Reasons for

1
Reasons for Government Intervention in the Market
2
Markets and the Role of Government

• Government intervention and social objectives
• The objective of social efficiency
• marginal social benefits and costs
• MSB gt MSC ? produce (or consume) more
• MSC gt MSB ? produce (or consume) less
• socially efficient output where MSB MSC
• Equity
• concepts of fairness
• Trade-offs between equity and efficiency

3
Types of Market Failure

• Externalities
• External costs of production MSC gt MC

4
External costs in production
Costs and benefits
O
Quantity
5
External costs in production
MSC
MC S
Costs and benefits
D
P
O
Q1
Quantity
6
Types of Market Failure

• Externalities
• External costs of production MSC gt MC
• External benefits of production MSC lt MC

7
External benefits in production
MC S
Costs and benefits
D
P
O
Q1
Quantity
8
External benefits in production
MC S
MSC
Costs and benefits
D
P
O
Quantity
9
External costs and benefits in production
MSC
MC S
MSC
MC S
Costs and benefits ()
Costs and benefits ()
D
P
D
P
O
O
Q
Q
Q
Q
2
1
2
1
Quantity
Quantity
(a ) External costs
(b) External benefits
10
Types of Market Failure

• Externalities
• External costs of production MSC gt MC
• External benefits of production MSC lt MC
• External costs of consumption MSB lt MB

11
External costs in consumption
Costs and benefits
D
P
O
Quantity
12
External costs in consumption
Costs and benefits
D
P
MSB
O
Q1
Quantity
13
Types of Market Failure

• Externalities
• External costs of production MSC gt MC
• External benefits of production MSC lt MC
• External costs of consumption MSB lt MB
• External benefits of consumption MSB gt MB

14
External benefits in consumption
Costs and benefits
D
P
O
Q1
Quantity
15
External benefits in consumption
Costs and benefits
D
P
MSB
O
Q1
Quantity
16
External costs and benefits in consumption
Costs and benefits ()
Costs and benefits ()
P
P
P
P
MSB
MB
MB
MSB
O
O
Rail miles
Car miles
(a ) External costs
(b) External benefits
17
Types of Market Failure

• Public goods
• non-rivalry
• non-excludability and the free-rider problem

18
Types of Market Failure

• Market power
• lack of social efficiency

19
A monopolist producing less than the social
optimum

O
Q
20
A monopolist producing less than the social
optimum

MC MSC
P1
P2 MSB MSC
MC1
AR MSB
MR
O
Q
Q2
Q1
21
Types of Market Failure

• Market power
• lack of social efficiency
• deadweight welfare loss under monopoly

22
Deadweight loss under monopoly
MC ( S under perfect competition)

Consumer surplus
Producer surplus
AR D
O
Q
(a) Industry equilibrium under perfect competition
23
Deadweight loss under monopoly
MC ( S under perfect competition)

Consumer surplus
a
Ppc
Producer surplus
AR D
O
Qpc
Q
(b) Industry equilibrium under monopoly
24
Deadweight loss under monopoly
MC ( S under perfect competition)

Consumer surplus
Producer surplus
AR D
O
Q
(a) Industry equilibrium under perfect competition
25
Deadweight loss under monopoly
MC ( S under perfect competition)

Consumer surplus
a
Ppc
Producer surplus
AR D
O
Qpc
Q
(b) Industry equilibrium under monopoly
26
Types of Market Failure

• Ignorance and uncertainty
• by consumers
• by firms
• Immobility of factors and time lags
• Protecting peoples interests
• dependants
• merit goods

27
Government Intervention in the Market

• Taxes and subsidies
• to correct externalities

28
Using taxes to correct a market distortion
Costs and benefits
O
Quantity
29
Using taxes to correct a market distortion
MSC
MC S
Costs and benefits
D
P
O
Q1
Quantity
30
Using taxes to correct a market distortion
MSC
MC S
Costs and benefits
P
D
O
Q1
Quantity
31
Using subsidies to correct a market distortion
MC S
Costs and benefits
D
P
O
Q1
Quantity
32
Using subsidies to correct a market distortion
MC S
MSC
Costs and benefits
D
P
O
Quantity
33
Using subsidies to correct a market distortion
MC S
MSC
Costs and benefits
P
D
O
Q2
Q1
Quantity
34
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

35
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

36
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

37
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

38
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

39
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

40
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

41
The Virtue Matrix generating corporate social
responsibility
4
3
Socially beneficial and potentially profitable
Socially beneficial and unprofitable
THE 'FRONTIER'
Response to laws and regulations
Response to social norms
CIVIL FOUNDATION
1
2
42
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

43
The Virtue Matrix generating corporate social
responsibility
4
3
Socially beneficial and potentially profitable
Socially beneficial and unprofitable
THE 'FRONTIER'
Response to laws and regulations
Response to social norms
CIVIL FOUNDATION
1
2
44
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

45
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