Reasons For Government Intervention In The Market
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Reasons for Government Intervention in the Market
Markets and the Role of Government • Government intervention and social objectives • The objective of social efficiency – marginal social benefits and costs • MSB > MSC → produce (or consume) more • MSC > MSB → produce (or consume) less
– socially efficient output where MSB = MSC
• Equity – concepts of fairness
• Trade-offs between equity and efficiency
Types of Market Failure • Externalities – External costs of production MSC > MC
External costs in production
Costs and benefits
MC = S
P
D
O
Q1 Quantity
External costs in production
Costs and benefits
MSC
P
MC = S
D External cost
O
Q2 Social optimum
Quantity
Q1
Types of Market Failure • Externalities – External costs of production MSC > MC – External benefits of production MSC < MC
External benefits in production
Costs and benefits
MC = S
P
O
D
Q1 Quantity
External benefits in production
Costs and benefits
MC = S MSC
External benefit P
O
D
Q1 Quantity
Q2
Social optimum
External costs and benefits in production
D
P External cost
O
Q2
Q1
Quantity
(a ) External costs
MC = S MSC Costs and benefits (£)
Costs and benefits (£)
MSC MC = S
External benefit P
O
D
Q1
Q2
Quantity
(b) External benefits
Types of Market Failure • Externalities – External costs of production MSC > MC – External benefits of production MSC < MC – External costs of consumption MSB < MB
Costs and benefits
External costs in consumption
P
D
(MB) MU = D
O
Q1 Quantity
Costs and benefits
External costs in consumption
External cost
P
D
(MB) MU = D MSB O Social optimum
Q2
Q1 Quantity
Types of Market Failure • Externalities – External costs of production MSC > MC – External benefits of production MSC < MC – External costs of consumption MSB < MB – External benefits of consumption MSB > MB
Costs and benefits
External benefits in consumption
P
D
(MB) MU = D
O
Q1 Quantity
External benefits in consumption
Costs and benefits
External benefit
P
D MSB (MB) MU = D
O
Q1 Quantity
Q2
Social optimum
External cost P
P
Costs and benefits (£)
Costs and benefits (£)
External costs and benefits in consumption
External benefit
P
P MSB MB
MB MSB O
Q2
Q1 Car miles
(a ) External costs
O
Q1
Q2
Rail miles
(b) External benefits
Types of Market Failure • Public goods – non-rivalry – non-excludability and the free-rider problem
Types of Market Failure • Market power – lack of social efficiency
A monopolist producing less than the social optimum £ MC
P1
MC1
MR O
Monopoly output
Q1
AR Q
A monopolist producing less than the social optimum £ MC = MSC
P1 P2 = MSB = MSC
MC1
MR O
Monopoly output
Q1
Q2
AR = MSB Q Perfectly competitive output
Types of Market Failure • Market power – lack of social efficiency – deadweight welfare loss under monopoly
Deadweight loss under monopoly MC
£
(= S under perfect competition)
Consumer surplus
Ppc
a Producer surplus
AR = D O
Qpc Q (a) Industry equilibrium under perfect competition
Deadweight loss under monopoly MC
£
(= S under perfect competition)
Pm Ppc
O
Consumer surplus
Deadweight welfare loss
b a
Producer surplus
AR = D
MR Qpc
Qpc
(b) Industry equilibrium under monopoly
Q
Deadweight loss under monopoly MC
£
(= S under perfect competition)
Perfect competition
Consumer surplus
Ppc
a Producer surplus
AR = D O
Qpc Q (a) Industry equilibrium under perfect competition
Deadweight loss under monopoly MC
£
(= S under perfect competition)
Monopoly
Pm Ppc
O
Consumer surplus
Deadweight welfare loss
b a
Producer surplus
AR = D
MR Qpc
Qpc
(b) Industry equilibrium under monopoly
Q
Types of Market Failure • Ignorance and uncertainty – by consumers – by firms
• Immobility of factors and time lags • Protecting people’s interests – dependants – merit goods
Government Intervention in the Market • Taxes and subsidies – to correct externalities
Using taxes to correct a market distortion
Costs and benefits
MC = S
P
D
O
Q1 Quantity
Using taxes to correct a market distortion
Costs and benefits
MSC
P
MC = S
D External cost
O
Q2 Social optimum
Quantity
Q1
Using taxes to correct a market distortion
Costs and benefits
MSC
MC = S
Optimum tax = MSC – MC
P
D
MC
O
Q2 Quantity
Q1
Using subsidies to correct a market distortion
Costs and benefits
MC = S
P
O
D
Q1 Quantity
Using subsidies to correct a market distortion
Costs and benefits
MC = S MSC
External benefit P
O
D
Q1 Quantity
Q2
Social optimum
Using subsidies to correct a market distortion MC = S MSC
Costs and benefits
MC Optimum subsidy = MC – MSC P
O
D
Q1 Quantity
Q2
Government Intervention in the Market • Taxes and subsidies (cont.) – to correct for monopoly • use of lump-sum taxes plus subsidies
– advantages of taxes and subsidies • can vary the rate according to the size of the market distortion
– disadvantages of taxes and subsidies • infeasible to use different tax and subsidy rates • lack of knowledge
Government Intervention in the Market • Changes in property rights – the problem of limited property rights – extending property rights – limitations of this solution
• Laws prohibiting behaviour that imposes external costs – advantages of legal restrictions – disadvantages of legal restrictions
• Regulatory bodies
Government Intervention in the Market • Price controls – high minimum prices – low maximum prices
• Provision of information • Direct provision of goods and services – justification • social justice • large positive externalities • dependants • ignorance
The Case for Laissez-faire • Drawbacks of government intervention – shortages and surpluses – poor information – bureaucracy and inefficiency – lack of market incentives – shifts in government policy – voters’ ignorance – unrepresentative government – lack of freedom for the individual
The Case for Laissez-faire • Advantages of the free market – automatic adjustments – dynamic advantages of capitalism – high degree of competition even under monopoly/oligopoly • possible market contestability • competition from other closely related industries • threat of competition from abroad • countervailing powers • competition for corporate control
• Judging the arguments
Firms and Social Responsibility • The classical view on social responsibility – managers solely responsible to shareholders – justification and criticisms of this view
• The socio-economic view – a stakeholding society – corporate social responsibility – environmental scanning
Firms and Social Responsibility • The virtue matrix – a framework for analysing corporate social responsibility – the civil foundation • laws and regulation • social and moral norms
– the frontier • socially beneficial and potentially profitable activities • socially beneficial but unprofitable activities
The Virtue Matrix: generating corporate social responsibility
THE 'FRONTIE R'
CIVIL FOUNDAT ION
Socially beneficial and potentially profitable
Response to social norms
Socially beneficial and unprofitable
Response to laws and regulations
Firms and Social Responsibility • The virtue matrix – a framework for analysing corporate social responsibility – the civil foundation • laws and regulation • social and moral norms
– the frontier • socially beneficial and potentially profitable activities • socially beneficial but unprofitable activities
– development of corporate social responsibility over time
The Virtue Matrix: generating corporate social responsibility
THE 'FRONTIE R'
CIVIL FOUNDAT ION
Socially beneficial and potentially profitable
Response to social norms
Socially beneficial and unprofitable
Response to laws and regulations
Firms and Social Responsibility • The virtue matrix – a framework for analysing corporate social responsibility – the civil foundation • laws and regulation • social and moral norms
– the frontier • socially beneficial and potentially profitable activities • socially beneficial but unprofitable activities
– development of corporate social responsibility over time – globalisation and corporate social responsibility
Firms and Social Responsibility • Economic performance and social responsibility – possible costs to the firm – possible benefits to the firm • improved economic performance • enhancing the brand • attracting and retaining employees • access to capital
Markets and the Role of Government • Government intervention and social objectives • The objective of social efficiency – marginal social benefits and costs • MSB > MSC → produce (or consume) more • MSC > MSB → produce (or consume) less
– socially efficient output where MSB = MSC
• Equity – concepts of fairness
• Trade-offs between equity and efficiency
Types of Market Failure • Externalities – External costs of production MSC > MC
External costs in production
Costs and benefits
MC = S
P
D
O
Q1 Quantity
External costs in production
Costs and benefits
MSC
P
MC = S
D External cost
O
Q2 Social optimum
Quantity
Q1
Types of Market Failure • Externalities – External costs of production MSC > MC – External benefits of production MSC < MC
External benefits in production
Costs and benefits
MC = S
P
O
D
Q1 Quantity
External benefits in production
Costs and benefits
MC = S MSC
External benefit P
O
D
Q1 Quantity
Q2
Social optimum
External costs and benefits in production
D
P External cost
O
Q2
Q1
Quantity
(a ) External costs
MC = S MSC Costs and benefits (£)
Costs and benefits (£)
MSC MC = S
External benefit P
O
D
Q1
Q2
Quantity
(b) External benefits
Types of Market Failure • Externalities – External costs of production MSC > MC – External benefits of production MSC < MC – External costs of consumption MSB < MB
Costs and benefits
External costs in consumption
P
D
(MB) MU = D
O
Q1 Quantity
Costs and benefits
External costs in consumption
External cost
P
D
(MB) MU = D MSB O Social optimum
Q2
Q1 Quantity
Types of Market Failure • Externalities – External costs of production MSC > MC – External benefits of production MSC < MC – External costs of consumption MSB < MB – External benefits of consumption MSB > MB
Costs and benefits
External benefits in consumption
P
D
(MB) MU = D
O
Q1 Quantity
External benefits in consumption
Costs and benefits
External benefit
P
D MSB (MB) MU = D
O
Q1 Quantity
Q2
Social optimum
External cost P
P
Costs and benefits (£)
Costs and benefits (£)
External costs and benefits in consumption
External benefit
P
P MSB MB
MB MSB O
Q2
Q1 Car miles
(a ) External costs
O
Q1
Q2
Rail miles
(b) External benefits
Types of Market Failure • Public goods – non-rivalry – non-excludability and the free-rider problem
Types of Market Failure • Market power – lack of social efficiency
A monopolist producing less than the social optimum £ MC
P1
MC1
MR O
Monopoly output
Q1
AR Q
A monopolist producing less than the social optimum £ MC = MSC
P1 P2 = MSB = MSC
MC1
MR O
Monopoly output
Q1
Q2
AR = MSB Q Perfectly competitive output
Types of Market Failure • Market power – lack of social efficiency – deadweight welfare loss under monopoly
Deadweight loss under monopoly MC
£
(= S under perfect competition)
Consumer surplus
Ppc
a Producer surplus
AR = D O
Qpc Q (a) Industry equilibrium under perfect competition
Deadweight loss under monopoly MC
£
(= S under perfect competition)
Pm Ppc
O
Consumer surplus
Deadweight welfare loss
b a
Producer surplus
AR = D
MR Qpc
Qpc
(b) Industry equilibrium under monopoly
Q
Deadweight loss under monopoly MC
£
(= S under perfect competition)
Perfect competition
Consumer surplus
Ppc
a Producer surplus
AR = D O
Qpc Q (a) Industry equilibrium under perfect competition
Deadweight loss under monopoly MC
£
(= S under perfect competition)
Monopoly
Pm Ppc
O
Consumer surplus
Deadweight welfare loss
b a
Producer surplus
AR = D
MR Qpc
Qpc
(b) Industry equilibrium under monopoly
Q
Types of Market Failure • Ignorance and uncertainty – by consumers – by firms
• Immobility of factors and time lags • Protecting people’s interests – dependants – merit goods
Government Intervention in the Market • Taxes and subsidies – to correct externalities
Using taxes to correct a market distortion
Costs and benefits
MC = S
P
D
O
Q1 Quantity
Using taxes to correct a market distortion
Costs and benefits
MSC
P
MC = S
D External cost
O
Q2 Social optimum
Quantity
Q1
Using taxes to correct a market distortion
Costs and benefits
MSC
MC = S
Optimum tax = MSC – MC
P
D
MC
O
Q2 Quantity
Q1
Using subsidies to correct a market distortion
Costs and benefits
MC = S
P
O
D
Q1 Quantity
Using subsidies to correct a market distortion
Costs and benefits
MC = S MSC
External benefit P
O
D
Q1 Quantity
Q2
Social optimum
Using subsidies to correct a market distortion MC = S MSC
Costs and benefits
MC Optimum subsidy = MC – MSC P
O
D
Q1 Quantity
Q2
Government Intervention in the Market • Taxes and subsidies (cont.) – to correct for monopoly • use of lump-sum taxes plus subsidies
– advantages of taxes and subsidies • can vary the rate according to the size of the market distortion
– disadvantages of taxes and subsidies • infeasible to use different tax and subsidy rates • lack of knowledge
Government Intervention in the Market • Changes in property rights – the problem of limited property rights – extending property rights – limitations of this solution
• Laws prohibiting behaviour that imposes external costs – advantages of legal restrictions – disadvantages of legal restrictions
• Regulatory bodies
Government Intervention in the Market • Price controls – high minimum prices – low maximum prices
• Provision of information • Direct provision of goods and services – justification • social justice • large positive externalities • dependants • ignorance
The Case for Laissez-faire • Drawbacks of government intervention – shortages and surpluses – poor information – bureaucracy and inefficiency – lack of market incentives – shifts in government policy – voters’ ignorance – unrepresentative government – lack of freedom for the individual
The Case for Laissez-faire • Advantages of the free market – automatic adjustments – dynamic advantages of capitalism – high degree of competition even under monopoly/oligopoly • possible market contestability • competition from other closely related industries • threat of competition from abroad • countervailing powers • competition for corporate control
• Judging the arguments
Firms and Social Responsibility • The classical view on social responsibility – managers solely responsible to shareholders – justification and criticisms of this view
• The socio-economic view – a stakeholding society – corporate social responsibility – environmental scanning
Firms and Social Responsibility • The virtue matrix – a framework for analysing corporate social responsibility – the civil foundation • laws and regulation • social and moral norms
– the frontier • socially beneficial and potentially profitable activities • socially beneficial but unprofitable activities
The Virtue Matrix: generating corporate social responsibility
THE 'FRONTIE R'
CIVIL FOUNDAT ION
Socially beneficial and potentially profitable
Response to social norms
Socially beneficial and unprofitable
Response to laws and regulations
Firms and Social Responsibility • The virtue matrix – a framework for analysing corporate social responsibility – the civil foundation • laws and regulation • social and moral norms
– the frontier • socially beneficial and potentially profitable activities • socially beneficial but unprofitable activities
– development of corporate social responsibility over time
The Virtue Matrix: generating corporate social responsibility
THE 'FRONTIE R'
CIVIL FOUNDAT ION
Socially beneficial and potentially profitable
Response to social norms
Socially beneficial and unprofitable
Response to laws and regulations
Firms and Social Responsibility • The virtue matrix – a framework for analysing corporate social responsibility – the civil foundation • laws and regulation • social and moral norms
– the frontier • socially beneficial and potentially profitable activities • socially beneficial but unprofitable activities
– development of corporate social responsibility over time – globalisation and corporate social responsibility
Firms and Social Responsibility • Economic performance and social responsibility – possible costs to the firm – possible benefits to the firm • improved economic performance • enhancing the brand • attracting and retaining employees • access to capital
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