774 section 14 Market Failure and the Role of Government
3.According to the Coase theorem,when externalities
exist, bargaining will cause individuals to internalize
the externalities,making government intervention un-
necessary, as long as property rights are clearly defined
andtransaction costs—the costs of making a deal—are
sufficiently low. However, in many cases transaction
costs are too high to permit such deals.
4.Governments often deal with pollution by imposing
environmental standards,an approach, economists
argue, that is usually inefficient. Two efficient (cost-
minimizing) methods for reducing pollution are
emissions taxes,a form of Pigouvian tax,and
tradable emissions permits.The optimal Pigouvian
tax on pollution is equal to its marginal social cost
at the socially optimal quantity of pollution. These
methods also provide incentives for the creation
and adoption of production technologies that cause
less pollution.
5.When a good yields external benefits, such as technol-
ogy spillovers,themarginal social benefit of the
goodis equal to the marginal private benefitaccruing
to consumers plus its marginal external benefit.With-
out government intervention, the market produces too
little of the good. An optimal Pigouvian subsidyto
producers, equal to the marginal external benefit,
moves the market to the socially optimal quantity of
production. This yields higher output and a higher
price to producers.
6.When there are external costs from production, the
marginal social cost of a goodexceeds its marginal
private costto producers, the difference being the mar-
ginal external cost.Without government action, the
market produces too much of the good. The optimal
Pigouvian tax on production of the good is equal to its
marginal external cost, yielding lower output and a
higher price to consumers. A system of tradable produc-
tion permits for the right to produce the good can also
achieve efficiency at minimum cost.
7.Communications, transportation, and high-technology
goods are frequently subject to network externalities,
which arise when the value of the good to an individual
is greater when more people use the good.
8.Goods may be classified according to whether or not
they are excludable,meaning that people can be pre-
vented from consuming them, and whether or not they
arerival in consumption,meaning that one person’s
consumption of them affects another person’s con-
sumption of them.
9.Free markets can deliver efficient levels of production
and consumption for private goods,which are both ex-
cludable and rival in consumption. When goods are
nonexcludable, nonrival in consumption, or both, free
markets cannot achieve efficient outcomes.10.When goods are nonexcludable,there is a free-rider
problem:consumers will not pay for the good, leading
to inefficiently low production. When goods are nonri-
val in consumption,any positive price leads to ineffi-
ciently low consumption.
11.Apublic goodis nonexcludable and nonrival in con-
sumption. In most cases a public good must be sup-
plied by the government. The marginal social benefit of
a public good is equal to the sum of the marginal pri-
vate benefits to each consumer. The efficient quantity
of a public good is the quantity at which marginal so-
cial benefit equals the marginal social cost of providing
the good. As with a positive externality, the marginal so-
cial benefit is greater than any one individual’s marginal
private benefit, so no individual is willing to provide the
efficient quantity.
12.One rationale for the presence of government is that it
allows citizens to tax themselves in order to provide
public goods. Governments use cost-benefit analysis to
determine the efficient provision of a public good. Such
analysis is difficult, however, because individuals have
an incentive to overstate the good’s value to them.
13.Acommon resourceis rival in consumption but
nonexcludable. It is subject to overuse,because an indi-
vidual does not take into account the fact that his or
her use depletes the amount available for others. This is
similar to the problem with a negative externality: the
marginal social cost of an individual’s use of a common
resource is always higher than his or her marginal pri-
vate cost. Pigouvian taxes, the creation of a system of
tradable licenses, and the assignment of property rights
are possible solutions.- Artificially scarce goodsare excludable but nonrival in
consumption. Because no marginal cost arises from al-
lowing another individual to consume the good, the ef-
ficient price is zero. A positive price compensates the
producer for the cost of production but leads to ineffi-
ciently low consumption.
15.Antitrust laws and regulation are used to promote com-
petition. When the industry in question is a natural mo-
nopoly, price regulation is used.
16.The Sherman Act, the Clayton Act, and the Federal Trade
Commission Act were the first major antitrust laws. - Marginal cost pricingandaverage cost pricingare ex-
amples of price regulation used in the case of natural
monopoly to allow efficiencies from large scale produc-
tion without allowing the deadweight loss that results
from unregulated monopoly.
18.Despite the fact that the poverty thresholdis adjusted
according to the cost of living but not according to the
standard of living, and that the average income in the
United States has risen substantially over the last 30
years, the poverty rate,the percentage of the popula-
tion with an income below the poverty threshold, is no