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Chapter 9: Market Power and Market Failure

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Title: Chapter 9: Market Power and Market Failure


1
Chapter 9 Market Power and Market Failure
  • Purpose of chapter a detailed examination of
    how Pareto Optimality can be distorted in a
    market economy by Market Power and Market
    Failure.
  • Leads to Distortions between shares of the Social
    Endowment and Social Product of members of a
    society.

2
Market Power
  • Market Power the process of exploiting an
    advantage to give an individual some control in
    the market.
  • -- Distributes a larger share of the
  • social product (production) of the
  • economy to the powerful.
  • -- Makes the economy less
  • efficient, producing less social
  • product than under GCE.

3
Naturally Occurring Market Power
  • Naturally Occurring Market Power market power
    resulting from either the consumers initial
    endowment (gifts, talents, attributes), or the
    natural competitive process of business.
  • Natural part of an economy.

4
Naturally Occurring Market Power in the Labor
Market
  • Consider a labor market with a very high demand
    for a certain attribute.
  • Now consider individuals who have this attribute
    more than anyone else (and it doesnt have to be
    a lot more).
  • The result a large amount of market power for
    these individuals, and a very wage for them.
  • E.G. Michael Jordan, Julia Roberts.

5
Naturally Occurring Market Power in
Industry
  • Take an industry which undergoes great Economies
    of Scale large purchases of physical capital,
    leading to a large region of downward sloping
    Average Cost (AC)
  • Significant increases in efficiency, lower
    average costs for high volume of production as a
    result.
  • Drives many other businesses out.
  • Creates Barriers to Entry difficult for other
    businesses to enter to grab some of the positive
    economic profit.

6
The Extreme Case
  • Monopoly industry characterized by one
    producer.
  • Producer has driven everyone else out through
    economies of scale, significant barriers to entry
    make it very difficult for firms to enter in.
  • Illegal in US (early 20th Century).

7
Naturally Occurring Market Power Not Permanent
  • Consumers tend to lose attribute of being 1 in
    these highly competitive markets.
  • New technologies arise and produce superior
    products, bringing down original firms
    (e.g. IBM and Microsoft).

8
Artificially Occurring Market Power
  • Artificially Occurring Market Power market
    power stemming from institutional restrictions or
    social perceptions.
  • Most dangerous threat to competitive economy
    (Adam Smith).
  • Can be long-term, not eroded naturally.

9
Rent-Seeking and
Rent-Maintenance
  • Rent-Seeking an attempt to seek market power by
    achieving an artificially created advantage.
  • Rent-Maintenance an attempt to maintain market
    power by maintaining an artificially created
    advantage.
  • Application Is this occurring through lobbying
    by special-interest groups in Congress?

10
Examples of Market Power
  • Key protection or benefit of a segment of
    society at the expense of the competitive economy
    as a whole.
  • -- patents for inventors
  • -- tariffs and trade restrictions
  • -- laws to keep industries out of
  • villages (e.g. Wal-Mart)
  • -- discrimination (institutional laws and
  • social perceptions)

11
Discrimination and Gender
Pay Inequity
  • Consider two labor markets, with the same labor
    demand and requiring roughly equal human capital.
  • One is man-sphere jobs (MS).
  • Other is woman-sphere jobs (WS).
  • Equilibrium wage in WS jobs (WWS)

  • (WMS).

12
Discrimination and Gender
Pay Inequity
  • No discrimination (institutional or social
    perception) ? migration from low-paying WS jobs
    to high-paying MS jobs.
  • Supply of labor decreases in WS market ? WWS?.
  • Supply of labor increases in MS market ? WMS?.
  • Continues until WWS WMS.

13
Discrimination and Market Power
  • Discrimination either prevents this adjustment
    from happening by law (institutional), or
    discourages it from happening (social
    perception).
  • Rent-Maintenance done by group imposing
    discrimination.

14
Market Failure
  • Market Failure a market either doesnt form
    when needed, or it doesnt work smoothly and
    quickly to make necessary adjustments.

15
Market Failure and Public
Goods
  • Public Good a good which is non-partitionable
    (cannot be split up into pieces or degrees), and
    non-excludable (cannot exclude anyone from using
    it).
  • Examples national defense, fire protection,
    police protection.

16
The Free Rider Problem
  • Free Rider Problem since public goods are
    non-excludable, and non-partitionable, people can
    get full coverage for free. Therefore, everyone
    waits for someone else to pay for it. As a
    result, a market doesnt form (market failure).

17
Market Failure and
Externalities
  • Externality when the actions of one economic
    unit (consumer, firm) affect another economic
    unit.
  • Positive Externality affects in a positive way.
  • Negative Externality affects in a negative way.

18
Externalities and (Lack of)
Property Rights
  • Underlying reason for externalities actions
    affect shared community resource where property
    rights cant be assigned (e.g. air, water,
    environment).
  • Example second-hand smoke from cigarettes.

19
Externalities External Costs
and Benefits
  • Negative Externality imposes an external cost
    to society, due to spillover harm on other
    members.
  • Positive Externality produces an external
    benefit to society, due to spillover benefit on
    other members.

20
Marginal Private Benefit and Marginal Private
Cost
  • Marginal Private Benefit (MPB) the benefit to
    an individual person of doing one more unit of an
    activity (similar to marginal utility).
  • Marginal Private Cost (MPC) the cost to an
    individual person of doing one more unit of an
    activity (all economic costs).

21
Marginal Social Benefit and Marginal Social Cost
  • Marginal Social Benefit (MSB) the benefit to
    society of the person doing one more unit of an
    activity (similar to marginal utility).
  • Marginal Social Cost (MSC) the cost to society
    of the person doing one more unit of an activity
    (all economic costs).

22
Characteristics of MPB,
MPC, MSB, and MSC
  • All are measured in dollars ().
  • MSB MPB EB, where EB are External Benefits
    associated with a positive externality involving
    the action.
  • MSC MPC EC, where EC are External Costs
    associated with a negative externality involving
    the action.

23
Negative Externality A Graphical Representation
  • Negative externality implies that External Costs
    0 and MSC MPC.
  • MSC curve represented by an upward shift of the
    MPC curve.
  • Socially optimal level of activity (LS) Privately optimal level of activity (LP).

24
Negative Externality Conclusion
  • Inefficiency due to Market Failure.
  • Too much undesirable activity, shifts social
    costs to bystanders.

25
Positive Externality A Graphical Representation
  • Positive externality implies that External
    Benefits 0 and MSB MPB.
  • MSB curve represented by an upward shift of the
    MPB curve.
  • Socially optimal level of activity (LS)
    Privately optimal level of activity (LP).

26
Positive Externality Conclusion
  • Inefficiency due to Market Failure.
  • Too little desirable activity.

27
Negative Externalities
and Firms
  • Inherent problem in production.
  • Examples
  • -- acid rain and the environment.
  • -- dumping chemicals in lakes,
  • contaminating water supply
  • -- noise pollution
  • -- bars, adult places, and crime

28
Risk Externalities
  • Risk Externality externality resulting from
    creating an unintended risk for innocent
    bystanders.
  • Example -- DWI.
  • Technology to reduce incidence of risk
    externality breathalyzer/starter lock for car.

29
Market Power and Market Failure The Next Step
  • Creates inefficiencies in society, deviation from
    GCE.
  • Very realistic and common.
  • What can government do to remedy these problems?
  • When should government not try to remedy these
    problems?
  • Topic of next chapter.
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