The answers should be 1 short paragraph for each subpart.
a) Explain why, in the microeconomics view of the world, the operation of the private market as a default, maximizes economic efficiency--hence, why government intervention on efficiency grounds has to be specifically justified by particular circumstances.
b) What are the 3 specific circumstances, where the operation of private markets does not maximize economic efficiency, hence, where government intervention is conceptually justfied on efficiency grounds?
c) Picking 2 of the 3 examples from part (b), draw diagrams which show how the market responds to the optimal government intervention designed to correct the efficiency problem, and explain, with appropriate lettering in the figures,, the net economic effects on all of the affected parties, and the net efficiency effect that results when the "market failure" is fixed through government intervention.
d) Explain the conservative critique of the accounting result obtained in part (C), and the more general critique of the philosophy that government intervention is justified to fix the efficiency probblem in such cases. Please see attached handout on "market failure" versus "government failure" for explanation of these 2 terms.
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a. In the free market, an "invisible hand" is thought to control prices and therefore quantities demanded and supplied. This force is really the result of certain goods being more scarce or difficult to obtain. These goods command a higher price because the supply of them is more limited. Producers cannot make them easily or cheaply, so they must pass these costs along to the customer. Thus the market allocates goods efficiently - those that are important but scarce are more expensive, signaling buyers to use them carefully. You don't use diamonds to clean your fixtures, for example. It fails for only a few specific reasons. They include: (1) inability to exclude nonpayers from consumption (2) limited competition and market control by either buyers or sellers (3) external costs or benefits that are not reflected in demand price or supply price, or (4) limited or imperfect information about the product or market transaction by either buyer sellers.
One example of government interfering to the detriment of the economy are minimum wage laws. Some economists argue that minimum wage laws cause unnecessary unemployment, for the same reason that a minimum price on anything will decrease the quantity of it that people purchase. If a minimum wage law is passed that makes it illegal to pay less than M per hour, employers will continue to keep on payroll only those workers whose hourly work brings in more than M in revenues. Consequently, those workers who are least productive, and therefore are likely to be paid the least before a minimum wage, are also the ones most likely to become unemployed after a minimum wage is implemented.
b. While in theory the private market should allocate goods efficiently, in practice it often doesn't. This is because the prices in the market do not always reflect its true cost to society. For example, the price of gasoline reflects the costs of drilling the oil and refining it. But it doesn't include the cost of medical care for people who live in smoggy cities and develop lung diseases. This is because these ...
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