This section covers the following topics:

• Positive and negative externalities
• Public goods
• Antitrust policy and legislation
• Measuring income distribution
• Government income redistribution programs

Section Summary

Market failures occur when the market fails to achieve a socially desirable outcome. Government failure occurs when the government intervenes and makes things worse.

Externalities are external ramifications of a transaction that affect some third party. Positive externalities benefit society (e.g., education), while negative externalities hurt society (e.g., pollution).

Public goods are non-rival in consumption (everyone can consume them) and non-excludable (you can’t stop people from benefiting from them). The government generally has to provide public goods. The government can impose mandatory taxes to prevent people from becoming free riders, who benefit from the good but don’t pay for it.

The government also enforces antitrust policy to prevent companies from becoming monopolies. Monopolies produce fewer goods and charge more than perfectly competitive firms, and create a deadweight loss in the process.

If an industry is a natural monopoly, however, costs decrease as the number of goods produced increases. The government sometimes grants one company a monopoly and limits the price it can charge.

Firms can combine in various ways: in horizontal mergers, two companies at the same stage of the production process join, vertical mergers involve companies at different stages in the production process and conglomerate mergers fuse two unrelated companies.

The government created the Interstate Commerce Commission (now defunct) and the Federal Trade Commission to prevent unfair competitive practices. The Sherman Antitrust Act and Clayton Antitrust Act are also designed to prevent the formation of monopolies. The Herfindahl Index and n-firm concentration ratio are used to estimate how much influence the top companies have over an industry.

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