Transcript Chapter 16

Chapter 16: Government
Regulation of Business
McGraw-Hill/Irwin
Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.
Market Competition & Social
Economic Efficiency
• Social economic efficiency
• Exists when the goods & services that
society desires are produced & consumed
with no waste from inefficiency
• Two efficiency conditions must be met
 Productive efficiency
 Allocative efficiency
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Productive Efficiency
• Exists when suppliers produce goods &
services at the lowest possible total cost
to society
• Occurs when firms operate along their
expansion paths in both the short-run &
long-run
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Allocative Efficiency
• Requires businesses to supply optimal
amounts of all goods & services demanded
by society
• And these units must be rationed to individuals
who place the highest value on consuming
them
• Optimal level of output is reached when the
MB of another unit to consumers just
equals the MC to society of producing
another unit
• Where P = MC (marginal-cost-pricing)
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Social Economic Efficiency
• Achieved by markets in perfectly
competitive equilibrium
• At the intersection of demand & supply,
conditions for productive & allocative
efficiency are met
• At the market-clearing price, buyers &
sellers engage in voluntary exchange that
maximizes social surplus
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Efficiency in Perfect Competition
(Figure 16.1)
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Market Failure & the Case for
Government Intervention
• Competitive markets can achieve social
economic efficiency without government
regulation
• But, not all markets are competitive, and even
competitive markets can sometimes fail to
achieve maximum social surplus
• Market failure
• When a market fails to achieve social economic
efficiency and, consequently, fails to maximize social
surplus
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Market Failure & the Case for
Government Intervention
• Six forms of market failure can
undermine economic efficiency:
•
•
•
•
•
•
Monopoly power
Natural monopoly
Negative (& positive) externalities
Common property resources
Public goods
Information problems
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Market Failure & the Case for
Government Intervention
• Absent market failure, no efficiency
argument can be made for government
intervention in competitive markets
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Market Power & Public Policy
• Firms with market power must price above
marginal cost to maximize profit (P > MC)
• These firms fail to achieve allocative efficiency,
which reduces social surplus
 Lost surplus is a deadweight loss
• Allocative efficiency is lost because the profitmaximizing price does not result in marginalcost-pricing
 At the profit-maximizing point, MB > MC
 Resources are underallocated to the industry
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Louisiana White Shrimp Market
(Figure 16.2)
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Market Power & Public Policy
• When the degree of market power
grows high enough, antitrust officials
refer to it legally as monopoly power
• No clear legal threshold has been
established to determine when market
power becomes monopoly power
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Promoting Competition Through
Antitrust Policy
• A high degree of market power (or
monopoly power) can arise in three
ways:
• Actual or attempted monopolization
• Price-fixing cartels
• Mergers among horizontal competitors
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Promoting Competition Through
Antitrust Policy
• Firms may be found guilty of actual
monopolization only if both of the
following conditions are met:
• Behavior is judged to be undertaken for the
sole purpose of creating monopoly power
• Firm successfully achieves high degree of
market power
• Firms can also be guilty of attempted
monopolization
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Natural Monopoly & Market Failure
• Natural monopoly
• When a single firm can produce total
consumer demand for a good or service at
a lower long-run total cost than if two or
more firms produce total industry output
• Long-run costs are subadditive
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Subadditive Costs & Natural
Monopoly (Figure 16.3)
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Natural Monopoly & Market Failure
• Breaking up a natural monopoly is
undesirable
• Increasing number of firms drives up total
cost & undermines productive efficiency
• Under natural monopoly, no single price
can establish social economic efficiency
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Regulating Price Under Natural
Monopoly (Figure 16.4)
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Natural Monopoly & Market Failure
• With economies of scale, marginal-costpricing results in a regulated natural
monopoly earning negative economic
profit
• Two-part pricing is a solution that can
meet both efficiency conditions &
maximize social surplus
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The Problem of Negative Externality
• Externalities
• When actions taken by market participants
create either benefits or costs that spill over
to other members of society
• Positive externalities occur when spillover
effects are beneficial to society
• Negative externalities occur when spillover
effects are costly to society
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The Problem of Negative Externality
• Externalities undermine allocative
efficiency
• Market participants rationally choose to
ignore the benefits & costs of their actions
that spill over to others
• Competitive market prices do not capture
social benefits or costs that spill over to
society
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The Problem of Negative Externality
• Managers rationally ignore external
costs when making profit-maximizing
production decisions
• Social cost of production:
Social cost = Private cost + External cost
or
Social cost – Private cost = External cost
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Negative Externality & Allocative
Inefficiency (Figure 16.5)
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Pollution as a Negative Externality
(Figure 16.6)
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Finding the Optimal Level of Pollution
(Figure 16.7)
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Optimal Emission Taxation
(Figure 16.8)
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Nonexcludability
• Two kinds of market failure caused by
nonexcludability:
• Common property resources
• Public goods
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Common Property Resources
• Resources for which property rights are
absent or poorly defined
• No one can effectively be excluded from
such resources
• Without government intervention, these
resources are generally overexploited &
undersupplied
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Public Goods
• A public good is nonexcludable &
nondepletable
• The inability to exclude nonpayers
creates a free-rider problem for the
private provision of public goods
• Even when private firms supply public
goods, a deadweight loss can be avoided
only if the price of the good is zero
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Information & Market Failure
• Market failure may also occur because
consumers lack perfect knowledge
• Perfect knowledge includes knowledge
about product prices, qualities, and any
hazards
• Market power can emerge because of
imperfectly informed consumers
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Information & Market Failure
• Consumers may over- or under-estimate
quality of goods & services
• If they over-value quality, they will demand
too much product relative to the allocatively
efficient amount
• If they under-value quality, they will
demand too little
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Imperfect Information on Product
Quality (Figure 16.9)
16-32