Market Failures, Taxes, and Subsidies – Episode #21, Part 1

This week Crash Course takes a step in the pro-government direction, despite concluding at the end of this episode that neither markets nor government is “better,” but rather that the two must work together for everyone’s benefit.  This episode is such a doozy that it’ll be broken into two parts.  Let’s get started:

Prisoner’s Dilemma

The episode begins with a variation of the prisoner’s dilemma situation in game theory.  In short, the game offers someone a choice between something that will benefit them a lot vs. something that will benefit them a little, but if that person and other people (who are given the same choice) also choose the more beneficial option, then all parties end up with a very bad result.

 

prisoners_dilemma

The [prisoner’s dilemma] question alludes to one of the biggest problems with free markets: sometimes people have a personal incentive to do something that is against the collective interests of the group.

I found this connection pretty attenuated, since this problem doesn’t really have anything to do with free markets.  In fact, this problem could be just as easily (or more easily) be connected to the tragedy of the commons than to the free market.  We’ll better explain these terms (market failures and the tragedy of the commons) later in this post.

Market Failures

Despite it being so important that it’s named in the title of the episode, the term Market Failures is only briefly defined before moving on.  Let’s look at how Crash Course introduces it:

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Things that are for our collective well being, like fire protection, schools, and national defense are often funded by the government. When markets alone fail to provide enough of these things, that’s called market failures.

The term “Market Failure” is used to describe when the market does not produce something (or enough of something) to meet consumer demand.  Markets are always adjusting to meet consumer demand, but the term Market Failure is usually used for allegedly huge discrepancies between supply and demand.

For example, Crash Course purports that if government fire departments did not exist, then there would not exist any fire protection for people.  Since people need fire protection, the government must step in during these Market Failures.

Confusingly, evidence of privately-owned and operated Fire Departments is so abundant, I’m surprised that Crash Course would use this as one of their examples where the market cannot provide.  National Defense is a much harder example to argue against, so I’m wondering why Crash Course extrapolated on their weakest example.  Of course the market can provide for fire protection services, since it does in many areas for less cost.

Public Goods

Crash Course gives the textbook definition of public goods:

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The technical definition of a public good is anything that has two characteristics: non-exclusion and non-rivalry. Non-exclusion is the idea that you can’t exclude people that don’t pay. For example, it’s impossible to limit the benefits of national defense to only people that pay their taxes. People who pay no federal taxes still get the benefit of protection from bombs, and people who pay a lot of federal taxes don’t get extra protection.  Non-rivalry is the idea that one person’s consumption of the good doesn’t ruin it for other people. So, public parks are a great example. You can use it today, I can use it tomorrow; it can be shared.

It’s hard to improve upon this definition.  One particular area to note, however, is that things like Fire Departments would not be considered public goods, since they are not non-rival.  One city cannot adequately provide fire protection services to 50 buildings that are on fire in different locations at the same time.

 While the definition of public goods is accurate, some schools of economic