Chapter 5: The Public Sector

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Chapter 5 The Public Sector
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Economic and technical efficiency

• Technical efficiency no unemployed or
  underemployed resources (i.e., operating on PPC).
• Economic efficiency (also known as Pareto
  optimality) it is not possible to benefit one
  or more individuals without harming someone else
• Technical efficiency is a prerequisite for
  economic efficiency (but does not guarantee
  economic efficiency)

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Markets and economic efficiency

• voluntary trade in markets benefits each trading
  partner
• under ideal conditions, markets attain a state of
  economic efficiency (Pareto optimality)

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Market failure

• Markets may fail to achieve economic efficiency
  as a result of
• imperfect information
• externalities
• public goods
• the absence of property rights
• monopoly, or
• macroeconomic instability

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Imperfect information

• One party may not benefit from a market
  transaction if there is imperfect information
  about the item being sold
• Possible corrective action
• product labeling requirements (listing
  ingredients or including warnings)
• requiring guarantees (such as lemon laws)
• requiring truth in advertising
• licensing workers in certain professions
• providing public information about products

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Externalities

• Externalities are side effects of production or
  consumption that affect individuals not directly
  involved in the activity or transaction
• Positive externalities occur when one or more
  parties not involved in the transaction benefit
  from the activity
• Negative externalities occur when third parties
  are harmed.

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Positive externalities

• Those engaged in the transaction do not take the
  external benefits into account in their decision
  making
• This results in underproduction
• Possible remedies
• subsidy
• regulation

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Negative externalities

• Negative externalities result in social costs
  that are not borne by the parties involved in the
  transaction.
• results in overproduction
• Possible solutions
• taxation
• regulation

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Internalizing externalities

• The use of taxes or subsidies to correct for an
  externality is sometimes referred to as
  internalizing the externality.

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Public goods

• nonrival in consumption (one persons consumption
  does not affect the quantity or the quality of
  the good available to others)
• free-rider problem results in underproduction
• Possible solutions government production or
  subsidization

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Common property resources

• problem of the commons - resources are commonly
  owned
• benefits are received by those who use the
  resource
• costs are shared by all
• overutilization
• government regulation

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Monopolies

• higher prices and lower output
• antitrust law, regulation, or public production

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Macroeconomic instability

• economic inefficiency caused by unemployment
  during recessions
• government policies designed to stabilize the
  economy

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Public choice theory

• government policy is constructed by
  self-interested individuals
• participants in policy formation are concerned
  about their own self interest, not the public
  interest
• economic rent - a payment in excess of
  opportunity costs
• rent-seeking behavior on the part of
  special-interest groups

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Economic policy

• Microeconomic policy - designed to correct for
• imperfect information,
• externalities,
• public goods,
• the absence of property rights, and
• monopolies.
• Macroeconomic policy - designed to enhance
  macroeconomic stability and encourage economic
  growth.