The Market and The Government (ESP Chapter 10) (Problems with perfect…
The Market and The Government (ESP Chapter 10)
The Market and Efficiency
Market demand is equal to marginal social benefit
And market supply equals marginal social cost
In a free market, the amount that is provided will be the intersection of the demand and supply curves
And this quantity will also be the socially efficient one
If the right conditions hold...
The Market and Equity
One definition of equity could be full equality. e.g. equality of opportunity in education, or equal treatment for equal need in healthcare
Another could be minimum standards, e.g. minimum quality of housing, minimum level of income.
The market doesn't have a mechanism to ensure either definition e.g. people's incomes are determined in the labour market by the resources they can supply and the demand for them e.g. skills, property, capital to lend for profit.
Initial distribution of these resources are uneven, so full equality is unlikely.
Equally, there are likely to be individuals with low resources whose income therefore falls below a minimum standard definition of equity.
Problems with perfect demand
Lack of information for the consumer
Irrational consumer behaviour
Externalities - private benefit != social benefit
Problems with perfect supply
Lack of information for the producer
Externalities - private cost != social cost
Barriers to competition form monopolies
The Government and Efficiency
Government providers are usually monopolies without inducement to efficiency from competition or the threat of bankruptcy.
The problem of lack of consumer information may be overcome if it is true that public sector workers are altruistically motivated. Inefficiency would then be less likely to result from a poor benefit, but over-benefit that doesn't take account of the full social cost.
Tax and Subsidy
Taxes and subsidies move prices away from the supply/demand equilibrium and cause individuals to consume less or more than the efficient level. This may be intentional.
Subsidies cause excess demand and government must either meet all the demand (causing inefficiency because costs exceed benefit) or ration demand in a different way e.g. through waiting lists or decisions by bureaucrats, managers or professionals.
Taxes and subsidies convey incorrect information about the scarcity of a commodity. Government will have to try and find another way of determining the efficient level of output - and that is hard.
Voting may be attempted to indicate preference about government allocation, but this favours the median voter (to appeal to the largest number of voters).
Additionally, voters vote for a package of policies and can't give weight under a one vote system to particular priorities. It also opens up the information problem, since voters may not be adequately informed about the costs/benefits of political proposals.
If government knew the costs and benefits exactly, it could compel producers to the appropriate level through regulation - but it's too difficult to calculate.
Regulator capture can result from the regulators and the regulated forming too close a relationship.
Over-regulation can stifle innovation and entrepeneurship.
Price regulation impedes information transfer through prices just as taxes and subsidies do.
The Government and Equity
Replacing a monopoly private supplier with a government one may be more equitable in terms of the distribution of income as a result, and perhaps the likelihood of monopoly exploitation.
Tax and Subsidy
Minimum standard equity is likely to be achieved by a subsidy, though there are issues with both means-tested and universal subsidies.
Means-tested subsidies are targeted correctly but may suffer from issues of social stigma, administrative complexity, and marginal tax rate (welfare vs work).
Universal subsidies are not well targeted and can provide benefits to richer individuals who do not need it, inequitable. Excess demand can also require non-price rationing which can favour richer individuals.
Price controls can have perverse consequences for equity, like reducing the number of available jobs from a minimum wage, reducing the supply of housing through rent control.
Quality controls can restrict supply of labour boosting incomes inequitably, or preventing competition inequitably increasing the profit of existing producers.