Transcript 03_Market_Failure

Announcements: Tuesday


This week in the breakout sessions we
will be reviewing market failure and
surplus analysis.
Case questions are up on Oncourse for
all 4 cases.
1
Assignments: Thursday



Read: notes on public goods,
Blumenthal article, “The Greasy Pole”
for next week.
Next breakout: Discuss “The Greasy
Pole”, Blumenthal.
Case questions are up on Oncourse for
all 4 cases.
2
G302, Week 3
Market Failure
3
Why does the government care
about Pacific Gas and Electric?



But they don’t deliver profits
Yet electricity prices are high
And they are in constant trouble about
pollution
4
What you will learn today:
When do free
markets lead to bad
results?
5
Perfect competition requires…






Well-Defined Property Rights
Many Buyers and Sellers (price takers)
Homogeneous Products
Free Entry
Perfect Information (on product, price)
No Externalities (no spillovers)
6
Weak property rights leads to:


Taking instead of making
Low incentives for effort and innovation
7
Perfect competition requires…






Well-Defined Property Rights
Many Buyers and Sellers (price takers)
Homogeneous Products
Free Entry
MARKET POWER
Perfect Information (on product, price)
No Externalities (no spillovers)
A firm has market power if it can affect the price by
how much it sells
8
Choosing how much to sell


MC = P
A price taker picks Q so _______
A firm with market power picks Q
smaller so MC = marginal revenue
_________,
9
A price-taking firm
P
P*
supply
P
market price
average cost
profit
demand
marginal cost (supply)
Q* market
Market Scale
Qmarket
Q*firm
Firm-Level Scale
Qfirm
10
New firms enter...
MC
P
S
P*
S’
P
average cost
AC
market price
P*’
demand
marginal cost (supply)
Q* Q*’
Market Scale
Qmarket
Q*’ Q*
Firm-Level Scale
Qfirm
11
What if entry is blocked?


Costs and prices stay high. The market
fails to maximize surplus.
Why might entry be blocked?



Government regulation
Predatory pricing and other anticompetitive
tactics
Violence
12
A Monopoly’s Use of Market
Power
Price
Pmonopoly
Price-Taking Firm:
A+B+D
CS = ______
C+E
PS =_______
A
B
Pcompetitive
C
D
E
Marginal cost
(supply)
Demand
0
Qmonopoly Qcompetitive
Readings:
A Figure 13.1
marginal
revenue
curve
Quantity
Monopoly or
Cartel:
A
CS =____
B+C
PS = ____
DWL= D+E
____
The Problem:
13
Monopolies
reduce trade
____________________
Imperfect Information
If consumers lack information about
products, they may buy products that
yield negative consumer surplus.
Supply
Perceived value
B
A
CS = -A-B
PS= A
DWL= B
Actual value
14
What if producers differ?


High-quality producers will have to
leave the market if their costs are
higher
Consumers may stop buying altogether,
knowing this
15
Examples of Info Problems





Firestone tires
Diet drugs
Quality of doctors, dentists, lawyers
Initial public offerings
Used cars
16
The principal-agent problem



What if you can’t watch your employees
all the time to see if they’re working
hard?
They know the effort they are selling
you, but you don’t
Solutions? (write on a notecard)
17
Externalities (spillovers)



Two people exchange a good, but
third parties are also affected
_______________
harmful
If external effects are__________,
too much
markets produce_____________
trade
beneficial
If external effects are ____________,
markets produce _____________trade
too little
18
A $3/unit negative externality
social cost
supply+ The __________
$3/unit is the
P
23
22
20
DWL
supply
efficient
competitive
demand
100
Readings: Figure 13.5
120
supply cost plus the
externality cost
With a negative
externality, output
is ____________
too high
Q
19
Examples of Externalities

Negative

Positive
20