Market Failure & Public Choice

Main Point - Under some condition markets can create economic problems and the government can be the solution.

Main Point - Government policy action to deal with problems of market failure needs to recognized the limits of government ability.

Part # 1 - Market Failure

Reading - Market Failure - click here

Practice Problem - Effect of Policies - Sunshine Valley has a problem that its landfill is filling up quickly because the 10,000 people of Sunshine Valley do not recycle. Currently, each person in Sunshine Valley produces 2 bags of trash a week. At this rate, the landfill will be full in one year. Establishing a new landfill will take two years. The town is currently trying to decide between three plans for handling this problem. These are the plans:

• The fist plan is to limit each person in Sunshine Valley to one bag of trash a week – the town will only collect one bag from each person each week. Each person has to find another way of disposing of any additional trash.

• The second plan is to limit each person in Sunshine Valley to one bag of trash a week, but make all recycling free (the town would collect this, but it does not go in the landfill). The government makes money by selling recycling materials.

• The third plan is to put no limit on the amount of trash a person can throw out, but instead charge each person in Sunshine Valley $10 per bag trash and give them a $5 credit for each bag of recycling (the town would collect this, but it does not go in the landfill). The government makes money by selling recycling materials.

A. Which plan do you think is the best plan – explain the reasons this is the best plan?

B. Which plan do you think is the worst plan – explain the reasons this is the worst plan?

Practice Problem - Coase Theorem - Frank’s manure farm is located next to Fran’s restaurant in Sunshine Valley. Currently, Frank makes $200 in profits from running his farm. Fran would have $300 in profits if her restaurant was not affected by the manure farm. However, as could be expected, because of the manure farm, her profits are zero.

A. How is the air a common resource? How is the manure farm a case of a negative externality?

B. How would Frank and Fran solve this problem if Frank has the right to pollute the air?

C. How would the problem be solved if Fran had the right to clean air?

D. What would be the outcome if Frank’s manure farm had profits of $400 and Fran had the right to clean air?

A. In the first program, the government will pass a law that allows each company to only dump 2 tons of pollution into Lake Springfield. What would be the cost of this law on the businesses of Springfield?

B. In the second program, the government sets up a pollution trading system that limited the amount of pollution to 6 tons and issues each company 2 permits (each permit allows the company to dump one ton of pollution into the lake). In this situation, how much will it cost the businesses to reduce their pollution? In your answer, explain how permits will be traded and how that affects the cost to businesses. Important, count any revenues companies gain from selling their permits against the cost to businesses.

C. Which program do you think the town of Springfield should adopt? In your answer consider the economic efficiency of each program and how well each works in establishing incentives and punishments.

D. Local environmental activist, Lisa Simpson, is outraged that the government is willing to tolerate any pollution and vows to protest the adoption of either program. How could you explain to her that the two programs are not the same and that she could use one to eliminate all pollution?

Part # 2 - Public Choice

Reading - Government Failure & Public Choice - click here

Practice Problem - Voting and Public Goods - Consider a society made up of three people (Huey, Dewy & Lewy) who decide everything by majority vote. The society has the choice to engage in a project that will bring benefits of $1150 to the whole society, but will cost in total $900. The cost of the project will be paid equally by all three people in society – everyone will pay $300. However, the benefits will not be spread evenly, Huey will benefit by $700, Dewy will benefit by $250, and Lewy will benefit by $200.

A. Is this project economically efficient?

B. Will this society engage in this project if the decision is made by majority vote?

C. How could Huey make sure that they the vote would support the project?

Supplementary Materials