to pay the fixed costs, and
because those general taxes do not depend on a taxpayer’s
use of the service, the price for each use is zero
• The tax power of government is needed to finance provision
of these goods
• They can be free riders, benefiting, without paying, from the
amount of goods purchased by others
Increasing Returns to Scale
• A final efficiency problem for competitive markets occurs if
production of some commodities exhibits increasing returns
to scale
• The usual explanation for this type of cost structure is the
existence of capital costs that are large compared to variable
costs
• Industries with increasing returns to scale are often called
natural monopolies because it makes sense to have only one
producer rather than duplicate the required infrastructure
• The inescapable problem is that with
increasing returns to scale a price equal to
marginal cost cannot generate enough
revenue to cover total costs
• An alternative to government production of
goods with increasing returns to scale is
regulated monopoly production, with
government as the regulator
DISTRIBUTIONAL CONCERNS
• If individuals have different abilities and if the financial
resources for and incentives to acquire skills are not the same
for all, then substantial differences in income and welfare can
arise
• Theoretically, there is no reason that efficiency concerns
should dominate equity considerations, and so the efficiency
criterion may be relevant only if the socially-desired
distrivution is achieved
• An alternative is to have government provision and to alter
the prices of those spesific goods and services
EFFCIENT PROVISION OF PUBLIC GOODS
• The rule for efficient provisions of goods is that the marginal

cost should equal the marginal social benefit
• The efficiency rule for public goods is the marginal costs to
society should equal the sum of the marginal benefits of all
consumers
• Samuelson rule or Samuelson public goods equilibrium: the
marginal cost includes all the costs to the society, including
opportunity costs generated by production
EFFCIENT PROVISION OF PUBLIC GOODS (2)
Methods of Government Provision

• Government can intervene in private markets in at least three
ways: by directly providing goods and services, by creating
incentives to alter economic decisions through the use of
taxes and subsidies, and by regulating private economic
activity
• Lindahl equilibrium: With charges or tax shares equal to
marginal benefit shares
• If consumer’s marginal costs reflect their marginal benefits,
then the efficient amount of a public good will be demanded
EFFCIENT PROVISION OF PUBLIC GOODS
(3)
• Marginal benefits must be measured and assigned to
individuals or at least groups of individuals
• It may be not appropiate to charge marginal prices if
the marginal cost of another user is zero
• It may not be feasible to exclude consumers from use
if they refuse to pay the price set by the government
APPLICATION TO STATE AND LOCAL
GOVERNMENTS
• The problem of public goods, externalities, and increasing returns to scale
provide reasons for government action to improve the efficiency of the
economy, and many, although certainly not all, state-local government
activities can be explained by these reasons
• Education produces external benefits such as the gains to all from a
literate and educated populace and the information generated by research
at educational institutions
• Education has the potential to be an important mechanism for income
redistribution by affecting earnings potential
• Education benefits cannot generally be confined to a particular geographic
area or industrial sector, so intergovernmental arrangements may be
called for
THANK YOU

Chapter 2 Fisher

Diunggah oleh

Informasi Dokumen

Deskripsi Asli:

Hak Cipta

Format Tersedia

Bagikan dokumen Ini

Bagikan atau Tanam Dokumen

Opsi Berbagi

Apakah menurut Anda dokumen ini bermanfaat?

Apakah konten ini tidak pantas?

Hak Cipta:

Format Tersedia

Chapter 2 Fisher

Diunggah oleh

Hak Cipta:

Format Tersedia

MICROECONOMIC ANALYSIS: MARKET

EFFICIENCY AND MARKET FAILURE

STATE AND LOCAL PUBLIC FINANCE

• One possibility is that the marginal cost faced by

• The rule for efficient provisions of goods is that the marginal

Methods of Government Provision

Anda mungkin juga menyukai