THE WORLD GAME OF ECONOMICS:  LESSON 8
Focus on Market Failure & Externalities

NOTE:  It is highly recommended that you read over this entire lesson before you begin.

Preliminary Discussion:  The combined forces of Aggregate Demand and Aggregate Supply determine the level of output, prices, and employment for countries in the global economy.  Aggregate Demand (AD) is the amount of total spending on the part of consumers, businesses, government, and net exports at different prices.  Spending is inversely related to prices.  Aggregate Supply is the amount of output on the part of producers at different prices.  Production is directly related to prices.  The equilibrium level of output and prices for a given economy is where Aggregate Demand is equal to Aggregate Supply.

Aggregate Demand and Aggregate Supply schedules do not necessarily reflect all of the social costs and benefits associated with the production and consumption of goods and services.  There may be spillover costs or benefits which affect innocent third parties or the general public.  For example, pollution is an external cost to those who must contend with the emission of auto exhaust fumes, factory smoke, and waste dumped into a river or lake.  Garbage and its disposal are directly related costs of consumer goods packaging.

On the other hand, some products result in external benefits to society.  Education is an example.  When you get an education, you become a resource of trained labor for businesses.  You are less likely to commit crime, and you are a more informed voter.  These are all benefits to society which are beyond your own personal enrichment.

Market failure occurs whenever demand and supply do not reflect the full costs or benefits of economic activity.  The economic system will over-produce something if the market fails to incorporate external costs; and it will under-produce something if external benefits are not taken into account.

The role of government policy is to identify externalities and undertake steps to internalize them so that Aggregate Demand and Aggregate Supply schedules reflect the full costs and benefits to society. Government spending, regulations, taxes, and subsidies can improve the country's overall economic performance by taking externalities into consideration.

In The World Game of Economics you are the chief economic adviser to the leaders of the country of your choice.  You are in charge of economic policy.  The objective is to implement timely and appropriate economic polices to improve the overall economic performance of your country.  Good luck and have fun!

1.  Play The World Game of Economics to 100 points against up to six other countries that are either computer-managed (i.e., advised by Professor N. D. Cator) or Laissez Faire.  Note:  If you do not know how to play the game, then select "Tutorial" from the main menu first.  If you already know how to play, then select "New Game."

2.  You are the chief economic adviser to which country?  _______________________.
3.  How many other computer-managed countries are you playing against?  ________.

SOMETIME AFTER THE 3RD YEAR AND BEFORE THE 10TH YEAR OF THE GAME COMPLETE THIS EXERCISE:
4.  Which year have you chosen to complete this exercise?  __________.

CLICK ON THE ECONOMIC INDICATOR AT THE BEGINNING OF THIS TURN.  NEXT, CLICK ON THE CURRENT EVENT.

5.  On the template below, indicate where your economy and each of the other countries are currently positioned before clicking on ECONOMIC POLICY and going to the Policy Screen.  Use a colored felt pen to sketch flags or use abbreviations (e.g., USA = United States).  Note:  If you know how to use "Print Screen" tools, then use that method and attach to this exercise  Circle the current position of your country.

6.  Which countries, if any, are experiencing economic growth to the point where the costs to society of excessive garbage and pollution are greater than the benefits of producing more stuff?  ____________________________________________________________.

NOW SELECT YOUR ECONOMIC POLICIES AND COMPLETE THE GAME.  Print the final score and attach it to this exercise.

ANSWER QUESTIONS 7 - 11 ON THE BASIS OF THE DIAGRAM BELOW.  (Circle the letter before the best single answer).

7. In The World Game of Economics, if an economy is at E2 in the diagram:
(a) the economy is producing more goods than are being demanded at current prices.
(b) unbridled growth is generating excessive garbage and pollution, and the economy is over-producing the current composition of goods and services.
(c) external costs are inflating the GDP, so that it overstates the level of economic activity.
(d) an appropriate economic policy would be to raise tariffs on foreign products, so that pollution and garbage in other countries would be abated.
(e) All of these statements are true.

8. If your economy was at E3 in the diagram and the Aggregate Supply schedule failed to reflect external costs, then an appropriate economic policy would be to:
(a) depreciate the currency so that people can't buy as much.
(b) cut government spending for highways to decrease automobile travel.
(c) nationalize the manufacturing sector of the economy to reduce pollution.
(d) impose tougher environmental regulations on industry to raise the costs of production.
(e) declare a national emergency and halt production for one week.

9. Which of the following economic activities entail external costs?
(a) All of these activities entail social costs.
(b) fast-food production and consumption.
(c) agricultural production.
(d) commercial airline travel.
(e) automobile production and consumption.

10. If your economy was at E0 in the diagram but the Aggregate Demand and Supply curves failed to reflect external benefits to society, then:
(a) the GDP would overstate the true value of goods and services produced.
(b) the GDP would reflect an over-production of the current composition of goods.
(c) the GDP would reflect an optimal production of the current composition of goods.
(d) the GDP should be decreased so that the external benefits would be internalized.
(e) the GDP would reflect an under-production of the current composition of goods.

11. One reason that society provides public education K-12, community colleges, and state universities is:
(a) public schools are mandated by the Constitution.
(b) education is the key to solving all of our economic problems.
(c) there are external benefits to society which go beyond the personal rewards.
(d) ignorance is bliss, but uneducated people don't work.
(e) private education doesn't yield benefits to society.

End of Lesson 8

Note:  At the instructor's discretion, you will receive _____ possible points for this exercise.

Instructor's Option:  At the instructor's discretion, you may receive additional points according to the schedule below.

Examples:  If you play against 6 other countries and you place 1st, then you get 10 extra points!  If you play against 4 other countries and you place 3rd, then you get 6 extra points.  If you play against two other countries and you place 2nd, then you get 5 extra points.  In each case if you place last, then you get only 4 more points.

The World Game of Economics   (C) 1999 Ronald W. Schuelke   All Rights Reserved