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1 Announcements: Tuesday This week in the breakout sessions we will be reviewing market failure and surplus analysis. Case questions are up on Oncourse.

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Presentation on theme: "1 Announcements: Tuesday This week in the breakout sessions we will be reviewing market failure and surplus analysis. Case questions are up on Oncourse."— Presentation transcript:

1 1 Announcements: Tuesday This week in the breakout sessions we will be reviewing market failure and surplus analysis. Case questions are up on Oncourse for all 4 cases.

2 2 Assignments: Thursday Read: notes on public goods, Blumenthal article, The Greasy Pole for next week. Next breakout: Discuss The Greasy Pole, Blumenthal. Case questions are up on Oncourse for all 4 cases.

3 3 G302, Week 3 Market Failure

4 4 Why does the government care about Pacific Gas and Electric? But they dont deliver profits Yet electricity prices are high And they are in constant trouble about pollution

5 5 When do free markets lead to bad results? What you will learn today:

6 6 Perfect competition requires… Well-Defined Property Rights Many Buyers and Sellers (price takers) Homogeneous Products Free Entry Perfect Information (on product, price) No Externalities (no spillovers)

7 7 Weak property rights leads to: Taking instead of making Low incentives for effort and innovation

8 8 Perfect competition requires… Well-Defined Property Rights Many Buyers and Sellers (price takers) Homogeneous Products Free Entry Perfect Information (on product, price) No Externalities (no spillovers) A firm has market power if MARKET POWER it can affect the price by how much it sells

9 9 Choosing how much to sell A price taker picks Q so _______ A firm with market power picks Q _________, so MC = marginal revenue MC = P smaller

10 10 A price-taking firm Market ScaleFirm-Level Scale P P Q Q firm market market price supply demand Q* market P* average cost marginal cost (supply) profit Q* firm

11 11 New firms enter... Market ScaleFirm-Level Scale P P Q Q firm market market price S demand Q* P* average cost marginal cost (supply) Q* S P* Q* MC AC

12 12 What if entry is blocked? Costs and prices stay high. The market fails to maximize surplus. Why might entry be blocked? Government regulation Predatory pricing and other anticompetitive tactics Violence

13 13 A Monopolys Use of Market Power Monopoly or Cartel: CS =____ PS = ____ DWL= ____ Price-Taking Firm: CS = ______ PS =_______ The Problem: ____________________ Readings: Figure 13.1 A+B+D C+E A B+C D+E Monopolies reduce trade

14 14 Imperfect Information If consumers lack information about products, they may buy products that yield negative consumer surplus. Perceived value Actual value Supply CS = -A-B PS= A DWL= B A B

15 15 What if producers differ? High-quality producers will have to leave the market if their costs are higher Consumers may stop buying altogether, knowing this

16 16 Examples of Info Problems Firestone tires Diet drugs Quality of doctors, dentists, lawyers Initial public offerings Used cars

17 17 The principal-agent problem What if you cant watch your employees all the time to see if theyre working hard? They know the effort they are selling you, but you dont Solutions? (write on a notecard)

18 18 Externalities (spillovers) Two people exchange a good, but _______________ are also affected If external effects are__________, markets produce_____________ trade If external effects are ____________, markets produce _____________trade third parties harmful too much beneficial too little

19 19 A $3/unit negative externality The __________ is the supply cost plus the externality cost Readings: Figure 13.5 P Q competitive efficient supply supply+ $3/unit demand DWL With a negative externality, output is ____________ social cost too high

20 20 Examples of Externalities Negative Positive


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