Title: Chapter 9: Market Power and Market Failure
1Chapter 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.
2Market 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.
3Naturally 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.
4Naturally 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.
5Naturally 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.
6The 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).
7Naturally 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).
8Artificially 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.
9Rent-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?
10Examples 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)
11Discrimination 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).
12Discrimination 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.
13Discrimination 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.
14Market Failure
- Market Failure a market either doesnt form
when needed, or it doesnt work smoothly and
quickly to make necessary adjustments.
15Market 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.
16The 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).
17Market 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.
18Externalities 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.
19Externalities 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.
20Marginal 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).
21Marginal 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).
22Characteristics 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.
23Negative 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).
24Negative Externality Conclusion
- Inefficiency due to Market Failure.
- Too much undesirable activity, shifts social
costs to bystanders.
25Positive 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).
26Positive Externality Conclusion
- Inefficiency due to Market Failure.
- Too little desirable activity.
27Negative 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
28Risk 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.
29Market 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.