Tracy EminFeb 14, 2014
St. Vincent can’t come soon enoughFeb 5, 2014
In a purely competitive, fully informed market place there is very little need for ethics or regulatory law because all players act from self-interest. According to classic economic theory individuals are always motivated to pursue their own self-interest.
However, when the market fails, two things happen:
a. The outcome does not maximize public welfare, and
b. Individual players acquire discretionary power
In this manner monopolies can exploit consumers, polluters can off-load costs, free riders can ride without paying and knowledgeable actors can take advantage of those with less knowledge. Market failures provide the moral free space for individual actors to infringe on the interests and rights of other actors. Such situations call for some form of regulation by government (law) or some form of restraint (self-regulation) by the actors themselves (ethics = the study of the moral responsibility of the individual).
The premise of this course is that the market does not always work and when this happens we have what is known in economic terms as a “market failure”. When markets fail there are two possible remedies; either, government regulation through the enactment of laws and/or judicial decision making or voluntary individual self-regulation by following one’s ethical or moral guideposts. It is these market failures that create the need for government and self- regulation by means of laws and ethical standards. If a market failure does not exist then you do not have a legal or ethical problem.
The basic motivation for this course is that you are not going to work in a perfectly competitive market world based on pure self-interest (classic economic theory). For various reasons, markets fail and when they do some form of restraint is required to prevent those who have power from abusing those who do not. Sometimes this restraint takes the form of a law, but it can also result from self-regulation or the ethics of the economic actors themselves. Most importantly, from the standpoint of this course, the failure of markets requires us to develop new conceptual and analytical frameworks for describing and evaluating actions in these situations. In short, the message of this course is that markets fail. And when markets fail regulatory and ethical remedies are required.
The first reading, Economic Theories of Regulation by Linda N, Edwards & Franklin R. Edwards, defines the four major market failures.
A natural monopoly occurs when the cheapest way to produce something is for only one firm to produce it. Although one firm (natural monopolist) produces the product it is a market failure because you will need to pay the price charged by the natural monopolist. The price will be set above marginal cost causing fewer goods to be produced and consumed.
Market failure: Fewer goods are produced and consumed.
Solution: The typical solution is governmental regulation in the form of price, output or profit controls.
Purepublic goods possess the two characteristics: jointness of supply and non-excludability. Quasi-Public Goods consist of one out of the above two characteristics, e.g. either (a) jointness of supply or (b) non-excludability.
a. Jointness of supply: Cannot divide it and resell it.
Once something exists it costs society nothing to allow another person to use it. It is sub-optimal to exclude anyone from using the good. In a free market economy no regulation is required because a supplier can sell his good repetitively to different individuals for profit. A public good, like a road, cannot be reproduced, divided and sold for individual profit/use so government intervention is warranted.
People cannot be excluded from enjoying or consuming the public good even though they contributed nothing to its production. The supplier of the public good is prevented from selling it for a profit.
Market failure: Goods do not get produced or get produced in less than optimal quantities.
Solution: Government provides the goods.
This occurs when goods have external effects. Exists where there is a divergence of the private and social costs of production or consumption, e.g. when either:
a) Social costs > private costs.
b) Social benefits > private benefits.
Market failure: the private market does not permit those who are harmed to demand and obtain compensation from those who harmed them or the person who confers a benefit upon others to be remunerated by the benefited parties.
Solution: The government intervenes because it can reduce the transaction costs associated with collective action or coerce parties to act in a different way. Concerted private action is impractical and the transaction costs of organizing a big group for collective action are too high.
The most pervasive of the four market failures asks: do individuals possess adequate information upon which to base their decisions? There is something special about information as it is not typically bought and sold. Information, like public goods, possesses jointness of supply because once information exists the cost of a marginal person using the information is zero and non-excludability since the information can be used without using it up. Unlike most commodities, information can be used over and over again without being used up which drives the price of information to zero.
Solution: Since much information is for the public good the government corrects this market failure by either:
a) collecting, evaluating and dispensing information OR
b) regulating product quality (licensing & certification standards) and the flow of information between buyers and sellers (labeling & truth in advertising).
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