Microeconomics
\nSession 7
\nMicroeconomics
\nSESSION 7 – The Role of Organisations and Institutions
\nIn this subsection we are going to look in a bit more detail at the role
\nof institutions and organisation in microeconomics. Institutions and
\norganisations are important in microeconomics for while the market
\nis the main way in which goods and services will be exchanged in the
\neconomy, this is not the only way in which transactions can occur.
\nIn this session we are going to discuss the concept of public goods
\nand their externalities in more detail in addition to exploring the free
\nrider problem.
\nWe will also be considering the nature of collective goods and the
\nrole of both state and non-state governance in microeconomics. We
\nwill be exploring the nature of market design.
\nWe will also be discussing the concept of Arrow\u2019s Impossibility
\nTheorem before we finally conclude this session by looking at the
\ninfluence of policy upon the market and economy.
\n1
\nMicroeconomics
\nHere, we\u2019re going to be exploring the role of institutions and
\norganisations in microeconomics particularly in relation to
\ngovernments, government policy, and public goods.
\nPublic Goods
\nA public good can be defined as a good that can be consumed by
\nmore than one individual at a time. Examples of public goods could
\ninclude a fireworks display, a local pool or national defence. This is the
\nopposite of a private good which can only be consumed by a single
\nindividual. Examples of private goods could include a sandwich, a
\njacket, or a bicycle.
\nOne of the main key economic differences between public and private
\ngoods is that public goods are non-rivalrous while private goods are
\nrivalrous. In reality when we are considering goods we should think
\nof them existing on a continuum of non-rivalrous to rivalrous as most
\ngoods are not usually extreme in this way. If a good is completely
\nnon-rivalrous this would mean that we could keep adding consumers
\nwithout any enjoyment of the good being taken any from others. An
\nexample of this type of good would be a country\u2019s national defence
\nin which another consumer can be added and enjoy the benefit of
\ndefence without anyone else being adversely affected.
\nGoods can also be further defined as being excludable or nonexcludable.
\nIf a good is non-excludable it means that others cannot
\nbe excluded from enjoying goods. An example could be a fireworks
\ndisplay in which anyone who is close enough will be able to view the
\nfireworks without needing to obtain permission or pay for the goods.
\nIf a good is excluded others can be easily excluded from enjoying the
\ngood. An example of an excludable good could include a television
\nset in a private house.
\nBecause of their characteristics it is likely that producers who are
\nseeking profits will be more willing to produce excludable public or
\nprivate goods than they are willing to produce non-excludable goods.
\nOne potential problem when considering public goods which are
\nnon-rivalrous but non-excludable is known as the free-rider problem
\nand we will now discuss this in more detail.
\nThe Free-Rider Problem
\nThe free-rider problem is an externality associated with the production
\nof public goods. When a pure public good is supplied decentralised,
\nindividual behaviour does not result in optimal outcomes. This is
\nbecause of the strategic decisions that guide individual behaviour
\nwhen externalities are present.
\n2
\nMicroeconomics
\nThe problem with free-riders is that if too many individuals seek
\nto get \u201ca free ride\u201d based on the contributions of others, the total
\ncontributions collected will fail to meet the cost of the goods and
\nservices that are provided.
\nThe free-rider problem is an example of the prisoner\u2019s dilemma. This
\nis an element of game theory in which it is in each individual\u2019s best
\ninterest not to contribute no matter what the actions of others are.
\nBut, if nobody contributes the result is bad for everyone.
\nWays in which to solve the free-rider problem include government
\nintervention, by using market forces to provide some public goods,
\nor using incentive systems in order to make telling the truth in
\nindividual\u2019s best interests.
\nIn addition to applying to what are known as public goods the freerider
\nalso applies to goods known as collective goods. While the terms
\npublic goods and collective goods are very similar we are just going
\nto explore the unique features of collective goods now.
\nCollective Goods
\nCollective goods are very similar to public goods and relate to goods
\nand services which are used jointly by a number of individuals. In the
\ncase of collective goods it is generally not possible to leave payment
\nfor collective goods to the individual as this process will usually
\nfail. This is due to the fact that each individual will generally try to
\nminimise their contribution towards the cost of the good or service
\nand once again we will see the free-rider problem emerging.
\nAs we have now discussed public and collective goods and have
\nseen the issues associated with the free-rider problem, let\u2019s now
\nturn our attention to the role of state and non-state governance in
\nmicroeconomics.
\nState and Non-state Governance
\nSo far, we have discussed the influence of government policies a
\nnumber of times. This is because at various times most modern
\neconomies have relied upon state laws and organisations in order
\nto enforce laws and to provide security to transactions and contracts
\nmade in the economy.
\nIt is also the case however that at times the majority of states have had
\ninstitutions and organisations which were too weak, slow, inefficient
\nor biased to resolve issues in a state\u2019s economy. When this occurs
\nit is often the case that societies develop alternative institutions to
\nprovide economic governance. Consider for instance the role of the
\nmafia and black markets.
\n3
\nMicroeconomics
\nIn addition to governance influencing the economy, the way in which
\nthe market is designed and operates can also affect how transactions
\nare undertaken. So let\u2019s look in a bit more detail at market design.
\nMarket Design
\nIn addition to the main economic market there may be some situations
\nin which some specialised transactions are better served through the
\ncreation of a specialised market or market-like platform. Examples of
\nalternative markets include the internet which has been described as
\na \u201csharing economy\u201d and includes new market places such as Ebay.
\nMore local examples of specialised markets could include babysitting
\nclubs.
\nIn addition to specialised markets we may also see a number of
\ndifferent types of market designs being used. The most common
\nform of market is a matching market but other forms of markets can
\ninclude systems such as auctions.
\nNow we have considered how the design of the market can affect the
\nway in which the market operates, we are going to consider briefly
\nthe concept of Arrow\u2019s Impossibility Theorem.
\n4
\nMicroeconomics
\nArrow\u2019s Impossibility Theorem
\nArrow\u2019s Impossibility Theorem is named after Kenneth Arrow who
\ndevised this theory of social choice. Arrow\u2019s Theorem is a paradox
\nthat illustrates that it is impossible to have an ideal voting structure
\nthat reflects specific fairness criteria such as pareto efficiency. In other
\nwords Arrow\u2019s impossibility theorem indicates that a clear order of
\npreference cannot be established while adhering to principles of fair
\nvoting procedures.
\nIn order to demonstrate how this theorem operates let\u2019s consider
\nan election in which voters are asked to rank their preference for
\ncandidates Mr A, Mrs B, and Miss C.
\nWhen voting, 50 people vote to indicate that they prefer Mr A over
\nMrs B and prefer Mrs B over Miss C. 45 people vote to indicate that
\nthey prefer Mrs B over Miss C and prefer Miss C over Mr A. Finally 35
\npeople vote to indicate that they prefer Miss C over Mr A and prefer
\nMr A over Mrs B.
\nIn this election candidate Mr A has the most votes and would win
\nthis election however if Mrs B was not standing in the election Miss
\nC would be the winner as more people prefer candidate Miss C over
\nMr A. The result of this election would therefore demonstrate Arrow\u2019s
\nImpossibility Theorem.
\nIn microeconomics, a number of different tools are available to model
\n5
\nMicroeconomics
\nthe effects of economic choice and enable economists to think about
\nthe decisions people make in a political context.
\nIn order to conclude this subsection we are now going to briefly
\nconsider the influence of policy upon the market and economy in a
\nbit more detail.
\nThe Influence of Policy upon the Market and Economy
\nGovernment policy can be effective at controlling and influencing the
\nmarket and the economy. Nonetheless, governments do not have a
\nfree hand to impose any policies they wish on the market.
\nIn reality, democratic systems and checks have been developed to
\nensure that proposals for legislation that may harm the economy
\nare limited and must be discussed at a range of committees and
\nsubcommittees. These will debate any proposals and will recommend
\nonly policies with which they are in agreement. Once proposals have
\nbeen agreed, it is then usual for these to be debated further in the
\ngovernment before voting on occurs. The way in which governments
\ntherefore are able to ensure policy is managed, is known as voting
\nequilibrium. It results in what is known as a \u201cstructure-induced\u201d
\nequilibrium. It is so-called because the process results in a policy
\nproposal that lies in the middle of where all individual ideal points
\nwould be for those who have considered the idea.
\nSession Summary:
\nIn this subsection we explored the role of institutions and organisations
\nin microeconomics. We saw that institutions and organisations are
\nimportant actors in microeconomics and is one of the ways outside
\nof the market in which transactions will take place.
\nWe also considered the definition of a public good. We explored public
\ngoods in more detail and have looked at one of the externalities of
\npublic goods in terms of the free-rider problem. We saw that the freerider
\nproblem is something that exists for public goods and is a form
\nof the prisoner\u2019s dilemma. We discussed the free-rider problem in
\nsome detail including how and why this occurs and how this can be
\ndealt with.
\nWe also considered the nature of collective goods and sought to
\ndefine collective goods in more detail. We discussed the role of both
\nstate and non-state governance in microeconomics considering
\nwhat happens if state governance fails to take charge of a situation.
\nFollowing our discussions of governance we discussed some of
\nthe different market designs that can be developed outside of the
\ntraditional market design and structure.
\n6
\nMicroeconomics
\nWe also discussed the concept of Arrow\u2019s Impossibility Theorem and
\nlooked at some of the issues voting preferences can have and the
\nparadox that can be created from this.
\nFinally, we concluded this session by considering the influence of
\npolicy upon the market and the economy and one of the ways in
\nwhich governments ensure that radical and harmful policy is not
\nimposed upon the market.
\n7
\nVIDEO
\nCOMMENTARY
\nSESSION 7
\n8
\nMicroeconomics
\nSESSION 7 – The Role of Organisations and Institutions
\nIn our seventh we are going to look at ways to think about politics in
\neconomic terms. Specifically, in this session we are going to consider
\nthe Median Voter Theorem.
\nTo consider the Median Voter Theorem, we are going to use an
\nexample of a school board. The school board is comprised of five
\nmembers who need to agree the level of spending that will be made
\nnext year. In order to reach an agreement the democratic process of
\npairwise voting is used until a winner is found. The process will end
\nwhen a Condorcet winner is found. The Condorcet winner is the name
\ngiven to the proposal that has defeated all other proposals in pairwise
\nvoting.
\nIn order to explore how voting will proceed let\u2019s assume that the five
\nvoters will have single-peaked preferences over the level of spending.
\nThe voter whose peak is in the middle is known as the median voter
\nand is labelled with ym. If the median voter\u2019s proposed policy was up
\nagainst any proposal that fell to the left of it, we could assume that
\nany voter whose preference is to the right will be more likely to vote
\nfor ym than any proposal further to the left of this. In this case voters
\n4 and 5 will join with voter 3. If the proposal was against the right
\nthe same would occur with voters 1 and 2 voting for ym rather than
\nanything to the right.
\nAs there is not a proposal that can beat ym this proposal will be
\ndeclared the Condorcet winner. The Median Voter Theorem can be
\napplied to any situation in which an odd number of voters exist.
\n9
\nCASE STUDY
\nSESSION 7
\n10
\nMicroeconomics
\nSESSION 7 – The Role of Organisations and Institutions
\nThe Role of Government In a Market Economy
\nIntroduction:
\nIn this briefing we\u2019re going to look at the role of institutions and
\ngovernments within microeconomics in a bit more detail. We are
\ngoing to do this by considering an article by Libby Rittenbery and
\nTimothy Tregarthen entitled \u201cThe Role of Government in a Market
\nEconomy\u201d.
\nBy reviewing this article, we are going to consider the role of
\ngovernments in responding to market failures of public goods,
\nexternal costs and benefits, and imperfect competition. We are also
\ngoing to look at merit and demerit goods, and discuss the ways in
\nwhich governments redistribute income.
\nRittenberg and Tregarthen begin this article by stating that we want
\na great deal more from governments than we did several decades
\nago. They note that this has resulted in total government spending
\nper capita (when adjusted for inflation) increasing more than six fold
\nsince 1929.
\nRittenberg and Tregarthen continue by considering the different
\ntypes of government spending that may occur. This includes not only
\ngoods and services that are produced for the public, but also transfer
\npayments.
\nThe article next provides a summary of government revenue sources
\nand expenditures in 2007 for both the USA and EU. Rittenberg and
\nTregarthen note that for the USA, revenue mainly came from personal
\nincome tax and payroll taxes. Expenditure, meanwhile, was mainly
\nspent on transfer payments to individuals. For the EU, a greater share
\nof revenue comes from taxes on production and imports, and far less
\nis spent on defence than in the USA.
\nThe authors note that to understand the role of government, it is
\nuseful to distinguish between four types of government involvement
\nin the economy. These are:
\n1. Government attempts to respond to market failures to allocate
\nresource efficiently.
\n2. Government agencies act to encourage or discourage the
\nconsumption of certain goods and services.
\n3. Government redistributes income through programs such as
\nwelfare and social security.
\n11
\nMicroeconomics
\n4. Government uses spending and tax policies to influence the
\nlevel of economic activity and price level.
\nRittenberg and Tregarthen note that the first three of these types of
\ngovernment involvement are related to microeconomics, whilst the
\nfourth is related to issues of macroeconomics. The first three of these
\nareas are therefore discussed in more detail within the article.
\nThe first area discussed in more detail is responding to market
\nfailure. The authors note that when the market\u2019s output of goods and
\nservices falls short of the efficient level, it is possible that government
\nintervention will move production levels closer to their efficient
\nquantities.
\nIn the next section, Rittenberg and Tregarthen discuss public
\ngoods. They note that public goods include goods such as national
\ndefence and law enforcement. The authors note that the difficulty in
\nproducing public goods is that they are freely available to everyone,
\nand therefore the free rider problem occurs.
\nThe authors, therefore, argue that the theory of public goods
\ndemonstrates an important reason for government involvement in
\nthe economy.
\nNext, external costs and benefits, which are also known as externalities,
\nare discussed. The authors note that due to the lack of a market
\ntransaction, the person responsible for the external cost or benefit
\nwill not face the full cost or benefit of the choice involved. Rittenberg
\nand Tregarthen provide the example of a computer memory chip
\nfirm which generates water pollution to demonstrate this point. The
\nauthors indicate that, because the firm producing the good does not
\nface all of their production costs, the price can be expected to be
\nlower and the quantity produced can be greater than the efficient
\nlevel.
\nThe authors also provide the example of infectious disease
\ninoculations and note that these lead to external benefits, but as
\nthis exceeds the private benefit, the market is likely to produce less
\nthan the efficient quantity. In this case, the government may need to
\nprovide such goods and services.
\nThe final area discussed in the article relates to imperfect competition.
\nThe authors note that in a perfectly competitive market, price will
\nequal marginal cost. However, if competition is imperfect, individual
\nfirms would face downward-sloping demand curves and will charge
\nprices greater than marginal cost. In this type of market, firms will
\nproduce less of a good than is efficient. In response, governments
\nmay legislate against uncompetitive behaviour such as monopolies.
\n12
\nMicroeconomics
\nRittenberg and Tregarthen note that in each of these three cases
\nthere is the potential for government intervention in order to try
\nto move the market towards a more efficient model. The authors
\nprovide a number of figures that review the potential gains that
\nmay be generated as a result of government intervention in cases of
\nmarket failure.
\nFollowing the discussion of market failures, the authors of this article
\nnext discuss merit and demerit goods. They provide an explanation of
\nmerit and demerit goods and discuss the reasons why governments
\nmay sometimes provide merit goods and prohibit demerit goods.
\nFinally in this article, Rittenberg and Tregarthen discuss the concept of
\nincome redistribution. They discuss the nature of income distribution
\nand note that distribution of income generated by a private economy
\nmight not be satisfactory for a number of reasons. The authors note
\nthat government intervention in income redistribution will often be
\nseen as a public goods argument.
\nTo conclude this article, Rittenberg and Tregarthen provide some
\nexamples of actual and proposed government programmes which
\neach relate to government intervention within the market, before
\nfinally providing a case study of government involvement within the
\noil pricing of the USA in 2008.
\nTake a moment to discuss these points from the session.
\n\u2022 Discuss the possible microeconomic reasons for government
\ninvolvement within the market and its potential effect on the
\nmarket.
\n\u2022 Discuss the difference between merit and demerit goods. In what
\nways can a government seek to control such goods?
\n\u2022 Discuss the advantages and disadvantages of public goods and
\nthe free rider problem.
\n13<\/p>\n","protected":false},"excerpt":{"rendered":"
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