| UNIT TWO |
CHAPTER 5
The Economic Role of Government
I. What
is Government?
A. The entity that
has a monopoly over the legitimate use of force to modify the actions of adults.
B. An
institutional process through which individuals collectively make choices and
carry out activities.
II.
Differences and Similarities Between Market and Collective Action
A.
Competitive behavior is present in both the market and public sectors.
B.
Public‑sector organization can break the individual
consumption‑payment link.
C.
Scarcity imposes the aggregate consumption‑payment link in both
sectors.
D.
Private sector action is based on voluntary choice; public sector (when
democratic) is based on majority rule.
E.
When collective decisions are made legislatively, voters must choose
among candidates who represent a bundle of positions on issues.
F.
Income and power are distributed differently in the two sectors.
III. The Cost of Government
A. The Opportunity
Cost of Government is the Sum of the Following
1. Opportunity cost of resources
used to produce goods supplied through the public sector.
2.
Cost of resources expended in the collection of taxes and the enforcement
of government mandates
3.
Excess burden (deadweight loss) of taxation.
IV.
Economic Efficiency and the Role of Government
A.
Economists often use concept of efficiency to judge actions because
efficient use of resources implies maximum value of output from resource base.
B. Two conditions
are necessary for ideal economic efficiency:
1.
All activities that provide individuals with more benefits than costs
must be undertaken.
2.
No activities that provide benefits less than costs should be undertaken.
C.
Protective Function of Government: The most fundamental function of
government is the protection of individuals and their property against acts of
aggression.
1.
Involves the maintenance of a legal structure (rules) within which people
interact peacefully and have a process for the settlement of disputes.
D.
Productive function of Government
1. Involves the provision of a limited set of goods that are difficult to supply a good through the market.
V. The
Role of Government and Shortcomings of the Invisible Hand
A.
There are four major reasons why invisible hand may fail to allocate
resources efficiently: (1) Lack of competition, (2) Externalities, (3) Public
goods, and (4) Poor information.
1.
Lack of Competition: Sellers may gain by restricting output and raising
price. Too few units will be produced.
2.
Externalities—Failure to Register Fully Costs and Benefits
a.
External cost: Present when the actions of an individual or group harm
the property of others without their consent. Note problem arises because
property rights are imperfectly
defined and/or enforced.
(1) Because costs are not fully registered, supply curve understates the true cost of production.
(2) Units may be produced that are valued less than their cost.
(3) From the viewpoint of efficiency, too many units are produced.
(4)
Pollution problems are often a side effect.
b.
External benefits: Present when the actions of an individual or group
generate benefits for nonparticipating parties.
(1)
Demand curve understates total value of output.
(2)Units
that are more highly valued than costs may not be produced.
(3)
From the viewpoint of efficiency, too few units may be produced.
B.
Public Goods
1. Goods that are (a) jointly consumed--individuals
can simultaneously enjoy consumption of same product or service and (b)
nonexcludable--consumption of the good cannot be restricted to the customers who
pay for it.
a.
If a public good is made available to one person, it is simultaneously
made available to others.
b.
Because those who do not pay cannot be excluded, no one has much
incentive to help pay for such goods. Each
has an incentive to become a free rider, a person who receives the benefits of
the good without helping to pay for its cost.
c.
But when a lot of people become free riders, too little is produced.
d.
Note: It is the characteristics of the good, not the sector in which it
is produced, that distinguishes a public good.
e.
Examples of public goods: national defense, radio and television
broadcast signals, and clear air.
f.
Markets often develop ways of providing public goods (e.g. use of
advertising to support provision of radio and television.) Nonetheless, public
goods often cause a breakdown in the harmony between self‑interest and the
public interest.
C.
Problems Arising From Poor Information
1.
The consumer’s information problem is minimal if the item is purchased
regularly.
2.
Major problems of conflicting interests and unhappy customers can arise
when goods are either (a) difficult to evaluate on inspection and seldom
repeatedly purchased from the same producer or (b) potentially capable of
serious and lasting harmful side effects that cannot be predicted by a lay
person.
3.
Asymmetric information: Either the potential buyer or potential
seller has important information that the other side does not have.
a.
Lack of information, may cause a party to agree to an exchange they will
later regret.
