Question

Perfect competition will not necessarily be efficient or equitable. You will also learn how government can correct for free market failures. Up until now, we have looked at partial equilibrium analysis that examines only one market at a time. But a good economist knows that changes in one market can affect many other markets as well. Go back to the chapter of demand and supply. We know that demand for a particular product is affected by the price of substitutes and the price of complements. The following is a partial list of potential substitutes for gasoline:

Motorcycles

Bicycles

Mass transportation

Electricity

Natural gas

Water (hydrogen)

Walking

And I am sure there a many others. In the past chapters, we learned how a decrease in the supply of gasoline affected the price of gasoline (partial equilibrium analysis), but an increase in the price of gas would cause the demand for substitutes of gas to shift to the right and complements of gas to shift to the left. General equilibrium would not be achieved until adjustments were made in all the markets related to gasoline.

Many times, the government has a program designed to affect one market but does not understand that many other goods and services are also economically connected to this market. For example government decided to encourage the production of ethanol as a substitute for oil. The government provided a 54 cent subsidy to the gasoline refineries for every gallon of ethanol blended with regular gas. The demand for ethanol increased significantly. Currently, most ethanol is produced with corn; therefore, the demand for corn increased, and as a result, the price of corn shot up to record levels. Good for the corn producers but bad for the beef producers who feed their cattle with corn. I am sure the government had no intention of hurting the beef producers, but it happened as result of the markets being economically linked together. When the price of corn increased, it motivated farmers to make different planting decisions. Farmers planted more corn, which means they planted fewer soybeans, wheat, and other crops. Now the supply of these other crops shifted to the left and the price of food increased. If the people implementing those policies would have had a better understanding of general equilibrium analysis, the outcome may have been different.

1- Do you agree or disagree with each of the following statements? Explain your answer.

a) Medical care is a public good and should be produced by the government.

b) A patient not knowing the performance record of his/her doctor or hospital is a market failure. Explain.

c) The government should break up all monopolies.

2) Which of the following are examples of pareto efficient changes? Explain your answer.

a) The North American Free Trade Act is passed, which allows free trade between Canada, Mexico, and the U.S.

b) Bernie Madoff swindles billions on a Ponzi scheme.

c) The federal government lends G.M. and Chrysler billions of dollars.

d) Bob buys a used car from Bill.

Answer 1

1) (a) Medical care is a public good and should be produced by the government. Agree

Medical services are not an ordinary commodity but more like a “public good” which should be financed using a regulated public utility model. A “public good” is a product or service which benefits everyone in the community. Public goods are characterized by: (1) value that has benefit to the community as a whole beyond any purchase price paid, (2) often requiring large initial investment costs that are generally too expensive for any individual or private corporation to afford and earn a reasonable return. If we see this now from medical care perspective, 1% of the total population consumes 25% of medical care (by cost), 5% of the population consumes 49% and 50% of the population consumes only 3% of medical care by cost. Since relatively few people incur rare, huge, often catastrophic costs on a largely unexpected basis, pooling of risk is necessary. And the bigger the insurance pool is, the better it functions economically. “Public goods” are not well distributed by market mechanisms. “Health Care is A Human Right!” and it better if it is provided by the govenment. Under the current insurance system, it si the docror and not the patient who makes purchasing decisions. While one can discover a price for one item or service, it is totally impossible to have any sense of the ultimate charges for any significant package of medical services, so it is impossible to price shop even when there is time.Furthermore, most doctors provide care with little or no knowledge of the patient’s actual purchasing power, with or without insurance. Finally, we all know that there is virtually no opportunity for service or product substitution. You had best get the right care the first time. If your care is inadequate you may be dead or disabled or in any case set back and it is heroic to seize the opportunity to identify and ‘consume’ alternative services. For all these reasons, health care services do not belong in the commercial marketplace and the market must be significantly modified by government or should be provided by the govenment.

(b) A patient not knowing the performance record of his/her doctor or hospital is a market failure. Agree

Transparency provides a better tool for engaging providers and informing consumer choices. A person not knowing the quality or having no access to performance data to his medical provider not just in the form of physical access but also in the form of information that is easily understood and used by him will not let him know of he has an incentive for better care. Transparency in medical care holds promise for enhancing the level of care at lower costs. Patients especially disadvantaged when it comes to the lack of transparency around the price and cost of healthcare products and services. Hence it is a market failure. So as costs increase, market proponents should insist that consumers have access to comparative information, the price and cost of the products or services compared, and an analysis of the possible scenarios relevant to their purchasing decision.

(c) The government should break up all monopolies. Disgaree

Though there are many disadvantages of monopoly like Higher prices than in competitive markets and Decline in consumer surplus but all monopolies are not bad.

Also, it is not easy for government to break monopolies, govenment can pass regulations to control and reduce the negative impacts and it is the ideal way to deal with monopolies. Monopolies can be more efficient because of the advantages of economies of scale. Just for an example, it wouldn’t make sense to have many small companies providing electricity. The large-scale infrastructure makes it more efficient to just have one firm. Firms with monopoly power are not necessarily bad. Google has monopoly power on search engines – but it makes them invest more in innovation and attempt to make it more and more efficient.

2) To know whether the below cases are cases of Pareto Efficiency or not, we need first understand what is Pareto Efficiency. Pareto efficiency is a state of allocation of resources from which it is impossible to reallocate so as to make any one individual or preference criterion better off without making at least one individual or preference criterion worse off. Now let us consider each of the cases:

a) The North American Free Trade Act is passed, which allows free trade between Canada, Mexico, and the U.S.
It is not an example of Pareto Efficiency.

NAFTA produced a significant net benefit to Canada and United State. Economists consider that NAFTA was beneficial for the United States. NAFTA fundamentally reshaped North American economic relations, driving an unprecedented integration between Canada and the United States’ developed economies and Mexico, a developing country.

But what has shown issues is the deal’s direct effects from other factors, include rapid technological change, expanded trade with other countries such as China, and unrelated domestic developments in each of the countries. NAFTA’s impact on employment and wages, with some workers and industries facing painful disruptions as they lose market share due to increased competition, and others gaining from the new market opportunities that were created. NAFTA has received a lot of criticism for taking U.S. jobs. It had a negative impact on both American and Mexican workers and even the environment. Since labor is cheaper in Mexico, many manufacturing industries withdrew part of their production from the high-cost United States. Thanks to NAFTA, Mexico lost 1.3 million farm jobs. The 2002 Farm Bill subsidized U.S. agribusiness by as much as 40 percent of net farm income. In response to NAFTA’s competitive pressure, Mexico agribusiness used more fertilizers and other chemicals, costing $36 billion per year in pollution.

Hence thought the economy improved but the unemployment and job cuts decreased hence it cant be a pareto efficient solution.

b) Bernie Madoff swindles billions on a Ponzi scheme.
It is not an example of Pareto Efficiency

Bernard Lawrence "Bernie" Madoff is an American financier who executed the largest Ponzi scheme in history, defrauding thousands of investors of tens of billions of dollars
Despite claiming to generate large, steady returns through an investing strategy called "split-strike conversion, "which does exist. Madoff simply deposited client funds into a single bank account, which he used to pay clients who wanted to cash out. When clients wished to redeem their investments, Madoff funded the payouts with new capital, which he attracted through a reputation for unbelievable returns and grooming his victims by earning their trust.
So in this case he was making some people better off by giving the cash while making others worse off by taking money from them hence it is not an example of pareto efficiency.

c) The federal government lends G.M. and Chrysler billions of dollars.

It is not an example of Pareto Efficiency

This is again not an example of Pareto Efficiency as government lent GM and Chrysler the amount from the tax payers money. They made the auto companies better off and did create 340,000 additional jobs but made some other people worse off who could have been benefited from that public money which could have been spent on some other public activity and improving the lives of people. It benefited auto makers and the people who were employees but made the others worse off where the fund could have been used.

d) Bob buys a used car from Bill.

It is an example of Pareto Efficiency

It is a case of Pareto efficiency as Bob pays the money to Bill to buy his car. Here Bill gets the money and Bob the car, resources are reallocated without making anyone worse off.