Transcript 9.0 Market Power, Market Failure and General Equilibrium

9.0 Market Power, Market Failure and
General Equilibrium
9.1
Pareto optimal general competitive equilibrium
is a special case of all the possible equilibria
There are others that are possible when market
power and market failure exist
Social Endowment
Social Product
Without Power Distortions
A
A
B
B
With Power Distortions
A
B
A
B
Figure 9.2.1 - Distribution of Society's Endowment and Distribution of Society's Product With and Without Power Distorts
Giving “A” market power,
the pie is smaller,
but A has a larger share of the pie
9.2.1
Exercising market power is not productive
It is exploiting an advantage that you have over the
market
If you have it, it is wonderful
There are costs, thoughSmaller piece for others
Makes the system less efficient
9.2.2
Monopoly – being the only seller in a market
Monopsony – being the only buyer in a market
Here, you are not a price taker
You can choose price/quantity combinations that are
most advantageous
There are two sources of market
power:
Naturally occurring and
Artificially created
9.2.3
Naturally occurring market power does not come
from distortions within the market process
They just happen
Ex. Supermodels, Michael Jordan
Egg donation – NY Times ad
9.2.4
The naturally occurring market power might have
different effects in different markets
Ex. Basketball vs. Tiddlywinks
9.2.5
Why did Michael Jordan make so much?
Huge derived demand and limited possibilities for
input substitution
Best possible case for a worker
Did he work hard?
Yes - making the most of his natural gift
9.2.6
If a firm produces huge amounts of a product,
it may begin to experience economies of scalebecause of the size of your operation, you can make
things much cheaper per unit
A firm that experiences large
economies of scale
call kill off all competition by virtue of this “head
start”
It will be able to underprice any new entrant
Economies of scale can be a barrier to entry to a
market
This can lead to a natural monopoly a single supplier with no competition
9.2.7
Natural advantages may slip away
Bodies get older,
firms face new technologies, etc
9.2.8 Artificially created market power
Patents – don’t occur in nature, come from
governments
Firms sometimes buy up patents to protect their
market power
9.2.9
Rent-maintenance – the exploitation of institutional
power to sustain a market advantage
Ex. Donations to Congress or other rules-makers to
prevent competition for your firm
9.2.10
Sometimes it’s not just about sustaining your
advantage
Rent-seeking is when you try to create an advantage
that isn’t there now
Lobbyists also do this
9.2.11
Smith pointed to rent-maintenance and rent-seeking
as threats to the market system in Great Britain
9.2.12
Artificial market power can be created through
political institutions,
but social institutions can also factor into our
perceptions of what is appropriate for
certain genders or races
9.2.13
Not only may social forces alter your own
perceptions about what you may become,
they may also affect those who hire/admit you
This is a powerful, yet almost invisible, constraint
that yields artificial market power for the
privileged
9.2.14
Two jobs
MS = Men’s sphere
WS = Women’s sphere
Comparable jobs
Men’s sphere has higher pay to start
p
WS
p
MS
S
S
p0
p0
D
D
Q
Figure 9.2.2 - Market Pictures: Two Comparable Jobs, No Market Power
Q
What happens with no market power?
Workers enter MS market, supply shifts out
As people leave WS, supply shifts back
Wage falls until all advantage is gone
p
p
WS
S1
MS
S0
S0
S1
p0
p1
p1
p0
D
D
Q
Figure 9.2.3 - Market Pictures: Two Comparable Jobs, No Market Power - Adjustment
Q
9.2.15
Relaxing the nice assumption of equal access to
markets
If women are crowded into a certain set of jobs,
excess supply – lower wages
And
This also restricts supply in male set of jobs – so
higher wages result because of no female
competition
9.2.16
Market power lessens efficiency
Firms don’t have to be totally efficient because
perfect competition isn’t forcing them to do so
Pareto optimality is not reached
Equity – fairness – is another
matter
Those with market power can alter the distribution of
benefits to their advantage
Is that fair?
Maybe or maybe not, but it is a different yardstick
9.2.17
Apartheid in South Africa
Whites were a minority, but had a vast majority of
the wealth
Limiting opportunities for Blacks preserved that
power advantage
Education, or a lack thereof, had economic
consequences
9.2.18
High skill versus low skill jobs
Without market power
HS
LS
p
p
S
S
p0
p0
D
D
Q
Figure 9.2.4 - Market Pictures: High Skill vs. Low Skill Jobs without Market Power
Q
With market power of apartheid
p
p
HS
S
LS
(S)
Dashed
Lines Reflect
Case Without
Power
p'
p0
(S)
S
p0
p'
D
D
Q
Figure 9.2.5 - Market Pictures: High Skill vs. Low Skill Jobs with Market Power
Q
9.2.19
Limits on education weren’t the only ones
Limits on mobility – passes
Limits on access to markets
All were “legal” – enforced by police and military
9.2.20
South Africa paid a price for this
system
Loss of efficiency
Most of the population’s energy and creativity is
blocked out
Pie could have been larger
Resources spent on rent-maintenance could have
been better spent
WITH POWER
FAIR RACE
W
W
B
B
Figure 9.2.6 - Distribution of South Africa's "Pie"
9.2.21
The price of maintaining that advantage grew more
and more expensive
Popular revolt – more jails and jailers
International sanctions hurt
Eventually Mandela goes from jail to President
Just changing laws is not the only change to make it
a fair society
9.2.22 Conclusion on market power
It often exists
It reduces efficiency and changes the equity of the
market system
Understanding the effects of market power enriches
our analysis of the world
We have a much more realistic model
9.3.1 Market Failure
We assume markets will form to quickly coordinate
choices
If the market doesn’t form, or can’t coordinate well,
we have a case of market failure
There are several types of market failure:
9.3.2 Public Goods
a public good is non-partitionable and nonexcludable
Ex. National Defense
9.3.3
Public goods suffer from the free rider problem
If you believe you will get the benefit without
paying, you might not pay
Ex. PBS - public television, National Public Radio
If everyone behaves as a free rider, the good might
disappear
9.3.4
Another type of market failure is an externality
This occurs when property rights can not be assigned
or enforced
9.3.5
Air rights
Air can be used for breathing, or as a place to
dispose waste
Ex. Smoking or polluting
A firm which pollutes has a consequence to others,
but
its effect is external to its own assessment of the cost
of the activities
9.3.6 - 9.3.11
The problem becomes that there is no market for air
there is no price signal
There is no way to quantify the external effect on
others caused by their activity
These two examples are called
negative externalities because there is an
external cost to others
It is also possible to have a positive
externality which adds an external benefit to
others
Ex. Beekeeper pollinates local plants, too
Piano lesson music spills over to others
In the case of a negative externality,
the Marginal Social Cost = Marginal Private Cost +
Marginal External Cost
MSC = MPC + MEC
or MEC = MSC - MPC
If there is no externality, MEC = 0 and
MPC=MSC
In the case of a positive externality,
the Marginal Social Benefit = Marginal Private
Benefit + Marginal External Benefit
MSB = MPB + MEB
or MEB = MSB- MPB
If there is no externality, MEB = 0 and
MPB=MSB
Since society as a whole must
consider
all costs and benefits when determining an optimum,
from a societal point of view, one should produce
where
MSB=MSC
However,
a private firm has its own decision rule
they produce where MPC=MPB
If no externalities exist,
then private optimization means social optimization
this is not always the case when you have market
failure
Graphical representation - Negative Externality
MSC = MPC +MEC
MEC
MPC
MPB=MSB
Ls
Lp
Output
With negative externalities,
firms tend to overproduce because
the market failure means the market does not allow
them to realize the extra “bad” that they do
Graphical representation - positive externality
MPC = MSC
MSB = MPB +MEB
MEB
MPB
Lp Ls
Output
With positive externalities,
firms tend to underproduce because
the market does not reflect the extra “goodness” they
do
9.3.12
Risk eternality - creating an unintended risk for
others
Ex. Drunk driving
9.3.13
Risk externalities and technology
Scientific experiments sometimes create unintended
consequences
9.3.14
Firms and individuals act in self-interest, but
unintended costs and benefits affect others
Market failure is why this happens
Lack of property rights, no price signal, etc.
What happens when markets fail?
Some feel this is is where government should get
involved