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Rationales for public policy: other limitations of the competitive framework

5 important questions on Rationales for public policy: other limitations of the competitive framework

In thin markets, that is markets with few sellers or few buyers, imperfect competition can lead to prices that differ from the competitive equilibrium and hence result in Pareto-inefficient allocations of inputs and goods. This often serves as a rationale for public intervention. Examples of thin markets are:

Natural monopoly leads to noncompetitive behavior
Pure monopsony: a single buyers faces competitive suppliers and therefore can influence price by choosing purchase levels.
Oligopoly: two or more firms account for a significant fraction of output -> cartelization

The assumption that the utility of individuals depends only on the goods that they personally consume (self-regarding preferences) isn't always correct in the sense that most of us are also other-regarding. Cases of interdependence in the sense that we do care about the consumption of at least some others:

Gifts/ donations / consumption of family members (children)
greater difficulty when utilities depend not only on the absolute quantities of goods people consume but also on the relative amounts (who gets more). Preferences based on relative consumption limit the straightforward, intuitive interpretation of the Pareto principle.

Efficient and complete insurance markets do not exists in the real world. Two sets of factors limit the range of contingencies that can be insured at even approximately actuarially fair prices:

Characteristics of the contingencies themselves (experience rating/law of large numbers)
Behavioral response to the available insurance

Behavioral responses to available insurance are:

Adverse selection (can be made mandatory to avoid)
Moral hazard: the reduced incentive that insurees have to prevent compensable losses. (requiring copayments to avoid)
people may underinsure for contingencies involving the loss of irreplaceable goods that cannot be exactly replicated

The underinvestment arguments states that:

Consumption by someone in the future should be given the same weight from the social perspective as consumption by someone today. (but seems to ignore the legacy of capital from one generation to the next)