Intertemporal Markets Efficiency & Failure

Definition of Intertemporal Efficiency

Intertemporal efficiency means that a firm, government or nation maintains the right balance between resources used for current consumption as opposed to future use. Given the specific factors of production available in the economy, an increase in the production of consumption goods implies a decrease in the maximal amount of investment goods that can be produced.

The focus of many government policies is to achieve greater intertemporal efficiency so that we use our resources sustainably and current generations do not impose an unfair burden on future generations.

If the market mechanism is such that it ensures full employment with efficient production, then there is no hurdle in ensuring intertemporal efficiency. But in many cases, the market fails, entailing the case for government intervention to guard the public interest. The optimal stabilizing policy is the one which minimizes the deviations of the actual from the desired levels of target variables.

Through Diamond and Dybvig’s model, it can be proved that the monetary mechanism of risk-sharing may be able to elicit information regarding heterogeneous agents with lower communication costs and may provide some justification for such a role for policy in an intertemporal overlapping-generation setting.

Intertemporal Markets Efficiency

The focus of many government policies is to achieve greater intertemporal efficiency so that we use our resources sustainably and current generations do not impose an unfair burden on future generations. An intertemporal bias has its roots in Adam Smith’s work. From Smith’s day to the present times, economists have treated intertemporal trade-offs as different from other trade-offs that market participants face.

According to Mankiw, because resources are scarce, devoting more resources to producing capital requires devoting fewer resources to producing goods and services for current consumption. That is, for society to invest more in capital, it must consume less and save more of its current income. The growth that arises from capital formation is not a free lunch: it requires that society sacrifice consumption of goods and services in the present in order to enjoy higher consumption in the future.

Therefore, by encouraging savings and investment is one way that a government can encourage growth and, in the long run, raise the economy’s standard of living.” But the problem arises on what grounds would the government “encourage” people to make the intertemporal trade-off differently than they would make it without the encouragement.

Intertemporal Markets Failure

The intertemporal market failure occurs as the benefits of most of the public goods are experienced by the present generation while the costs will be borne by future generations. This mainly occurs because of uncertainty surrounding the benefits that future generations will require, for instance, the need for open space. It also occurs due to time preference.

Generally, people discount future benefits because they prefer to consume and prefer things now rather than in future. But when we look from society’s point of view, society has much longer time horizons and therefore cannot possibly discount the future benefits as individuals do.

This is the cause of the failure of intertemporal markets when it comes to social or public goods. Such goods will require intervention by the government to ensure the provision at all periods of time.

Read More in: Theory of Public Finance

1. Public Finance: Meaning, Nature & Scope
2. Role of Government in Economy
3. Role of Government in Mixed Economy: Public & Private Sector
4. Role of Government under Cooperation and Competition
5. Role of Government in Economic Development and Planning
6. Concept of Public Goods, Private Goods, and Merit Goods
7. Concept of Market Failure and Functions of Government
8. Market Failure and Functions of Government: Decreasing Costs
9. Market Failure and Functions of Government: Externalities
10. Market Failure and Functions of Government: Public Goods
11. Future Market: Meaning, Role & Uncertainty
12. Concept of Information Asymmetry
13. Theory of Second Best: Concept & Explanation
14. Problem of Allocation of Resources: Public & Private Mechanisms
15. Preferences: Meaning, Types & Problems of Preference Revelation
16. Preference Aggregation & Its Mechanism
17. Voting Systems, Direct Democracy, Representative Democracy, Leviathan Hypothesis & Arrow’s Impossibility Theorem
18. Economic Theory of Democracy: Concept & Explanation
19. Politico Eco Bureaucracy: Concept & Explanation
20. Rent-Seeking and Directly Unproductive Profit-Seeking Activities
21. Rationale for Public Goods: Concept & Explanation
22. Benefit Theory or Voluntary Exchange Theory
23. Lindahl Model: Concept, Equilibrium & Limitations
24. Bowen Model: Concept, Advantages & Limitations
25. Samuelson’s Model of Public Expenditure
26. Musgrave’s Model of Public Expenditures
27. Demand Revealing Schemes for Public Goods
28. Vickery-Clarke-Groves Mechanism
29. Groves-Ledyard Mechanism
30. Tiebout Model: Concept, Assumptions Equilibrium & Simple Tiebout Model
31. Theory of Club Goods
32. Keynesian Principles of Stabilization Policy
33. Difference Between Keynesian Economic Thought and Others
34. Role of Expectations and Uncertainty in Formulating Stabilization Policy
35. Intertemporal Markets Efficiency & Failure
36. Liquidity Preference Theory
37. Diamond-Dybvig Banking Model
38. Preference Shocks, Adverse Selection & Central Bank
39. Equilibrium Deposit Contract
40. Social Goods and Its Effect on Stabilization Policy
41. Effect of Infrastructural Facilities on Stabilization Policy
42. Effect of Distributional Inequality on Stabilization Policy
43. Effect of Regional Imbalances on Stabilization Policy
44. Wagner’s Law of Increasing State Activities: Explanation, Graph & Criticism
45. Peacock-Wiseman Hypothesis: Explanation, Graph & Criticism
46. Public Expenditure: Concept, Objectives, & Public vs Private Expenditure
47. Pure Theory of Public Expenditure
48. Structure & Growth of Public Expenditure in India
49. Trends, Lessons & Priorities in Public Expenditure in India
50. Social Cost-Benefit Analysis: Project Evaluation, Estimation of Costs & Discount Rate
51. Performance Based Budgeting and Zero Based Budgeting
52. Theories of Tax Incidence: Concentration Theory, Diffusion Theory & Modern Theory
53. Tax System and Its Principles
54. Equity Principle and Efficiency Principle of Taxation: Meaning, Explanation & Examples
55. Ability to Pay and Benefits Received Principle of Taxation
56. Theory of Optimal Taxation: Excess Burden & Distortions of Taxation
57. Deadweight Loss of Taxation: Causes, Measurement & Example
58. Concept of Equity & Efficiency in Economics
59. Trade-Off Between Equity and Efficiency: Meaning & Example
60. Theory of Measurement of Dead Weight Loss
61. Double Taxation: Meaning, Desirability, Forms & Solution
62. Solution to Problem of Double Taxation: Intra-Country & International
63. Double Taxation Avoidance Agreement (DTAA) and Indian Policy
64. Classical View on Public Debt
65. Compensatory Aspect of Public Debt Policy
66. Public Debt or Borrowings: Concept, Need, Sources & Types
67. Concept of Public Debt or Public Borrowings
68. Need for Public Debt or Public Borrowing
69. Sources of Public Debt
70. Classification of Public Debt
71. Burden of Public Debt: Meaning, Types & Explanation
72. Debt Through Created Money or Deficit Financing
73. Public Debt (Public Borrowings) and Inflation (Price Level)
74. Crowding Out of Private Investment and Activity
75. Principle of Public Debt Management and Debt Repayment