Lecture: Role of Government Chapter 19 Outline

Rational for government intervention

• Externalities:
• Goods that have third-part effects.
• When a third party is affected by another person’s consumption or production of a good. And price mechanisms to compensate these people.
• E.g. neighbors loud music, smoke, air pollution, contagious diseases (SARs, Bird Flu)
• Problem is that externalities are not reflected in the price of a good.
• Factories don’t pay extra because they made the air dirty (hopefully in the future they will).

Rational for government intervention

• MC: Marginal Cost = Price – Supply Curve

• Price

• Health Care

• D: Demand curve or private
• marginal benefit curve.

• MEB: Marginal external benefit

• MSB: Marginal Social Benefit

• Qm

• Qopt

• Case of immunizations

• Efficient point for society

Rational for government intervention

• MC

• Price

• Health Care

• D

• MEB

• MSB

• Qm

• Qopt

• Case of immunizations

• MC with subsidy

• Policy Response:
• Subsidize price of good.

Rational for government intervention

• Are subsidies to producers passed onto consumers?
• Depends on the slope of the demand and supply curves.

• P1

• P1-S

• P2

• S1

• S2 : after subsidy

• D

• P

• Q

• P

• Q

• Consumer and producer benefits

• Only consumer benefits

Rational for government intervention

• Policy Options for Externality:
• For negative externalities (air pollution, dumping feces into water supplies)
• Subsidy
• Regulation and mandates (laws).
• Public provision/finance of some goods
• immunizations in developing countries have vaccination campaign days and weeks
• disease surveillance
• Charitable externality: can be sufficiently important to justify large social insurance programs.