EFFICIENCY IN PERFECTLY COMPETITIVE MARKETS

1
EFFICIENCY IN PERFECTLY COMPETITIVE MARKETS

• What is a Perfectly Competitive Market?
• A market in which no buyer or seller has the
  power to influence price

2
Why Cant Buyers or Sellers Influence the Price?

• There are a large number of small buyers and
  sellers.

• The output produced by all firms in the market is
  identical.
• Buyers and sellers have perfect information.

3
MARKET EFFICIENCY

• A market is efficient if it executes all
  potential transactions that would benefit a
  buyer, a seller, and any third parties affected
  by the transactions.
• A market is inefficient if, once market
  equilibrium is reached, there is an additional
  transaction that would benefit a buyer, a seller,
  and any third parties affected by the transaction

4
MARKET SPILLOVER

• If there are no spillovers, there are no third
  parties who would be affected by market
  transactions.
• The market is efficient if there are no
  additional transactions that would benefit a
  buyer or a seller.

5
6.00
Price of Syrup ( per pint)
5.00
SUPPLY
4.00
3.00
2.00
1.00
DEMAND
6
5
7
4
3
Pints of Syrup per week (thousands)
6
6.00
Price of Syrup ( per pint)
5.00
SUPPLY
4.00
3.00
2.00
1.00
DEMAND
6
5
7
4
3
Pints of Syrup per week (thousands)
7
The Invisible Hand

• Instead of using a bureaucrat to coordinate the
  actions of everyone in the market, we can only
  rely on the actions of individual consumers and
  producers, each guided only by self-interest.

8
GOVERNMENT INTERVENTION

• Price Ceiling -- If a government passes a law
  that sets a maximum price below the equilibrium
  price.
• Price ceiling example Rent Control
• Maximum Price Effects
• - Decrease in quantity supplied, since fewer
  suppliers are able to cover costs
• - Reduced quality to help lower costs as
  revenue is declining
• - Fewer market transactions than if free
  market left to prevail.

9
MAXIMUM PRICE
PRICE
Creates inequality between quantity
supplied and demanded, and decreases quantity
supplied increases quantity demanded
creates unsatisfied demand consumers limited
to quantity supplied for amount supplied,
consumers now willing to pay more than
equilibrium price.
Rent
Supply
420
i
Demand
400
360
Maximum Price
800
760
880
QUANTITY Number of Apartments
10
GOVERNMENT INTERVENTION

• Price Floor - Imposition of minimum price which
  may be accepted for a specific good or service.
• Example Agricultural Price Support Programs
• Minimum Price Effects
• - Increased quantity supplied and reduced
  quantity demanded, creating surplus
• - Government typically buys surplus
• - Corporate farmers receive greatest
  support, while family farmers receive least
  support
• - Landowners enjoy appreciated land prices
• - Consumers pay artificially inflated
  product prices and pay for program with taxes.

11
Minimum Price
Price per ton
MINIMUM PRICE
Supply
Creates inequality between quantity supplied
quantity demanded Encourages farmers to
produce more Causes consumers to buy
less Government buys surplus Consumer pays
higher price (110) and pays taxes to cover
government support (400 x 110 44,000).
110
100
Demand
1,000
1,200
800
QUANTITY Tons of Corn
12
GOVERNMENT IMPOSED QUANTITY CONTROLS

• LICENSING
• Limits the number of firms, increases the
  price and decreases the quantity consumed.
• IMPORT RESTRICTIONS
• Tariffs, quotas or other devices which
  reduce imports -- market supply from outside
  the country.

13
LICENSING

• Intended to protect consumers from high prices
  and low quality goods and services
• Requires fee from producer or service provider
• Examples Taxi service building contractors dry
  cleaners, tobacco farms, liquor stores, appliance
  repairers, dog groomers, etc...
• Effects of Licensing
• - Lower quantity supplied
• - because of fewer products or providers,
  consumers will pay higher rates
• - because licensing moves market away from
  equilibrium, it causes inefficiency.

14
LICENSING
Price per mile
Each driver provides 10 miles of service per
hour originally 100 drivers 1,000 miles at
3.00 licensing limits number of drivers to
80 limits miles to 800 / hour consumers now
willing to pay 3.60 for each mile
providers willing to offer 800 miles for
2.60 / hour.
Supply
3.60
3.00
2.60
Demand
1,000
800
QUANTITY Miles of taxi service per hour
15
IMPORT RESTRICTIONS

• Devices established to support domestic industry
  by reducing competition from foreign producers.
• Examples Tariffs, quotas, etc....
• Effects of Import Restrictions
• - reduce quantity of imports
• - reduce quantity total market supply
• - raise price of good
• - raise price of total market supply.

16
Import Restrictions
Domestic (U.S.) Supply
Price per pound
No imports supply / demand equilibrium _at_
0.26 / pound and 220 million pounds
Imports total supply (domestic plus imported)
shifts right Supply equilibrium _at_ 360 and
12 Import restrictions total supply w/
imports restricted Supply curve shifts left
Quantity decreases to 300 Price increases to
15.
Total Supply w/ restrictions
0.26
0.15
0.12
Demand
Total Supply w/ imports
220
360
300
QUANTITY Millions of pounds of Sugar per day
17
SPILLOVER PRINCIPLE

• For some goods, the associated costs or benefits
  are not confined to the individual or
  organization that decides how much of the good to
  produce or consume.

18
PUBLIC vs PRIVATE GOODS

• PUBLIC GOODS -
• A good available to everyone to consume,
  regardless of who pays and who doesnt.
• - Spillover benefits
• - Non-rival in consumption and non-
  excludable
• EXAMPLES national defense, law enforcement
• PRIVATE GOODS -
• A good consumed by a single person or
  household
• - No spillover benefits
• - Rival in consumption and excludable
• EXAMPLES food and drink

19
FREE-RIDER PROBLEM

• If everyone tries to get a free ride, no one will
  contribute any money to support the public good,
  so it wont be provided.
• The flip side of the free-rider problem is the
  chump problem no one wants to be the chump (the
  person who gives free rides to other people), so
  no one contributes any money.

20
FREE-RIDER PROBLEM

• The problem with using voluntary contributions to
  support public goods.
• Each person will try to get the benefits of a
  public good without paying for it.
• Each person will try to get a free ride at the
  expense of others.
• The free-rider problem suggests that the
  replacement of taxes with voluntary contributions
  would force the government to cut back or
  eliminate many programs.

21
SPILLOVER COSTS

• Costs acquired by those who do not produce a
  product, nor benefit from the production of a
  product.
• May appear in the form of environmental
  destruction as a result of producing a good or
  service.
• Example Pollution of streams and rivers with
  paper processing run-off.

22
SPILLOVER COSTS AND MARKET INEFFICIENCY IN PAPER
MARKET

• Even though paper market may operate at
  equilibrium, inefficiency occurs because of
  spillover costs
• Paper production requires cities
  downstream from mill to have added
  water-treatment costs.
• If paper production decreased by one ton,
  water-treatment costs would be reduced by 20.

23
SPILLOVER COSTS AND MARKET INEFFICIENCY IN THE
PAPER MARKET
Price / Ton of Paper
SUPPLY
I
Market Equilibrium
60
DEMAND
100
Quantity Tons of Paper per day
24
SPILLOVER COSTS AND MARKET INEFFICIENCY IN THE
PAPER MARKET

• If the city agreed to pay paper producers 1 for
  unproduced ton of paper
• Paper producer revenue would be reduced by
  same amount as costs would be reduced --60. The
  one dollar paid by the city would be incentive
  enough to produce one less ton of paper.

25
SPILLOVER COSTS AND MARKET INEFFICIENCY IN THE
PAPER MARKET
Price / Ton of Paper
SUPPLY
j
I
Market Equilibrium
62
60
DEMAND
100
99
Quantity Tons of Paper per day
26
SPILLOVER COSTS AND MARKET INEFFICIENCY IN THE
PAPER MARKET

• If the city agreed to pay the paper consumers 3
  for consumption of one less ton of paper.
• While paper consumer would receive 2 less
  benefit by not consuming the last (i.e., 100th)
  ton of paper, the dollar exceeding this cost,
  paid by the city, would be incentive enough for
  purchasers to purchase one less ton of paper.

27
SPILLOVER COSTS AND MARKET INEFFICIENCY IN THE
PAPER MARKET

• If the city agreed to pay the paper producers 1
  not to produce the 100th ton of paper and 3 for
  paper consumers not to consume the 100th ton of
  paper
• City dwellers would have to pay 4 more in
  taxes to cover the incentive payments to the
  paper producer and paper consumer.
• However, city dwellers have 20 less to pay
  for water treatment.

28
ROLE OF GOVERNMENT IN MARKET WHERE SPILLOVER
COSTS ARE GENERATED

• POLLUTION TAX - Tax imposed on each unit of waste
  generated force firms to pay for waste they
  generate.
• REGULATIONS -- Direct control of pollution
  generated by specific firms, requiring
  installation of abatement equipment and decrease
  in volume of waste generated.
• MARKETABLE POLLUTION PERMITS -- Issue of a fixed
  number of pollution permits, allowing firms to
  buy and sell permits.