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Competition should eliminate discrimination because

a. good companies always win out over bad companies

b. companies who discriminate will be boycotted by consumers

c. companies who don't discriminate will have higher worker morale

d. companies who don't discriminate should be able to hire workers of equal productivity for a lower wage and therefore earn higher profits

In "winner-take-all" markets,

a. there is only one available worker

b. small differences in human capital translate into large pay differences

c. high wages are given to the worker with the highest marginal productivity

d. the most competitive firm hires all qualified workers

e. wages are lower than in other markets

Chief executive officers are paid on average about 1000 times what ordinary workers are paid because

a. they operate in winner-take-all markets

b. their compensation is set by corporate boards who have a personal stake in setting high CEO salaries

c. the value of their leadership is difficult to measure

d. many of them have MBAs and years of experience

e. all of the above

Chapter 14 provides an overview of the following public policy issues:

1. How to deal with "natural monopolies"

2. How to price publicly provided services

3. How best to provide health insurance

4. How best to discourage pollution

What unifies the answers to all these questions?

An emphasis on incentives.

How do we provide incentives to people to behave in ways that are efficient, and honest, and likely to lead to good social outcomes?

I am going to focus on health and pollution, which I think are particularly important from a policy perspective.

1. A natural monopoly occurs when technology makes it more efficient to have one big company rather than many competing ones (high fixed costs) or when the company that gets biggest fastest can outcompete the others (declining long run average costs, also known as economies of scale). The problem: monopolies lead to higher prices and too little output. The solution: government regulation. BUT, the cure CAN be just as bad as the disease. For instance, "cost-plus" regulation as a form of price-setting encourages inefficiency; regulatory agencies are also subject to political "capture."

2. When government provides something--like basic water services, should it provide it for free? No, not if it has a cost. E.g. consider the problems that come from failing to price water, now that it has become scarce. When there are shortages we are forced to implement "one size fits all" rules such as "no lawn watering." It would be more efficient to charge people for the cost of the water, thus giving them an incentive to use less but the flexibility to make their own decisions (perhaps they would rather water their roses than take a bath). Problem is that such policies bear more heavily on low-income families--but that could be dealt with directly, by a "lump-sum transfer" or a tax rebate.

3. Health insurance. Our medical care system offers a perfect example of the way in which pricing, incentives, monopoly, and regulatory design can combine to create huge inefficiencies. By some measures it is one of the best in the world--e.g.. if you're going to get a coronary bypass or treatment for liver cancer, get it in the U.S.. But by other measures it is very poor--our life expectancy is lower than that of many countries, and there is far more inequality by class and race/ethnicity. It's also quite inefficient--we spend a larger percentage of our GDP on health than most countries, with much poorer results. A large amount of this is bureaucratic paperwork--filling out insurance forms. See Ultimate Field Guide graphs 7.1, 7.2.

Should health care be a commodity? Or should everyone have access to it? Think back to the first weeks of the course, when your homework assignment asked you to consider such questions?

Virtually all advanced industrial countries have given mixed answers--the U.S. is the only major country that does not have a unified national system. I say "unified" because we do have a system--but it is an incredible patchwork. We have Medicaid for very poor individuals. We have Medicare for individuals over age 65 who have paid into Social Security, and we have emergency room treatments for those in between. Almost everyone agrees it's a mess; but they can't reach agreement on how to fix it.

In principle, some kind of cost/benefit analysis is a good idea, given scarce resources.. The "third-party payment" system creates significant distortions. People will always tend to "over-consume" a free good. A partial solution--high deductibles. But important also to give health care providers an incentive to reduce costs. This is why HMOs or Health Maintenance Organizations came into prominence.

Problem: HMOs go to the OPPOSITE extreme, giving physicians an incentive to deny care--and to speed up provision of services. Their contracts often offer bonuses for helping keep costs down and they are paid "per person" so the more patients they see, the more money they make.

On the other hand, both professional standards and norms (and the threat of malpractice suits) keeps them from going too far (in most instances).

But health care costs keep going up--putting pressure on employers to cut back on provision of benefits, and also making it difficult for individuals to pay. Medicaid and Medicare costs in particular, are rising very quickly, but states don't have the money to pay (especially given the current fiscal crisis). So they keep trying to cut reimbursements rates for hospitals and doctors, which in turn have to rise prices for other customers in order to make up the difference. Problems of "adverse selection" have intensified.

PLUS, there has been a great deal of consolidation and "monopolization" in the health care sector, and huge bureaucratic firms that are more oriented toward making profits than providinq quality care. TENET corporation is a good example--one of the largest health care providers in the country--it's stock price has recently toppled with the revelation that they have been bilking the Medicare system, manipulating prices to overcharge the government. The corporation has a history of serious malfeasance--defrauding private insurance companies and it was forced to pay a huge settlement in the early 1990s when it admitted keeping mental patients incarcerated and under medication in order to prevent their release.

The textbook lays out a system for simplification, centralization and government reimbursement for health insurance costs, sometimes called a "single-payer" system. Canada has a version of this. Many of the details need more elaboration, but it's a very promising idea.

Environmental Regulation

Let's take it as a given that we need stronger environmental regulation to protect our climate, our air and water quality, our wilderness areas, etc. because these are "common property resources" that offer enormous "externalities" or benefits to us all.

What's the best way to do this? Sometimes we need to set standards, e.g. "just say no" to things like lead in gasoline, or asbestos in building materials. Also, we need to pay attention to the political process by which standards are set, which often seems politically corrupt, to say the least. E.g. SUVs were exempted from mandatory standards of fuel economy--the resulting additional consumption of gas about equivalent to supplies in Arctic wilderness preserves,

But let's also think about prices and efficient incentives.

The price of gas is TOO low. It doesn't reflect the negative externalities that use of automobiles create. It creates incentives for over-utilization of cars. By some estimates, it would be more appropriate to put the price of gas at about $5.00 a gallon. Or, in general, to impose a "carbon tax" on consumption of all forms of polluting greenhouse gases, including the coal and oil and natural gas used to generate electricity and warm houses.

Ohmigod, you might say. That would be so expensive. But the money raised could be used to reduce other taxes, leaving overall after-tax income unchanged. So why is there so much resistance to this idea? Auto and oil companies hate it. But also consumers hate big changes--they have already invested in a capital stock of existing cars and houses that is "oil-intensive"--older consumers in particular.

A related idea--trading pollution "permits." Idea here is similar--instead of a "one size fits all" rule, such as "everyone needs to cut their emissions by 50%" the government could auction off pollution permits at a price designed to achieve the same result:

See example 14.7, on p. 14.7

Cost of Reducing Pollution for Two Firms with Five Technologies

Which technology would each firm use in the absence of regulation? What would resulting level of pollution be?

Each would use Process A. Resulting pollution = 8 tons.

What would be the effect of a regulation requiring each company to reduce by one-half?

Each would use technology C. Total cost would be 980, compared to 400 using technology A. So total additional cost is $580.

Now, what would the effect be if the government auctioned the price of a pollution permit for one ton at $101?

First ask what Sludge Oil would do. They would choose technology B, which costs only $100 more than technology A, and is cheaper than buying a permit. But it will have to buy a permit for the 3 tons it is emitting--spending $303. Note that this is their best option for minimizing costs. Compared to process A, it is spending an additional $100 on technology (let's not count the cost of the permit because that can be offset against other taxes).

What would Northwest Lumber do? It would choose Technology D, and buy a permit to pollute 1 ton, for $101. Compared to process A, it is spending $180 .

The resulting level of pollution is 4 tons a day--same as with a "one size fits all" reduction of 50%. But the costs to the firms is only $280--because the policy created an incentive for the firm with the most favorable technology (Northwest Lumber) to reduce the most.