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Market Failure and Government Intervention

take effect, and 2012, Mr. Lloyd said. It would [add about $1,000 to the cost of a new car] in the state by 2015.2

That the social supply curve for cars is $300 above the private supply curve.

There are also negative consumption externalities and positive production externalities and the media are loaded with examples.  After all “third parties” are people are affected by other peoples’ business, and when they get incensed about it, it becomes news.  

Externalities  prevent the private market equilibrium from correctly delivering the social optimum.  To correct such a market failure, the government can intervene in a number of ways:

1.Prohibitions on production or consumption.  Prohibitions are suited to goods which produce clear public harm without compensatory public benefit.  In the United States this kind of intervention is used for many types of drugs, other harmful products, prostitution, violence, and a wide number of antisocial behaviors.

2. Nationalization or Public Enterprise.  When a good is highly dangerous but has a clear, offsetting, and overriding benefit, the government may nationalize a private firm or go into business itself as a public enterprise.  The government sets up public enterprises like NASA to run the space program, the U.S. Post Office, the public education system, and many other services.

3. Regulation.  The government can directly limit prices, output, profit, conduct, and performance of a firm.  The government closely regulates utilities, government contractors, the banking system, and firms engaged in national security.

4. Taxes and Subsidies.  Taxes and subsidies can be tailored in such a way that they force a firm to pay the full cost (or receive the full benefit) of an externality.  For example, government imposes specific taxes on cigarettes, alcohol, gambling and other slightly deleterious luxuries.  On the other hand, it has subsidized semiconductors, synthetic fuels, American shipping, and other industries contributing to national security.

5. Creating new markets or adjusting existing ones.  Often a market failure can be corrected by changing market incentives.  For example, states like California have created pollution rights to streams or environments.  If environmentalists wish to buy the pollution rights, they can and pollution will be prevented.  However, if firms receive the highest bid, they can pollute according to the right that they purchase.

Generally the least intrusive or restrictive form of government intervention should be used to correct distortions due to externalities.  

C.  Divisibility and Excludability

A pure private good or service can be divided into infinitely small units for

2 http://online.wsj.com/search/0,,,00.html - SB108682890293233452

California Is Set To Crack Down On Car Emissions

June 10, 2004; Page D6

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