I. Market Failures and Regulation 447require the company to lower prices. Subsequently, the company voluntarily
reduced AZT’s price by 20 percent.
The story of AZT’s development and introduction raises a number of questions.
What roles should private firms and government regulators play in bringing thera-
peutic drugs to market? How should safety be ensured? How should prices be set?Ours is a mixed economy. Private markets provide an astonishing variety of
goods and services. But there are many things they cannot guarantee, includ-
ing safe streets, clean air, national security, an educated citizenry, and protec-
tion from potential carcinogens. Indeed, government sets the most basic
ground rules without which private markets could not function. Government
policies and laws define and enforce basic property and contractual rights of
business firms and individuals. The government also acts to ensure open and
free competition. Finally, the government produces or buys many public goods,
from defense expenditures to highways. The government finances its expen-
ditures through tax revenues or public borrowing.
The role of government in economic decision making encompasses three
broad areas: microeconomic, macroeconomic, and distributive. Government’s
microeconomic role is to provide certain public goods and services, undertake
public investments, and regulate operations of private markets. Government’s
macroeconomic task is to help steer the course of the aggregate economy:
reducing the frequency and severity of recessions, promoting economic growth,
and maintaining low rates of inflation and unemployment. In its distributive
role, government attempts to reduce income inequality; ensure minimum
health, education, and living standards; and improve the welfare of the poor.
Many government programs serve more than one goal. For instance, a pro-
gram of increased expenditures may stimulate an economy threatened by reces-
sion, redistribute income, and finance spending on particular government
budget categories.
This chapter focuses on the microeconomic function of government. In
this sphere, the government has two main roles: (1) to regulate private markets
by providing basic rules and correcting for market failures that would otherwise
result in inefficient production or consumption, and (2) to provide certain
desirable public goods and services that are not, or cannot be, provided via
private markets. Part I of this chapter focuses on regulation; Part II applies
benefit-cost analysis to evaluate public programs.I. MARKET FAILURES AND REGULATION
Private markets depend on well-defined property rights. In modern economies,
the person on the street sometimes takes property rights for granted. (This is
not so in some developing countries, where government politics, judicial fail-
ures, and even corruption have hindered the development of private markets.)c11RegulationPublicGoodsandBenefitCostAnalysis.qxd 9/29/11 1:34 PM Page 447