Is a market failure better than government intervention?

Critics of Free Market Shouldn't Overreach
by: Greg Ip
Sep 24, 2015
Click here to view the full article on WSJ.com

TOPICS: Behavioral Economics

SUMMARY: It has been a good month for free-market skeptics. In Britain a socialist is the Labour Party leader. Pope Francis condemns markets for "extreme consumerism." Economists are joining them, writes Greg Ip.

CLASSROOM APPLICATION: Instructors can introduce the issue of whether markets lead to unscrupulous behavior or whether markets promote economic efficiency, and whether policy makers in an attempt to correct market failure would be subject to their own behavioral biases. The need for policy intervention in market relies not only the traditional economic arguments based on market power of sellers, asymmetric information, and transactions costs, but also on the behavior of consumers. "Behavioral economics goes further, arguing that people systematically make decisions that economists consider irrational. They save too little for retirement, eat too much fatty food, or don't exercise enough because they put too little value on the future. They pay inflated prices or accept inferior products because of personal biases, limited information or inertia." However, "While the insights of behavioral economics are now broadly accepted, applying them in a practical way isn't straightforward."

QUESTIONS: 
1. (Advanced) Define "behavioral economics." What are examples of non-optimizing consumer behavior? What are examples from studies in behavioral economics that have led to appropriate market regulations?

2. (Advanced) Does evidence that consumers do not maximize by systematically undervaluing future savings from more efficient cars, homes, and appliances imply that government regulation of the energy efficiency of these products is needed to promote economic efficiency? If so, what intervention would correct for consumer behavior?

3. (Introductory) What are examples of government regulators interjecting their biases when setting economic policy?

Reviewed By: James Dearden, Lehigh University

The market system