Market Power, Market Failure, and General Competitive Equilibrium - PowerPoint Presentation

1. Market Power, Market Failure, and General Competitive EquilibriumChapter 9

2. The Nice AssumptionsNo Market PowerIndividuals haveEqual access to informationEqual access to the marketNo market failureMarketsForm quickly when neededFunction quickly & effectively

3. Relaxing No Market Power:The ConsequencesMarket Power reduces efficiencyThose with power do not have to exert themselves as much to win in the marketthey have the power to “win” anywayThose without power have little incentive to exert themselves because try as they might…they are going to “lose” anyway

4. Relaxing No Market PowerThe ConsequencesMarket Power affects equityThose with power get a bigger share of the social product (the pie) …Those without power get a smaller share of the social product (pie) …Whether this is more or less “just” is a moral, not an economics questionBut there is a redistribution, so equity is clearly affected.

5. Market Distribution…Perfect Competition vs. Market Power

6. Market Power – The FormsMonopoly – a single sellerno competition on the supply side (ex. ?)Monopsony – a single buyerno competition on the demand side (ex. ?)Oligopoly – collusion among a few sellersno competition on the supply side (ex. ?)so long as none of the colluders cheatOligopsony - collusion among a few buyersno competition on the demand side (ex. ?)so long as none of the colluders cheat

7. Barriers to EntryElements that make it hard for one to enter a marketTechnologyCapitalGovernment restrictionsQuotas

8. Market Power…The SourcesNaturally Occurring Market PowerArtificially Created Market Power

9. Naturally Occurring Market PowerEconomies of Scale can create naturally occurring market power:If increasing scale significantly lowers the cost structure, then a BIG company can charge a very low price.Competitors at a smaller scale and a higher cost structure can’t compete on price, so they can’t compete at all (ex. ?) … No competitionMkt. Power

10. Naturally Occurring Market Power - Labor Mkt. ExamplesAnother source of naturally occurring market power is natural talent or natural gifts.We all have our gifts, but some are more marketable than others, and some of these enjoy a much larger market than othersTo the degree you have a marketable gift that others don’t …No competitionMkt. Powerthey can’t compete with you.Marketable

11. Artificial Market Power - Labor Mkt. Examples An “unnatural” way is …SteroidsCheating on tests/quizzes5 hour energy??Artificial market power may also be socializedGenderRaceGeneral levels of wealth

12. Artificial Market PowerWhy would someone seek market power?The return for market power is called a “rent”The term “rent” here goes back to Adam Smith’s assertion in The Wealth of Nations that … “landlords, like all other men, love to reap where they never sowed, and demand a rent even for its [(the land’s)] natural produce.”

13. RentAs Smith uses the term, rent is not a return to the landlord’s effort or productive contribution …It is a return to the landlord’s power over the land, and thus his ability to demand a share of the product that comes from that naturally productive land

14. RentHow can you tell if a return is a rent?Like profit …Rent is a return above and beyond opportunity cost, i.e., beyond a normal returnBut unlike profit, one who enjoys a rent has the power to eliminate competitors

15. RentSo, how can you tell if a “distributive share” is a rent?If you can take a “share” away without changing incentives in the market …it’s a rent

16. RentFor example, ceteris paribus (e.g., independent of wealth effects), if you cut pro athletes’ salaries in half, most would continue in their current roles because they are earning far beyond a normal return on their labor and their investment in human capital … far more than their opportunity cost. They enjoy a rent.So too…someone who makes mega bucks in other markets, e.g., Wall Street

17. Why Rent??Because it PAY$ !

18. Artificially Created Market PowerWe’ve assumed that individuals are rational, utility maximizing beings.Doesn’t it make sense for a rational, utility maximizing person to pursue market power to get a bigger return from the market?

19. Rent Maintenance and Rent SeekingUsing resources to sustain market power is called rent maintenanceDonations to politiciansUsing resources to pursue market power for the sake of a rent is called “rent seeking”Hiring lobbyists

20. Artificially Created Market PowerA key distinction between naturally occurring market power and artificially created market power is:Naturally…is a free gift of natureArtificial…requires using resources to achieve or sustain the market power advantage

21. Artificially Market Power and InefficiencyThe fact that achieving or sustaining artificially created market power requires using resources adds to the inefficiency of market powerNaturally occurring power results in natural incentives or disincentivesArtificial power requires using resources to maintain the power

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23. Artificially Created Market PowerApartheid in South AfricaResources that could have been used to nurture people, building schools, hospitals, and so on …went instead to buying bullets, batons, etc… in order to oppress people so that the white minority could maintain POWER and enjoy huge “rents”

24. Artificially Created Market PowerIn South Africa society didn’t benefit from the energy and imagination and creativity of the black community, because the members of that community didn’t have the incentive to contribute their energy or the opportunity to contribute their gifts …What did the white community gain from its power? A larger share of a smaller “pie”.This gain was at the greater society’s expense.

25. How do the following cases reflect market power?And … what kind of power do they represent?

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31. He is a doctor …He is an executive …He is a chef …she is a nurse …she is a secretary … she is a waitress …Rent generating power can come from social or political institutions … or both

32. Artificial Power and Limiting the Market

33. Constraining the MarketTwo jobsMS = Men’s sphereWS = Women’s sphereComparable jobsMen’s sphere has higher pay to start

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35. What happens with no market power?Workers enter MS market, supply shifts outAs people leave WS, supply shifts backWage falls until all advantage is gone

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37. With Market PowerRelaxing the nice assumption of equal access to marketsIf women are crowded into a certain set of jobs, excess supply – lower wagesThis also restricts supply in male set of jobs – so higher wages result because of no female competitionWe could use this same example with high and low skilled jobs

38. How Would the Market Look w/Power?

39. Market Power and FirmsMarket power lessens efficiency Firms don’t have to be totally efficient because perfect competition isn’t forcing them to do soPareto optimality is not reached

40. Equity – Fairness?Those with market power can alter the distribution of benefits to their advantageIs that fair?Maybe or maybe not, but it is a different yardstick

41. Market Failure

42. Public Goods

43. Public GoodsExist to provide for what the free market may notBenefit societyApparent in markets that would, most likely, fail without government interventionNot are public goods are “true” public goods

44. Defining a Public GoodA “Pure” Public Good isNon-ExcludableIf you provide it to anyone you are providing it to everyone, because no one can be excludedNon-PartitionableHowever much you provide to anyone is available to everyone .. you can’t control the size of the shares

45. Public GoodsMilitary defense is an example of a pure public goodIf you’re inside the defense perimeter, the safety afforded by that perimeter is non-excludable and non-partitionable

46. Problem of Public GoodsSince a public good is non-excludable and non-partitionable …Once it’s provided to anyone, everyone else gets to enjoy all its benefits without having to pay for it, so it leads to a Free Rider Problem

47. Problem of Public GoodsThe initial provider bears the full burden of the cost and no one else has to contribute since they can “ride along for free”, ergo:Free Rider ProblemWell, no private individual or firm is going to provide under this condition so even if it’s good for the public the market won’t meet that need, ergo:Public Good Problem

48. Problem of Public GoodsIf you watch public television you’ll hear pleas like: “we depend on support from viewers like you …please give today to this station.”But you don’t hear fundraisers on the radio or TV with lines like: “we depend on support from citizens like you …please give today to the… “U.S. Army”

49. Problem of Public GoodsAs a nation we recognize that our national defense is an essential public good.We can debate about how much is enough and what the defense priorities should be, but we fund national defense by taxing citizens because, given the free rider problem, we can’t depend on donations.

50. Problem of Public GoodsPublic Goods represent a Market FailureHere we see that when the markets fail, there may be a role for government.

51. Externalities

52. ExternalitiesA positive or negative effect of a private activity on nominally uninvolved individuals. It is, therefore, a cost or benefit that private individuals or firms don’t take into account when making their activity decisions.It is external to the concerns of these private actors and, therefore, not a part of their considerations as they make choices.

53. ExternalitiesExamples:Positive – Nice music in the parkNegative – Second hand smokeOther examples?Positive?Negative?

54. ExternalitiesSource of the Externality Problem:Failure to assign or enforce property rightse.g.: Suppose you want to smoke in here …If I “own” the air in this room …If you “own” the air in this room …

55. Externalities Now suppose…neither of us owns or can enforce our property right to this airNo market forms … and so no market coordination signal is generatedWhat’s this missing signal called?The Price!!

56. ExternalitiesExternality as Market Failure:Due to a failure to define or enforce property rights…No market formsand so no price signal is generated to coordinated choices

57. Risk ExternalitiesExternalities that involve risks to others…Drunk DrivingGenetic EngineeringPollution

58. ExternalitiesSince private individuals or firms only consider their own private costs or benefits when making decisions, the presence of an externality means they don’t take into consideration the full costs or benefits of their choices on society.We can represent this graphically as follows …

59. ExternalitiesWhat the private actor considers$Level ofActivityMarginal Private CostMarginal Private BenefitMPCMPBLPOptimal Level Of Private Activity

60. Externalities: Building the GraphNegative externalities create “external costs,” ECThese are social costs that the individual or firm doesn’t take into accountThey are external to the individual’s or firm’s decision making

61. Externalities: Building the GraphPositive externalities create “external benefits,” EBThese are social benefits that the individual or firm doesn’t take into accountThey are external to the individual’s or firm’s decision making

62. Externalities: Building the GraphWhen private individuals or firms ignore the full effect of their behavior, not taking externalities into account…their private calculations understate the full impact of their choices on society

63. Externalities: Building the GraphTo measure the full social effect of each successive unit an activity we add the external effect to the private effect:For negative externalitiesMarginal Social Cost: MSC=MPC+ECFor positive externalitiesMarginal Social Benefit: MSB=MPB+EB

64. Externalities: Building the GraphIn the absence of any externalities:EC=0, then MSC=MPCEB=0, then MSB=MPBGraphically, the absence looks like…

65. $Level ofActivityMPC = MSC EC = 0MPB = MSB EB = 0LPOptimal Private and Social Level are the same=LS

66. Representing a Negative Externality$Level ofActivityMPCMPB = MSB EB = 0LPMSCLSOptimal Private and Social Level are differentEC= MPC + EC: LP > LS

67. Representing a Negative Externality$Level ofActivityMPCMPB = MSB EB = 0LPMSCLSOptimal Private and Social Level are the different+EC= MPC + EC: LP > LSWhat does LP > LS mean for society?

68. Representing a Negative Externality$Level ofActivityMPCMPB = MSB EB = 0LPMSCLSOptimal Private and Social Level are the different+EC= MPC + EC: LP > LSLP > LS means that, due to ignoring the negative external effects, the firm is overdoing its activity because it is not considering the full costs of its activity. This is socially inefficient

69. For Symmetry: Representing a Positive Externality$Level ofActivityMSC = MPC EC=0MPBLSLPEBOptimal Private and Social Level are the different: LP < LS= MPB + EBMSB

70. Positive ExternalityLP < LS means that the firm is underdoing its activity, because it’s not considering the full social benefits of its activity…and that’s socially inefficient.

71. ExternalitiesExternality as Market Failure:Due to a failure to define or enforce property rights, no market forms and so no price signal is generated to coordinate choices…this leads to social inefficiency …a less than Pareto Optimal market outcome