MARKET FAILURES POLITICS AND REGULATION Market failure equilibrium

MARKET FAILURES, POLITICS AND REGULATION Market failure: equilibrium price ≠ marginal utility of consumers or price ≠ marginal cost of output unit Market failure = inefficient allocation of resources Sources of market failures: 1. monopoly power; 2. externalities; 3. imperfect information Economic regulation: limit entry into a particular industry and control both price and service quality. Source of it: natural monopoly but also other reasons The capture hypothesis: regulators serve the interests of regulated firms (who have „captured” them through the political process), not of consumers 1

IS CAPTURE HYPOTHESIS RIGHT? Turns on its head the idea that economic regulation protects the public interest from monopoly Some examples of industries that like being regulated: airlines and telephone companies. A case when a small group of firms prevail politically against the interests of many consumers. How is it possible? Because it is harder to organize a large number of people who care only a little about than a small, wealthy group that cares a lot Regulators are political like legislators but they do not react only to the political power of regulated firms 2

SOCIAL REGULATION Deals with externalities such as air pollution or asymmetric information An externality – action of a household or a firm directly affects other households or firms and these spillover effects not fully reflected in market prices The capture hypothesis not very helpful here Regulated firms not a small easily organized group Usually large groups involved: workers, green movements, consumers 3

Government and market failures Better access to public goods Externalities and optimal regulation Better information Less inequality in income distribution Protection of competition Stabilization of the economy 4

Public goods A private good- a good that if consumed by one person can not be consumed by another (a cake). A public good- a good that even if consumed by one person, is still available to others ( a clean river, national defense) The „free - rider” problem. No incentive to buy a piece of national defense – some one else shall do it Government decides how much of each public goods should be produced: Patents motivate private firms to invest in R&D Highway tickets motivate private firms to invest in highway construction 5

Results of the UN climate conference in Durban Reduction of carbon dioxide from 20% to 30% (2020) difficult to achieve US, China and Russia do not agree on Kyoto agreement Does it mean that industry equally important as climate protection? Poland keeps temporary surplus of rights to emission Poland allowed to sell the surplus to other countries (value of 2 billion euro) Prices of those rights going down What does it mean? Prices of energy will be growing slower (Rzeczpospolita, Dec. 13 th. 2011) 6

Externalities Negative and positive externalities Pollution- private costs and social costs. Market price does not cover the social cost of pollution Positive externalities repainting the house, social benefits > private benefits Externalities caused by „missing markets” – consumption (waste in the river) or production (nice views) of goods with no prices Externalities - a form of public goods 7

Externalities control A pollution tax paid by firms that cannot reduce pollution not used in the US, but applied in Germany US experience – 1) engineering standards: firms obliged to use certain types of devices reducing pollution, 2) performance standards permitted limits of pollution Standards prevent firms to diminish costs of pollution reduction but do not motivate to higher pollution reduction, And… have side effects – no incentive to replace older cars polluting more Are standards easier and more practical to apply than taxes? Which one costs less? 8

Taxes versus engineering standards Some money could be saved by using pollution taxes But how to calculate a tax rate? Marginal cost and marginal benefit difficult to estimate Other solutions? Permits specifying a permissible level of pollution -as in performance standards, but firms are allowed to buy and sell permits(tradeable permits approach) Effects: minimization of cost reduction and a desired level of pollution reduction achieved 9

Imperfect information Asymmetry in buyers and sellers access to information: chemicals causing cancer at work place, unsafe toys The private costs , social costs, over production of goods involving risk Firms no incentive to study long run health hazards to which workers or kids exposed State intervention-higher wages to pay for high risk jobs, regulation concerning safety standards, working conditions, information labels on goods Should seat belts and air bags be obligatory? Are people making decisions they should be making? 10

Regulatory failures Successful regulation needs a good understanding of causes and effects, costs and benefits of regulation A conflict over the value of regulation between those who argue for cost-effective regulation and those who argue that certain values (health, life) beyond economic calculation Regulatory reform: how to improve the quality of regulation Efforts of OECD and EU Commission 11

Deregulation Strong deregulation movement in the late 1970 s and early 80 s The role of economists: arguments that regulation did not serve the public interest Regulators own goalss „stay in the business as long as possible” A strong support of competition in such industries as telecommunication, airlines, gas production Deregulation started, airlines the most favorite case Its effects (1970 -1984): costs per passenger mile have fallen substantially, per capita miles flown doubled 12

Should the state take care of equal income distribution? Income distribution produced by free market has no ethical claim to be fair Private markets can produce many different final distributions Modern governments engage in income redistribution Modern governments engage to ensure the right level of consumption of particular goods Income redistribution tools: taxes, transfers 13

Government limits market power and protects distribution The role of deregulation Effects of deregulation in airline transport, telecommunication: prices go down, productivity goes up, economy more innovative Privatization and nationalization- forms of regulation and deregulation Cartels and collusions illegal Regulation controlling fusions and firms takeover 14

Government makes economy more stabile Financing of R&D Changing structure of the economy through taxes and subsidies: agriculture versus industry, machine building versus raw materials industries Regional policy, the role of EU structural funds Modification of fluctuations of the business cycle Fiscal and monetary policy helps to keep the economy close to the full employment 15