Class Notes 9


AED Economics 200 Principles of Food and Resource Economics Winter, 2003

9. Government Intervention: Poverty Externalities and Public Goods
Income Distribution and Poverty 1. Some facts
	- Incidence of poverty as defined by "poverty threshold" - Distribution of income by quintiles Exhibit 15-1 - Distribution over time 1929 vs. 1993 - Ex ante income distribution - before taxes and transfers - Ex post distribution - after taxes and transfers
2. Measuring income inequality
	Lorenz curve - cumulative distribution of income vs. cumulative distribution of families Gini coefficient - comparison of actual cumulative income distribution with perfect income equality
		0 = perfect equality 1 = one person has everything
3. Why does income inequality exist?
	- innate ability - work vs. leisure - education, training (human capital) - risk taking - luck - wage discrimination
		Even in world with no discrimination, some income differences would exist.
4. What should the income distribution look like?
	Rawl's Normative Standard
		Veil of ignorance
	Problems with defining what ought to be - due to conflicting principles of justice or fairness
	Laissez faire - pay according to marginal revenue product, or people should be regarded on basis of what they contribute economically. (marginal productivity normative standard) Egalitarian income - pay all equally. If individuals have same marginal utility from same amount of money, societies welfare can be maximized by paying all the same. (absolute income equality normative standard) Merit - some may deserve more than laissez faire approach provides. Examples, artists, musician, farmers (?)
	Poverty
		What is poverty? Relative poverty always exists Absolute standards - U.S. govt. definition
		limitations - these standards fail to consider - regional differences - based only on monetary income - some of poor can't be found-homeless
		Causes of poverty - same as causes of unequal income
		- innate ability - work vs. leisure - education, training (human capital) - risk taking - luck - wage discrimination
		Alternative programs to address poverty
		Welfare System - pre-1996
		Cash benefits - e.g. Aid to Families with Dependent Children In-kind benefits - food stamps, public housing, Medicaid
		Welfare System - post 1996 (Personal Responsibility and Work Opportunity Act of 1996)
		Elimination of AFDC Cut food stamp program Block grants to states Time limits for participation
		Negative Income Tax Market oriented program
	Can Markets Fail to Maximize Societal Welfare?
	1.	Market outcome under perfect competition
		* In long run competitive equilibrium, a. price = marginal cost = average total cost b. (consumer surplus + producer surplus) are maximized * Power of the market a. enables people to cooperate peacefully while pursuing their self interest. b. transmits information c. provides incentives to: adopt new methods of production use resources frugally produce products that are highly valued by consumer d. determines distribution of income
	2.	"Market failure" can occur in some situations
		a. imperfect market structures example, monopolies b. externalities example, pollution c. common property example, fishery or commons d. public goods example, national defense e. asymmetric information f. inappropriate discount rate or ignoring future generations example, use of finite natural resource
	Externalities
		- side effect of an action affects third party not involved in market exchange
	Negative Externality - cost imposed on third party
		Examples - air, water, noise pollution, unkept neighborhood Model - Marginal social cost > marginal private cost Net social cost of market solution
	Positive externality - benefit given to third party
		Examples - education, victorious football team, well kept neighborhood Model - Marginal social benefits > Demand Solution to externality Internalize externality - party generating externality incorporates it into their own internal costs and benefits
		Persuasion Assign property rights - example: assign ownership of stream to either downstream users or to polluter Voluntary exchange - example: Forster cut neighbor's overgrown lawn in exchange for free kid's piano lesson Combine b and c - the economists solution problem - transaction cost Taxes or subsidies Regulation
	Common Property - essentially the problem is the same as a negative externality. Property rights are not assigned, so user ignores all costs.
		common property (i.e., the commons)
		- property with unrestricted access - rivalry in consumption and nonexcludability
		Examples - grazing land, ocean fishing, space Public Good - consumption by one does not reduce consumption by another (nonrivalrous)
		- can't prohibit another from using good once it is produced (nonexcludable) - free riders enjoy free usage For goods to be "public goods" they must be nonrivalrous and nonexcludable.
		Examples: -rivalrous, excludable - steak -nonrivalrous, excludable - theater -rivalrous, nonexcludable - fish in ocean -nonrivalrous, nonexcludable - national defense
		Market solution - market only reflects demand of person with the greatest demand Solution - restrict access
	Asymmetric information - information is held by buyer or seller and not the other
		-like externality but no third party
		adverse selection - A.I. occurs before transaction Example: "Lemons" moral hazard - A.I. occurs after transaction Example: change in behavior after purchase of insurance
	Natural resource and environment issues What is the problem? What is the cause? What are solutions?
		Acid rain Wildlife Point and nonpoint source water pollution Soil erosion Lake Erie fisheries Timber harvesting Fossil fuels Endangered species Recycling Global warming Population growth Urban sprawl
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