Government regulation and market failures: examining economic efficiency

Market Failure

Running Page: GOVERNMENT REGULATION, BOON OR BANE?

Weimer and Vining (2004) perceive a perfectly competitive economy as the rational setting for public policy. Public policy is the creation of both positive and negative incentives by the government in order to encourage collective choices. An economic theory assumes that many profit-driven firms and utility-maximizing exist in that perfectly competitive economy. Their interplay leads to efficient patterns of production and consumption. It is described as efficient in that the players' behavior pattern cannot be changed without putting some persons at an advantage over others. They make private choices, which create circumstances, which in turn justify public policy. These circumstances are called market failures or MF, which interfere with efficiency in production or consumption. Social values -- such as human dignity, distributional equity, economic opportunity and political participation -- also justify public policy (Weimer & Vining).

Utility refers to a person's perception of his well-being. Economists view a utility function as serving two key assumptions (Weimer & Vining, 2004). The first says that the more a person has of a good, the greater its utility. The second says that more and more of the same good progressively decreases its utility. This latter function is also called declining marginal utility. Economists believe that people in a society maximize their well-being by using their income to buy goods with the greatest utility. A General Equilibrium Model applies to explain the situation earlier mentioned. It states that prices arise and distribute factor inputs to firms and goods to people in a way that put some at an advantage and others at a disadvantage. Economics refer to this as Pareto efficient. The Pareto efficiency justifies government intervention or public policy in making some persons better without making someone else worse. Pareto efficiency occurs when it is no longer possible to raise the sum of compensating variation and rents by re-allocating factor inputs or final production (Weimer & Vining).

Market Failures

Public Goods

A Pareto-efficient allocation of goods and services occurs as a result of utility maximization by individuals and profit maximization of firms (Weimer & Vining, 2004). Violations, however, occur, which contravenes Pareto efficiency. These are market failures, which in turn, justify government intervention into private affairs. These violations are a pure public good, externalities, natural monopoly and information asymmetry. A private good is completely consumable by one person and, thus, described as non-rivalrous and excludable. There are also toll goods, which are under-consumed because are inefficiently priced and under-supplied. This happens when the consumer does not use the good if the price is greater than the marginal benefit as priced by producers at marginal cost. In contrast, a pure public good is non-rivalrous and non-excludable. Everyone benefits from it regardless of the amount paid for it As a result, users do not reveal their true demand for it (Weimer & Vining).

Externalities

An externality is a positive or negative impact on non-participants or unwilling participants in a voluntary exchange (Weimer & Vining, 2004). Attenuated property rights cause an externality. An externality is positive and affects externalities when the under-supply or under-consumption of a good benefits society. It is negative when there is over-consumption and over-supply, which exact a cost to society. The solution is the reallocation of goods to increase social surplus (Weimer & Vining).

Natural Monopoly

This occurs when the fixed costs involved in producing a good are higher than the variable cost (Weimer & Vining, 2004). The average cost, thus, declines through a range of demand. Natural monopoly includes both declining average cost and relevant range of demand for a firm to produce the good at a lower cost than at another market scheme. Price elasticity of demands determines the impact of natural monopoly on public policy. The demand is inelastic when he absolute value of price elasticity is less than one. This increases price and total revenue rather than efficiency. Inelasticity leads firms to choose outputs that will maximize their profit at the expense of social surplus. This leads to market failure. Natural monopolies have no incentive to produce at minimum cost and this creates inefficiency.

Information Asymmetry

Information about a good and its distribution between an external supplier and consumer influence social surplus (Weimen & Vining, 2004). Consumers or buyers who over-estimate the value of a good will under-consume it. They estimate the value of a good by the information provided by its producer. The three categories of goods are search goods, experience goods and post-experience goods. A search good is determined after purchase and, thus, seldom produce information asymmetry, affect efficient distribution or justify public policy. An experience good can lead to information asymmetry, as it is determined by or limited to the information provided by the producer. Its value is revealed only in secondary markets. And a post-experience good has strong inefficiency potential because the buyer is uncertain about its value. The uncertainty proceeds from the unexpected effects of the good's use. The buyer is unable to connect the use of the good to its quality (Weimer & Vining).

Planning and Rational Choice

Planning is the process used in attaining ends (Banfield, 1959). Planning is good if it is likely to attain those ends or maximize their chances of attainment. And the attainment of ends is likeliest through the process of rational choice. The process consists of an analysis of the situation, an end reduction and elaboration, a design of the courses of action, and a comparative evaluation of consequences. In analyzing the situation, every possible course of action must be considered in order to attain the stated ends. The courses of action must be viewed within the conditions fixed by the situation, such as available resources and the obstacles the situation presents. The plan must include courses of action, which are really open. End reduction and elaboration mean specifying terms in the concrete circumstances of the plan. The goal must be set in a future context as well as the current and active components of the goal. The design of the courses of action describes the major actions or steps taken to achieve the goal. These are premises on which a general course of action is based. A more defined course of action can proceed from this while considering alternatives and consequences. And a rational plan must take all intended and imagined consequences into account. Good planning, as a matter of fact, give space and proactively addresses unintended consequences or developments (Banfield).

Planning in the Public Domain

Friedmann (1987) introduced the three concepts of rationality as market rationality, social rationality and a combination of these two. Market rationality derives from a philosophy of possessive individual as pre-existing society. Society was formed only to serve as a mechanism for the individual's pursuit of his private interests. He uses reason to maximize his personal or private satisfactions. Social rationality assumes the opposite, whereby the social group or society grants the individual identity of its members. It uses reason to seek collective interest and serves as the means to communal satisfaction. And the third concept strikes a middle ground between the two. This balance entails restraint on the excesses of market rationality and provision for public good. It is called social or modern planning and focuses on social outcomes. The assumption draws from an objective view of the world, which uses rationality to create goal-fulfilling processes into which it is put. Rationality is not perceived as anything developing out local processes but as something equal to the act or knowledge. It treats rational knowledge as a source of certainty and truth (Friedmann).

It moves along the Enlightenment assumption that the world is objectively knowable through sense experience or empirically (Friedmann, 1987). It sees the knowledge of the truth as the validated product of scientific inquiries, working as the basis of the mastery over nature. It also views human affairs as susceptible to verifiable methods, just like the natural sciences. Verifiable empirical knowledge can, then, be subjected to manipulation. This is opposed to merely personal and appreciative, emotional, intuitive and imaginative types of knowledge, which are also valid but categorized as purely private (Friedmann).

Favor bestowed on rational knowledge evolved from the scientific and philosophic revolutions of the 16th and 17th centuries, as well as the social revolutions influenced by the Age of Enlightenment (Friedmann, 1987). The alignment between religion and philosophy about the final end of humanity and nature was dissolved. The roots of western civilization, Greek philosophy and revealed religion came to a common belief on final causality. What reason can grasp about the world of nature is coherent with the concept of a benevolent and reasonable creator or God. That shared view made religion a science and science a religion. Knowledge is deemed scientifically verifiable truth from evidence of experience and measurable data. It no longer needed purposes or goals or the basis of things in the absence of questions. Questions and issues on values and meanings ceased to exist in the true knowledge (Friedmann).

Rational Planning Model

The objective of this model is to reduce the excesses of industrial capitalism while managing conflict among capitalists, which result in production and reproduction inefficiency (Friedmann, 1987). Its beliefs about knowledge and society are linked to the rise of capitalism, the formation of the middle class, the rise of scientific legimation, the concept of an integrated and orderly society meant to meet the needs of its members and the provision for an interventionist state. It perceives technical rationality as a valid, appropriate and superior means of rendering public decisions. Scientific information is, therefore, seen as enlightening, convincing and engaging. This rational planning model is the operative mode of inquiry of policy analysis in societal guidance planning. It has been the singular approach to problem-solving through the systematic evaluation of alternative means to achieving a goal. The basic steps are: verifying, defining and detail the problem; establishing criteria of evaluation, identifying alternatives to attain the goal; evaluating alternative policies; implementing the preferred alternatives; and monitoring and evaluating outcomes and results (Friedmann).

Criticisms

Most of the problems this planning model aims at working on cannot be solved in the isolation of a laboratory (Friedmann, 1987). They cannot be manipulated by technical solutions in that setting. The planning model has also been criticized as attempting to describe and satisfy the demands of exhaustive alternative evaluations by securing complete information requirements beforehand. The rational technician performs his role at the expense of other roles, such as advisor, mediator and administrator, which are just as important. Moreover, the value-free evaluative criteria it proposes to use appear to depend on the choices of the scientist or researcher, which cannot be isolated from the beliefs in which they originate (Friedmann).

Policy Paradox

Equity and equality are to be understood differently. Complete equality is not really feasible or possible, in that everyone receives perfectly equal shares of everything (Stone, 2001). Equity, on the other hand, is the more preferable and reasonable way of distributing goods and services. It is considered fair and equitable although often not equal. The three important factors involved in distribution are who the recipients are, what is being distributed and the process of distribution (Stone).

Factors have to be considered in determining if distribution is, indeed, equitable.

Questions on who gets what, when and how must be answered. There are four major opinions on how things can be equitably distributed. The first says that it is fair if it proceeds from a voluntary and fair process. The second fixes the extent of acceptable interference as the price of redistributive justice. Third is concerned with whether property is to be considered an individual or collective creation. And the fourth determines whether work evolves from individual human need or natural drive and satisfaction (Stone).

Evaluating efficiency is difficult because people have individual and different perceptions of efficiency (Stone, 2001). The problem with using efficiency to measure quality lies in the difficulty with measuring inputs and outputs, comparing them, when to stop counting and when another person interprets it as waste. Efficiency should be measured, using a market-based model. But it confronts problems and challenges such as the formation of monopolies, the frequent want of complete information on alternatives and the polis. As regards problems from the polis, the distributions of wealth and income are vastly unequal. Hence, purely voluntary exchanges do not really work in actual situations. The availability of information and the interdependence of welfare within communities also matter (Stone).

One argument set up against affirmative action is a shift from group-based to rank-based distribution (Stone, 2001). Distribution according to race or gender is illegitimate and fair even if intended to be compensatory. Favoring disadvantaged minority groups or women necessarily discriminates against whites and men. Another argument accepts a compensatory slant but the criteria on which groups deserve compensation should be fairly determined. Public policy should compensate those who have been disadvantaged socially and economically. There should be clear criteria of "disadvantaged background," rather than merely belonging to a particular race or ethnic group or gender. On the other hand, advocates of affirmative action say that need and disadvantage are not only difficult to measure. A change in the basis of affirmative action will also nullify its very purpose and use in eliminating race and gender discrimination, which is the very aim of affirmative action. As it is, discrimination is already too prevalent to ignore and so pervasive that even the most privileged among them experience it (Stone). #