PO 141: INTRODUCTION TO PUBLIC POLICY Summer I (2015) Claire Leavitt Boston University.

PO 141: INTRODUCTION TO PUBLIC POLICY

Summer I (2015)

Claire Leavitt

Boston University

TABLE OF CONTENTS

• Creative Destruction + the Amorality of Markets

• Government versus Markets, Part I– Monopolies versus competitive economies

• Externalities and Policy Responses• Public Goods and the “Free Rider Problem”• Government versus Markets, Part II

– Redistribution; paternalistic policies (?)

CREATIVE DESTRUCTION

The process by which innovation makes older skills/trades/technologies obsolete

Creative destruction apotheosizes the amorality of markets Losses are often concentrated, but not necessarily

THE GREAT TRANSFORMATION (1944)

Written by Hungarian economist Karl Polanyi

The Industrial Revolution was one of the most important sociopolitical events in history

The IR disembedded the market from other political institutions; the market became self-regulating and free from government intervention

Other social countermovements emerged in response

THE GREAT TRANSFORMATION (1944)

Because of the natural boom-bust cycles of capitalism (liberal markets), people responded to far-right nationalistic political parties that promised to alleviate human misery by state control of the economy

Lesson: Utter fealty to and prioritization of the free market has (often disastrous) political consequences

AMORAL MARKETS

Other instances of amoral markets? Some examples of markets that should not exist?

PROPERTY RIGHTS

Control of a unit of personal property—a material good, an asset, an artistic creation or invention It is the government’s responsibility to define and defend property rights

GOVERNMENT AND THE MARKET

Government ensures that markets can operate—it ensures that people can engage in voluntary transactions and make the most efficient use of resources

Government ensures/provides: Universality of the medium of exchange (currency)

Information (food labeling)

Regulation (legal protection)

GOVERNMENT AND THE MARKET

Government promotes competition

Monopoly versus competitive market:

In a monopolistic economy, a firmwill produce less and earn more In a competitive economy, firms willproduce more and earn less

COMPETITIVE MARKETS

In a competitive market, the fight to capture the most demand (customers) means that suppliers will charge a price very close to the marginal cost because….

…there will always be a firm willing to sell a good/service for less as long as it can still make a profit

MONOPOLIES

In a monopoly, one entity controls all production of a certain good or service

As a result, a monopolistic firm can charge higher prices, as expected—but it will also produce less. Why?

A monopolistic firm can make more profit producing less and charging more than by producing more and charging less!

MONOPOLIES

If a monopolistic firm lowers its price, it sells more units (demand increases), but it could have sold just as many units for a higher price! So why would a monopolistic firm ever lower its prices?

A monopolistic firm has to weigh the costs of production of the good against potential profit from the sale of the good. Since it costs money to produce, why would a monopolistic firm produce more than it has to?

MONOPOLIES

Assume a good costs $10 to produce

Firm sells good for $20 and makes 20 units Revenue: 20 x $20 = $400 Cost: 20 x $10 = $200

Profit = $200

Firm sells good for $11 and makes 20 units Revenue: 20 x $11 = $220 Cost: 20 x $10 = $200

Profit = $20

MONOPOLIES

Firm sells good for $20 and makes 15 units Revenue: 15 x $20 = $300 Cost: 15 x $10 = $150 Profit = $150

Firm sells good for $11 and makes 25 units

Revenue: 25 x $11 = $275 Cost: 25 x $10 = $250 Profit = $25

If the cost of a good remains constant, a firm will charge more and produce less!

MONOPOLIES IN THE REAL WORLD

Government tries to ensure monopolies do not exist because monopolies are disastrous and unfair for the consumer

Firms (in an ideal world) want to prevent competition and increase their profits at the expense of the consumer

Firms may collude (via cartels) with other, similar firms and collectively act as a monopoly. Government oversight should prevent this.

INDIVIDUAL VERSUS SOCIAL COST

What is the individual cost of driving an SUV?

Cost of the car; cost of gas; benefit of beingsafer on the highway

What is the social cost of driving an SUV? Increased carbon emissions and environmental damage; putting drivers in smallercars at greater risk; encouraging other drivers tobuy SUVs

EXTERNALITIES

Negative externalities result when individuals engage in market transactions that impose a cost on innocent parties (parties that were not involved in the transaction)

Increased carbon emissions and environmental damage; putting drivers in smaller cars at greater risk; encouraging other drivers to buy SUVs…

…are all negative externalities of the choice to drive an SUV

EXTERNALITIES

Market equilibrium quantities/prices of a good do not take externalities into account; market equilibrium quantities are determined by price (e.g., what are consumers willing to pay after factoring in the individual cost to themselves?)

Social welfare demands a new equilibrium: Where the price of a good factors in the social cost of that good (what society as a whole pays, not just what a consumer or a firm pays)

THE CARBON TAX (?)

The price of gasoline in the United States does not account for the negative externalities of burning fossil fuels (e.g., environmental damage) Possible policy response: Carbon taxing (direct tax on the CO2 emissions of various

fossil fuels)

Pros and cons?

THE CARBON TAX (?)

Effects of a carbon tax?

CAP-AND-TRADE

The price of gasoline in the United States does not account for the negative externalities of burning fossil fuels (e.g., environmental damage) Possible policy response: Cap-and-trade scheme

Pros and cons?

CAP-AND-TRADE

Cap the amount of CO2 (or other pollutant)

firms are allowed to emit per year

Issue emissions permits to firms that collectively add up to the capped amount

Allow firms to trade with one another (according to market dictates governing allocation of scarce resources) for ownership of the permits

WHAT ELSE CAN GOVERNMENT DO?

Can the market allocate all kinds of scarce resources? No. Markets allocate scarce private resources; what about collective resources?

Fish and wildlife National security Clean water and air

Markets cannot efficiently and fairly regulate collective resources

COLLECTIVE RESOURCES

What are the characteristics of collective resources?

They are noncompetitive (consumption of the good does not reduce the amount available to others or, once a lighthouse protects one ship, it protects them all)

They are nonexclusive (a person who didn’t contribute to paying for the good can still enjoy the good)

THE FREE-RIDER PROBLEM

Occurs when some of the people who benefit from a good/resource do not pay for that good/resource

Effects:

a) the good is under-produced—not enough people contribute to the good’s actual cost

b) the resource is over-used—everyone gets to use the resource, not just the people who pay for it

THE FREE-RIDER PROBLEM

Policy responses to the free-rider problem? Taxation—government can force citizens to pay forconsumption of the public good (roads, environmental protection, national security, lighthouses)

Examples: Union dues and collective bargaining; “right-to-work” laws

Advocacy groups

The $300 billion “tax gap”

ALLOCATION/REGULATION OF GOODS

Who produces these goods and/or decides how they are distributed?

Private goods (shoes, cars, smartphones)

Club goods (pools, gym equipment, golfcourses, membership benefits)

Public goods (lighthouses, national intelligence)

Common-pool resources (air, wildlife, oceans)