No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Thirteen: Market “Failure” and the Role of the Government 307 externality. But when we say a market fails, it is always “as compared to what viable alternative?” Market critics would suggest that goods yielding positive externalities should be subsidized to produce an optimal quantity, while goods producing negative externalities could be regulated to reduce production. Yet government action in no way can solve the problem of not being able to make interpersonal comparisons of subjective utility. I can’t know how much you dislike or like something—there is no objective measurement to compare to; and neither can the government with some wise, central planning bureaucrat. To arrive at a centrally planned socially optimal production decision, we would need an institutional arrangement that includes someone with omniscience . Unfortunately, that attribute is reserved for God—neither markets nor government has it! To illustrate the depth of this problem, let’s remember our old friend “opportunity cost” as we consider Mr. Anderson’s flower garden. One way to increase social welfare for flower viewing is to let the neighbors, in effect, pay for additional flowers. We could take taxpayer money (a subsidy of say, $1 per plant) to give to flower planters in order to plant the bureaucrat’s idea of a socially optimal amount of flowers, as in Figure 13.7 . But remember, there is no free lunch! If we choose to subsidize flowers so more flowers are planted in everybody’s yard, the resources that are used for the subsidy had to come from taxpayers. How does the central planner know whether the taxpayer values flowers in someone else’s yard more than what the taxpayer would have purchased with his money before it was taken in taxes? Of course the answer is that the central planner cannot know—omniscience is still required. And if the central planner thinks taxpayers like flowers more than they actually do, he or she will take more resources away from the taxpayer than they would ideally like. The opportunity cost in terms of lost consumption of other goods will be greater than the benefit of the additional flowers. In this case, attempting to improve the social welfare will actually reduce social welfare. The knowledge problem for a central planner to arrive at a socially efficient outcome is insurmountable. The same situation would occur with the negative externality: if the government central planner regulates production, how will he or she know how much P ($) Q (#) Q 1 Q 2 P 1 S D 1 D 2 Figure 13.6, Mr. Anderson Considers his Neighbors. When Mr. Anderson considers his neighbor’s enjoyment of flowers in his yard as well as his own enjoyment, his demand for flowers will increase as shown. When we say a market fails, it is always “as compared to what viable alternative?” Subsidy: a payment made by the government to encourage a particular behavior or outcome. The knowledge problem for a central planner to arrive at a socially efficient outcome is insurmountable.