MARKET FAILURE

The primary rationale for governement intervention through public policy is that the market for the good or service is not perfectly competitive.  In others words, there are problems with:

• asymmetric information between the buyer and seller of a service;
• inaccurate information about the quality of the service;
• lack of information or good information due to uncertainty or risks
• monopolies or monopsonies in the distribution or provision of the good or service;
• barriers to entry for buyers or sellers of a good or service;
• potential positive or negative externalities in the production of the good or service; or
• the good is a public good.

The problem of providing collective goods is often exemplified by the prisoner's dilemma.  When goods are public, their price does not reflect the marginal social cost of production or the marginal social benefit of consumption.  As a result, the good is overproduced or overconsumed.  Individuals acting in their self-interest fail to use resources wisely and end up reducing the well-being of their community as well as their own personal well-being.  In these cases, the community and each individual would be better off if an institution or policy could be designed to encourage behavior that promoted the public interest.

COMPETING VALUES

Efficiency  may not be the most important value in determining the optimal allocation of goods and services.  Morevoer, self-interest may not be the only motivating factor for individuals.  If individuals care about the welfare of others and are altruistic or motivated by other values believed to be in the public interest, then government may justify intervention in the market and re-distribute goods and services to promote these other objectives.  In the most straightforward case, if my welfare is directly affected by your welfare then re-allocating goods from me to you may, in fact, be a pareto-improvement.  The classic economic discussion of Pareto-optimality presumes that goods and services are the only things that directly enter into each individuals' utility.  Therefore, a re-distribution of goods and services between two individuals could not be Pareto-improving.

Other values which may affect the public policy choices we make include:

• Individual autonomy and personal liberty
• Fairness
• Horizontal Equity
• Vertical Equity
• Equality of Opportunity

While individuals balance competing values in designing public policies, societies also have different views on how to improve social welfare. Much of public policy analysis is based on a utilitarian ethic propsed bt Jeremy Bentham and John Stuart Mill.  Other norms of distributive justice lead to differing conclusions about what is in the public interest or what would maximize social welfare.  In class, we considered only one of these theories -- Rawl's theory of justice.  Graphically, we can show how different norms of justice or decison-making rules may lead policy analysts to promote different policies with the following example from Wiener and Vining's book, "Policy Analysis: Concepts and Practice" (p. 136).  In class we worked through, an example using immigration policy and various groups of workers.  The determination of individual utilities in this example is not important, the consequences of using different norms of distributive justice as a basis for decision-making is.
 
 

ALTERNATIVE SOCIAL WELFARE FUNCTIONS

	Person 1's Utility (U1)	Person 2's Utility (U2)	Person 3's Utility (U3)	Utilitarian Function U1+U2+U3	Rawlsian Function Min (U1,U2,U3)
Policy A	80	80	40	200	40
Policy B	70	70	50	190	50
Policy C	100	80	30	210	30
				Choose Policy C	Choose Policy B