Role of Government in Market Economy

JWI 515 Managerial Economics, week10 summary, 12/15

The role of government in business and life became clearer to me from this week's learning. Due to externalities, society needs government regulation and public policy to balance public and private interests and promote economic growth. Government must also fund things that are in society's best interest overall.

Dr DP

JWI 515 Managerial Economics, Week10 Summary, 12/15
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(1) Externalities - unintended effect on third party that is not directly involved in a transaction.
Positive externality: education => Pigovian subsidies or grants paid
Negative externality: Oil spill => Pigovian Sin Taxes used to correct it; encourage main actors to find less harmful ways to operate
Key question: How to measure the full social cost associated with an economic activity ?
Governments make externality a part of the decision making process.

(2) Private goods are exclusionary - when you use them, other people cannot eg. food, clothing
Public goods are non-exclusionary - everyone can use them whether or not they paid for them eg. national defense, police, fire protection, public TV & radio
Free rider problem - consumers avoid paying full share of cost of public good.

(3) If at least one person is better off and no one is worse off - such public projects are Pareto satisfactory.
When all such projects are done, it is Pareto optimal.

(4) Marginal social cost - cost of production + marginal external costs not directly borne by producers or consumers.
Marginal social benefits - sum of marginal private benefits + marginal external benefits.
Social benefits maximized when MSBs across all programs equals MSCs across all programs.
For production of public goods and services, Marginal social benefit must exceed Marginal social cost.

(5) Market failure - one or more criteria for perfect market is violated.
- Not enough buyers and sellers
- product heterogeniety
- entry and exit of market not free
- imperfect information sharing:cost, price, product quality information not known by all buyers and all sellers
- inadequate competition leading to deadweight loss

(6) Corporate Social Responsibility (CSR) is an alternative to government action that could also be profitable for firms.