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dataeaGovernment Intervention in the Market Chapter Summary
The government plays a significant role in any economy. Although competitive private markets provide the best mechanism for allocating society’s resources, there are occasions when government’s need to intervene in the markets. For example, governments are required to enforce the rule of law, particularly over contract and property rights, or to overcome externalities.
However, whilst government intervention is sometimes necessary, there are also situations where government intervention occurs, but is not required. For example, the private interest view states that politicians can sometimes intervene in markets largely becau of the rent-eking claims of a small group of individuals or firms. This type of intervention leads to government failure, as the net result to the overall economy is often a loss of efficiency. The difficulty in correctly pricing insurance policies stems from asymmetric information, which happens when one party to a transaction has less information than the other party. Asymmetric information is also prent in the market for ud cars. Asymmetric information leads to adver lection. Adver lection occurs when one party to a transaction takes advantage of knowing more than the other party. The insurance industry is also subj
ect to moral hazard, which is the tendency of people to change their actions becau they have insurance. Insurance companies u deductibles and co-payments to reduce moral hazard.
Adver lection and moral hazard also affect firms and investors in financial markets. When a firm has sold stocks and bonds it may spend the funds in ways not in the owners’ best interests. Since the owners of the firm’s stock also own the firm itlf, this can be a major problem. Moral hazard can also be prent in labour markets. Once hired, workers may shirk their obligations and not work hard. Firms may deal with this form of moral hazard by cloly monitoring workers and making their jobs em more valuable than other jobs.
Learning Objectives
When you finish this chapter you should be able to:
1.Know the nature and extent of government expenditure in Australia. The government plays a
significant role in Australia’s economy, accounting for around 16% of total employment, and 22% of GDP. The main expenditures of the Australian government are in social curity and welfare and health.
2.Understand why a market economy with competition is generally efficient. Chapter 5 outlines in
more detail how a competitive market results in the economically efficient level of output. In a competitive market, the interaction between supply and demand results in an equilibrium price and quantity, where the marginal benefit to consumers from the last unit consumed equals the marginal cost of providing that unit.
3.Understand the economic bas for government intervention in a market economy. There are a
number of situations where government intervention is required, to correct instances of market failure.
The include: the rule of law, maintaining competitive markets, natural monopolies, externalities, common resources, public goods, merit goods, asymmetric information, equity and macroeconomic stabilisation.
Government intervention in the market 210
4.Distinguish between market failure and government failure. Market failure occurs when the market
does not result in an economically efficient outcome. Government failure can occur when regulations are enforced not to improve efficiency, but to protect certain vested interests.
5.Define asymmetric information and distinguish between moral hazard and adver lection.
Asymmetric information occurs when one party to an economic transaction has less information than the other party. Adver lection refers to a situation in which one party to a transaction takes advantage of having more information than the other party. Moral hazard occurs when people change their actions as a result of having insurance.
6.Apply the concepts of adver lection and moral hazard to financial markets. Asymmetric
information exists in financial markets becau firms know more about their financial situation than do potential buyers of its stock and bonds. Moral hazard exists in financial markets becau firms may u funds raid through the sale of stocks and bonds to reduce profits or even steal funds. The larger the firm and the more carefully analysts follow their activities, the less likely moral hazard will be a problem. Chapter Review
Chapter Opener: Selling Noodles is Harder Than You Think
The chapter opener outlines the ca of Ken Lee, a migrant to Australia from Hong Kong. Mr Lee wanted to t up a restaurant in Canberra, following on from the successful restaurant he ran in Hong Kong. However, the regulatory burdens he faced in trying to t his business up, including health and safety regulations and compulsory staff training requirements, plus the additional labour market regulations, led him to question whether it was worthwhile to t his business up in the first place. This chapter looks at the (economic) role of the government in the Australian economy.
The Size of the Public Sector
华盛顿大学排名There are a number of ways to measure the size of the public ctor: government production as a proportion of Gross Domestic Product (22% in Australia in 2007/8), or public ctor employment as a proportion of total employment (16% in Australia in 2007/8), or by public expenditure as a proportion of total expenditure (35% in Australia in 2007/8). This final measure is larger due to the fact that the government also makes transfer payments to individuals and houholds (pensions, unemployment benefits and so on).
In relative terms, the size of Australia’s public expenditure is smaller than the UK, Canada and Scandanavian countries, but a similar size to the US, Japan and Switzerland. Although government
expenditure (net of transfer payments) has fluctuated since 1960, there was a general upwards trend through to mid-1980s and then a decline until 2003. This decline was due to microeconomic reforms undertaken, and the fact that many public enterpris were privatid during this period.
In terms of the where the government spends its money, the greatest share goes towards social curity and welfare (41% in 2007/8), followed by health (18%) and general government rvices (14%).
The Economic Bas for Government Intervention
We have learnt in previous chapters that competitive markets produce the most economically efficient u of resources. Whilst any intervention in the markets by governments that directly distorts outcomes will result in a loss of efficiency, there are still a number of areas where economists believe government intervention is a
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necessity. The often involve situations of market failure, and include:
•The legal system and rule of law (legislation is required to enforce private contracts);
•Maintaining or enforcing competition (inefficiencies can ari with monopolies or collusive behaviour between firms, and so the government need to regulate to ensure competitive, or at least contestable, markets exist);
fighting 什么意思•Natural monopolies (where economies of scale are so large that one firm can supply the entire market at a lower cost than two or more firms could);
•Externalities (a benefit or cost that accrues to third parties not directly involved in the production or consumption of a good – the are covered in Chapter 15);
•Common resources (an extreme ca of externalities, where no one can be denied access to a resource, but their u of that resource reduces the possible u of others – the are also covered in Chapter 15);
•Public goods (where consumption of a good or rvice is both non-rival and non-excludable, the government must provide this product to overcome the market failure of ‘free-riding’);
•Merit goods (goods that are deemed to be beneficial to society, such as muums and galleries, tha
t might otherwi not be provided by the private ctor);blastp
•Asymmetric information (regulation is required may be required to reduce the problems that occur when one side of a market has access to information not available to the other side – e below for more details);
•Equity (often involve normative judgements about what is ‘fair’, and so the government may intervene if a specific market equilibrium is deemed inequitable);virgina
•Stabilisation (macroeconomic) policy (policies that aim to stabili the overall economy, and provide low unemployment, low inflation and strong economic growth).
Market Failure and Government Failure
Although there may be a role for governments in cas of market failure, others argue that, for a variety of reasons, there may also be government failure that can actually make a situation less efficient. For example, the private interest view states that the rent-eking behaviour of groups and individuals can cau government failure. Rent-eking behaviour is the unproductive activity of an individual or group in the pursuit of economic surplus above that which would result in a competitive
market. Lobbyists may be employed by an industry, for example, to convince politicians to enact or maintain specific privileges for that industry. This can often occur becau the groups are more vocal in comparison to the general public, who may not know (or care) of the benefits they would otherwi receive. Examples of this include lobbying by small business to maintain restricted trading hours (e An Inside Look on page 456), or by professional groups who try to restrict entry into their profession to ‘protect the public’, but which therefore restricts supply and keeps their wages high. Whilst not all interest groups could be considered ‘rent-ekers’, it is still important to understand the actions of the groups with respect to regulation in the economy.
先考托福还是greIn some situations, economic efficiency can be improved through deregulation and/or privatisation. Deregulation can promote competition by reducing barriers to entry, as with the Australian telecommunications industry in the 1990s. The privatisation of government business enterpris (GBEs) in Australia was another method of promoting efficiency during the 1990s. During this period, many GBEs were sold, including state electricity and gas asts, as well as the Commonwealth Bank, Qantas and Telstra. Whilst deregulation does not guarantee economic efficiency will improve, the experience in many industries suggest that this often occurs.
Government intervention in the market 212
Helpful Study Hint
Making the Connection 14.1 (page 442) looks at the issue of whether drugs should be legalid.
Although the consumption and supply of many specific drugs are currently illegal in Australia,
some academics believe that this type of legislation incurs greater costs (through enforcement
costs and the like) than benefits. Milton Friedman, for example, was a strong advocate of the
freedom of individuals and a lack of regulation and control by governments. Nevertheless, it is
important to remember that while economics can contribute to this controversial debate, the
moral issues and societal preferences are often more important in deciding the types of issues.
Don’t Let This Happen to You (page 444) also examines the issue of asssing the relative
costs and benefits of regulation, and the opportunity costs associated with the decisions.
The Legal System
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For a market to function efficiently, participants must be confident that the contracts they enter into will be honoured and, if they are not, that they will be able to ek redress through the court system for compensation. In countries like Australia, there are fairly well established regulatory and legal mechanisms in place that provide for this certainty. In many developing countries, however, the rule of law is less well-established, and market transactions are often therefore slower and less efficient.
The government also has a role to play in the enforcement of patents and copyright. This system is designed to provide protection for a period of time over intellectual property, and is a reward for undertaking costly rearch and development. Without the enforcement of the rules, firms would be unwilling to undertake this rearch and development in the first place, which would hamper technological progress.
Information
The difficulty in correctly pricing insurance policies aris from the problem of asymmetric information. Asymmetric information is a situation in which one party to an economic transaction has less information than the other party. Guarding against the effects of asymmetric information is a major objective of llers in the insurance market and of buyers in financial markets.
贾斯丁比伯的歌The study of asymmetric information began with the study of ud car markets or the market for “lemons” by George Akerlof. Sellers of ud cars have more information about the cars they ll than do buyers. Most ud cars offered for sale will be lemons. This is due to adver lection. Adver lection is a situation in which one party to a transaction takes advantage of knowing more than the other party to the transaction. Ud car dealers can take steps to assure buyers they are not lling lemons by offering warranties that guarantee repair or replacement over a certain time period. Sellers can also build a reputation for lling reliable cars.
Buyers of insurance will always know more about the likelihood of the event being insured against than will insurance companies. Insurance companies cover their costs only if they t the prices (premiums) of their policies at levels that reflect how many claims for payment the people they have insured are likely to submit. The adver lection problem can be reduced if people are automatically covered by insurance. For example, state governments require drivers to have automobile insurance. Adver lection problems can also be reduced by offering group coverage to large companies and other organizations.
The insurance market is also subject to moral hazard. Moral hazard is the tendency of people who have insurance to change their actions becau of the insurance or, more broadly, actions taken by
one party to a transaction that are different from what the other party expected at the time of the transaction. An example of
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moral hazard is a firm that has taken out fire insurance may be less careful about avoiding fire hazards. Insurance companies u deductibles and co-payments to reduce moral hazard.
Helpful Study Hint
Making the Connection 14.2 (page 450) looks at the issue of moral hazard and adver
lection in the health insurance system. For example, becau insurance companies were not
allowed to charge different premiums to people bad on age, the average premiums were
higher than they would otherwi be. However, the higher costs dissuade some low-risk
people from taking out health insurance, meaning that the insurance companies may
disproportionately attract the more unhealthy members of society who claim frequently for
rvices, which may rai average premiums even further. This example of adver lection
was one reason for the federal government introducing incentives for people to take out health
insurance in 2001.
Adver Selection and Moral Hazard in Financial Markets
Adver lection and moral hazard po problems for firms, their owners and owners of their debt in markets for stocks and bonds. Since firms know more about their financial situations than stockholders, the firm can u the funds in ways that reduce profits. For example, a firm that has no debt on the balance sheet may suddenly issue a large quantity of bonds. This increas the risk to current owners of their stock. This is an example of the principal-agent problem, where the agent (for example, the manager of a business) pursues their own interests rather than the interests of the principal (the owners).
In Australia, the regulation of financial markets was overhauled in the 1990s following the Wallis Report in 1996. This resulted in the establishment of the Australian Prudential Regulation Authority (
bettermanAPRA), and the Australian Securities and Investments Commission (ASIC). However, given recent events in financial markets across the world, it is clear that the regulation of the markets has not overcome the problems of adver lection and moral hazard.
Helpful Study Hint
Making the Connection 14.3 (page 454) describes the difficulty that moral hazard pos for
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investors by examining the collap of One.Tel and insurance company HIH in 2001.
