Transcript internalize the externality

Benefits of Free Enterprise
• What are the basic principles of the U.S. free enterprise
system?
• What role does the consumer play in the system of free
enterprise?
• What is the role of the government in the free
enterprise system?
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The Basic Principles of Free Enterprise
Several key characteristics make up the basic
principles of free enterprise.
1. Profit Motive
The drive for the improvement of
material well-being.
2. Open opportunity
The ability for anyone to
compete in the marketplace.
3. Legal equality
Equal rights to all.
4. Private property rights
The right to control your
possessions as you wish.
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5. Free contract
The right to decide what
agreements in which you
want to take part.
6. Voluntary exchange
The right to decide what
and when you want to buy
and sell a product.
7. Competition
The rivalry among sellers
to attract consumers.
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The Consumer’s Role
A fundamental purpose of the free enterprise system is
to give consumers the freedom to make their own
economic choices.
Through their economic
dealings with producers,
consumers make their desires
known. When buying products,
they indicate to producers what
to produce and how much to
make.
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Consumers can also make their
desires known by joining interest
groups, which are private
organizations that try to persuade
public officials to vote according
to the interests of the groups’
members.
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The Government’s Role
Americans expect the government to protect them from
potential problems that arise from the production of
various products or the products themselves.
Public Disclosure Laws
Laws that require companies to provide consumers with
important information about their products, such as fuel
efficiency of automobiles, side-effects of medication.
Public Interest
Both state and federal governments’ involvement in concerns
of the public as a whole, such as environmental protection,
sanitary food production.
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Section 1 Assessment
1. Americans generally favor
(a) strong government control of the economy.
(b) limited government intervention in the economy.
(c) no government intervention in the economy.
(d) government control of manufacturing only.
2. The basic principles of free enterprise do NOT include
(a) competition.
(b) legal equality.
(c) profit motive.
(d) checks and balances.
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Section 1 Assessment
1. Americans generally favor
(a) strong government control of the economy.
(b) limited government intervention in the economy.
(c) no government intervention in the economy.
(d) government control of manufacturing only.
2. The basic principles of free enterprise do NOT include
(a) competition.
(b) legal equality.
(c) profit motive.
(d) checks and balances.
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Promoting Growth and Stability
• How does the government track and seek to influence
business cycles?
• How does the government try to promote economic
strength?
• Why and how does the government encourage
innovation?
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Tracking Business Cycles
• Macroeconomics is the study of the behavior and
decision making of entire economies.
• A business cycle is a period of a macroeconomic
expansion followed by a period of contraction.
• One measure of a nation’s macroeconomy is gross
domestic product (GDP). GDP is the total value of all
final goods and services produced in a particular
economy.
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Promoting Economic Strength
Policymakers pursue three main outcomes as they seek
to stabilize the economy.
Employment
• One aim of federal economic policy is to provide jobs for everyone
who is able to work.
Growth
• For each generation of Americans to do better than previous ones,
the economy must grow to provide additional goods and services.
Stability
• Stability gives consumers, producers, and investors confidence in
the economy and in our financial institutions, promoting economic
freedom and growth.
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Encouraging Innovation
The government encourages the development of new
technologies in several ways. Technology is the process
used to produce a good or service.
• Federal agencies fund many
research and development
projects. Also, new
technology often evolves out
of government research.
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• A patent gives the inventor
of a new product the
exclusive right to produce
and sell it for 20 years.
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Section 2 Assessment
1. Policymakers encourage all of the following EXCEPT
(a) stable productivity.
(b) high employment.
(c) stable prices.
(d) steady growth.
2. The government encourages advances in technology and improvements in
productivity by
(a) maintaining steady price controls.
(b) funding research and development projects at many levels.
(c) hiring more workers to reduce unemployment.
(d) regulating banks and other financial institutions.
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Section 2 Assessment
1. Policymakers encourage all of the following EXCEPT
(a) stable productivity.
(b) high employment.
(c) stable prices.
(d) steady growth.
2. The government encourages advances in technology and improvements in
productivity by
(a) maintaining steady price controls.
(b) funding research and development projects at many levels.
(c) hiring more workers to reduce unemployment.
(d) regulating banks and other financial institutions.
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Providing Public Goods
• What are public goods?
• What is a market failure?
• How does government manage externalities?
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Public Goods
• A public good is a shared good or service for which it
would be impractical to make consumers pay
individually and to exclude nonpayers.
– Public goods are funded by the public sector, the
part of the economy that involves transactions of the
government.
– A free rider is someone who would not choose to
pay for a certain good or service, but who would get
the benefits of it anyway if it is provided as a public
good.
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Market Failures
• Would the free market ensure that roads are built
everywhere they are needed?
• It’s doubtful. Neither could individuals afford to pay for
a freeway.
A market failure is a situation in which the market, on its
own, does not distribute resources efficiently.
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Introduction
• We consume many goods without paying: parks,
national defense, clean air & water.
• When goods are free, the market forces that normally
allocate resources are absent.
• The private market may fail to provide the socially
efficient quantity of such goods.
• Governments can sometimes
improve market outcomes.
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Public Goods
• Public goods are difficult for private markets to
provide because of the free-rider problem.
• Free rider: a person who receives the benefit of a
good but avoids paying for it
– If good is not excludable, people have incentive to
be free riders, because firms cannot prevent nonpayers from consuming the good.
• Result: The good is not produced, even if buyers
collectively value the good higher than the cost of
providing it.
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Public Goods
• If the benefit of a public good exceeds the cost of
providing it, govt should provide the good and pay for it
with a tax on people who benefit.
• Problem: Measuring the benefit is usually difficult.
• Cost-benefit analysis: a study that compares
the costs and benefits of providing a public good
• Cost-benefit analyses are imprecise, so the efficient
provision of public goods is more difficult than that of
private goods.
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Some Important Public Goods
• National defense
• Knowledge created through basic research
• Fighting poverty
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Some Important Common Resources
• Clean air and water
• Congested roads
• Fish, whales, and other wildlife
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Common Resources
• Like public goods, common resources are not
excludable.
– cannot prevent free riders from using
– little incentive for firms to provide
– role for govt: seeing that they are provided
• Additional problem with common resources:
rival in consumption
– each person’s use reduces others’ ability
to use
– role for govt: ensuring they are not overused
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CONCLUSION
• Public goods tend to be under-provided, while common
resources tend to be over-consumed.
• These problems arise because property rights
are not well-established:
– Nobody owns the air, so no one can charge
polluters. Result: too much pollution.
– Nobody can charge people who benefit from national
defense. Result: too little defense.
• The govt can potentially solve these problems
with various policy options.
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Externalities
• An externality is an economic side effect of a good or
service that generates benefits or costs to someone
other than the person deciding how much to produce
or consume.
– The building of a new dam and creation of a lake generates:
• Positive Externalities
– A possible source of hydroelectric power
– Swimming
– Boating
– Fishing
– Lakefront views
• Negative Externalities
– Loss of wildlife habitat due to flooding
– Disruption of fish migration along the river
– Overcrowding due to tourism
– Noise from racing boats and other watercraft
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Introduction
• One type of market failure: externalities.
• Externality: the uncompensated impact of
one person’s actions on the well-being of a bystander
– Negative externality:
the effect on bystanders is adverse
– Positive externality:
the effect on bystanders is beneficial
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Introduction
• Self-interested buyers and sellers
neglect the external effects of their actions,
so the market outcome is not efficient.
• Governments can sometimes
improve market outcomes.
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Pollution: A Negative Externality
• Example of negative externality:
Air pollution from a factory.
– The firm does not bear the
full cost of its production,
and so will produce
more than the
socially efficient quantity.
• How govt may improve
the market outcome:
– Impose a tax on the firm equal to the
external cost of the pollution it generates
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Other Examples of Negative Externalities
• the neighbor’s barking dog
• late-night stereo blasting from the dorm room next to
yours
• noise pollution from construction projects
• talking or texting on cell phones while driving makes
the roads less safe for others
• health risk to others from second-hand smoke
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Positive Externalities from Education
• A more educated population benefits society:
– lower crime rates: educated people have more
opportunities, so less likely to rob and steal
– better government: educated people make betterinformed voters
• People do not consider these external benefits when
deciding how much education to “purchase”
• Result: market equilibrium quantity of education too
low
• How govt may improve the market outcome:
– subsidize cost of education
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Other Examples of Positive Externalities
• Being vaccinated against
contagious diseases
protects not only you,
but people who visit the
salad bar or produce section
after you.
• R&D creates knowledge
others can use
• Renovating your house
increases neighboring
property values
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Thank you for
not contaminating
the fruit supply!
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“Internalizing the Externality”
• Internalizing the externality: altering incentives so that
people take account of the external effects of their actions
• In the previous example, the $1/gallon tax on sellers
makes sellers’ costs equal to social costs.
• When market participants must pay social costs, the
market equilibrium matches the social optimum.
(Imposing the tax on buyers would achieve the same
outcome; market Q would equal optimal Q.)
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Positive Externalities
• In the presence of a positive externality,
the social value of a good includes
– private value – the direct value to buyers
– external benefit – the value of the
positive impact on bystanders
• The socially optimal Q maximizes welfare:
– At any lower Q, the social value of
additional units exceeds their cost.
– At any higher Q, the cost of the last unit exceeds
its social value.
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Effects of Externalities: Summary
If negative externality
 market produces a larger quantity
than is socially desirable
If positive externality
 market produces a smaller quantity
than is socially desirable
To remedy the problem,
“internalize the externality”
 tax goods with negative externalities
 subsidize goods with positive externalities
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Private Solutions to Externalities
Types of private solutions:
• moral codes and social sanctions,
e.g., the “Golden Rule”
• charities, e.g., the Sierra Club
• contracts between market participants and the affected
bystanders
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Public Policies Toward Externalities
Two approaches
• Command-and-control policies
regulate behavior directly. Examples:
– limits on quantity of pollution emitted
– requirements that firms adopt a particular
technology to reduce emissions
• Market-based policies
provide incentives so that private decision-makers will
choose to solve the problem on their own.
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Section 3 Assessment
1. Which of the following is an example of the public sector of the economy?
(a) consumers purchasing goods from a private company
(b) laborers working for a private construction company
(c) government funding for a new national park
(d) individual donations to charity
2. What is government's role in controlling externalities in the American economy?
(a) government tries to encourage positive externalities and limit negative
externalities
(b) government tries to limit all externalities because they represent market failure
(c) government tries to limit positive externalities and encourage negative
externalities
(d) government tries to encourage all externalities so that the market will be
competitive
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Section 3 Assessment
1. Which of the following is an example of the public sector of the economy?
(a) consumers purchasing goods from a private company
(b) laborers working for a private construction company
(c) government funding for a new national park
(d) individual donations to charity
2. What is government's role in controlling externalities in the American economy?
(a) government tries to encourage positive externalities and limit negative
externalities
(b) government tries to limit all externalities because they represent market failure
(c) government tries to limit positive externalities and encourage negative
externalities
(d) government tries to encourage all externalities so that the market will be
competitive
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Providing a Safety Net
• What role does the government play in fighting
poverty?
• What government programs attempt to aid those facing
poverty?
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The Poverty Problem
The poverty threshold is an income level below that
which is needed to support families or households.
• The poverty threshold is determined by the federal
government and is adjusted periodically.
• Welfare is a general term that refers to government aid
to the poor.
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Redistribution Programs
Cash transfers are direct payments of money
to eligible people.
Temporary Assistance for Needy Families (TANF)
This program allows individual states to decide how to best use
federally provided funds.
Social Security
Social Security provides direct cash transfers of retirement income
to the nation’s elderly and living expenses to the disabled.
Stability
Unemployment compensation provides money to eligible workers
who have lost their jobs.
Workers’ Compensation
Workers’ compensation provides a cash transfer of state funds to
employees injured while on the job.
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Other Redistribution Programs
• Besides cash transfers, other redistribution programs
include:
In-kind benefits
• In-kind benefits are goods and services provided by the
government for free or at greatly reduced prices.
Medical benefits
• Health insurance is provided by the government for the elderly
and disabled (Medicare) and for poor people who are
unemployed or are not covered by their employer’s insurance
(Medicaid).
Education benefits
• Federal, state, and local governments all provide educational
opportunities for the poor.
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Section 4 Assessment
1. Welfare includes all of the following EXCEPT
(a) Temporary Assistance to Needy Families
(b) Occupational Safety and Health Administration
(c) Social Security
(d) Medicaid
2. Education programs make the economy more productive by
(a) adding to human capital and labor productivity.
(b) reducing taxes.
(c) providing more jobs in manufacturing.
(d) reducing injuries on the job.
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Section 4 Assessment
1. Welfare includes all of the following EXCEPT
(a) Temporary Assistance to Needy Families
(b) Occupational Safety and Health Administration
(c) Social Security
(d) Medicaid
2. Education programs make the economy more productive by
(a) adding to human capital and labor productivity.
(b) reducing taxes.
(c) providing more jobs in manufacturing.
(d) reducing injuries on the job.
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