Presentation on theme: "Announcements: Tuesday"— Presentation transcript:
1Announcements: 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.September 17, Eric Rasmusen
2Assignments: 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.
3G302, Week 3 Market FailureJuoy 15, 2002 Eric Rasmusen
4Why does the government care about Pacific Gas and Electric? But they don’t deliver profitsYet electricity prices are highAnd they are in constant trouble about pollutionIt wants to transfer its watersheds to federal instead of state regulation.It wants delay in upgrading pollution control in its Massachusetts plants.Its chromium emissions may have been poisoning people.
5When do free markets lead to bad results? What you will learn today:When do free markets lead to bad results?Remember, I told you I wasn’t going to teach you how to defend indefensible business practices.
6Perfect competition requires… Well-Defined Property RightsMany Buyers and Sellers (price takers)Homogeneous ProductsFree EntryPerfect Information (on product, price)No Externalities (no spillovers)Property rights. If they are not defined, or if property is communal when it shouldn’t be, free markets can’t work.Napster. It is hard even to decide what property rights protection maximizes surplus.Overfishing. If nobody owns the fish in an ocean, then fishermen will fish too intensively and not enough fish will be left to breed future fish.
7Weak property rights leads to: Taking instead of makingLow incentives for effort and innovationProperty rights. If they are not defined, or if property is communal when it shouldn’t be, free markets can’t work.Napster. It is hard even to decide what property rights protection maximizes surplus.Overfishing. If nobody owns the fish in an ocean, then fishermen will fish too intensively and not enough fish will be left to breed future fish.
8Perfect competition requires… Well-Defined Property RightsMany Buyers and Sellers (price takers)Homogeneous ProductsFree EntryPerfect Information (on product, price)No Externalities (no spillovers)MARKET POWERAll 3 things are related.Napster. It is hard even to decide what property rights protection maximizes surplus.Overfishing. If nobody owns the fish in an ocean, then fishermen will fish too intensively and not enough fish will be left to breed future fish.A firm has market power ifit can affect the price byhow much it sells
9Choosing how much to sell MC = PA price taker picks Q so _______A firm with market power picks Q _________, so MC = marginal revenuesmaller
10A price-taking firm supply P P average cost P* market price profit demandmarginal cost (supply)QQfirmmarketQ*Q*firmmarketMarket ScaleFirm-Level Scale
11New firms enter... MC S P S’ P AC average cost P* market price P*’ demandThe price settles down to P=MC=AC.If some firm has higher costs, it must exit.marginal cost (supply)QQfirmmarketQ*Q*’Q*’Q*Market ScaleFirm-Level Scale
12What if entry is blocked? Costs and prices stay high. The market fails to maximize surplus.Why might entry be blocked?Government regulationPredatory pricing and other anticompetitive tacticsViolenceStudents have this slide.
13A Monopoly’s Use of Market Power Price-Taking Firm:CS = ______PS =_______A+B+DC+EMonopoly orCartel:CS =____PS = ____DWL= ____Use an overhead here.AB+CD+EThe Problem:____________________Monopolies reduce tradeReadings: Figure 13.1
14Imperfect Information If consumers lack information about products, they may buy products that yield negative consumer surplus.SupplyCS = -A-BPS= ADWL= BPerceived valueBAActual value
15What if producers differ? High-quality producers will have to leave the market if their costs are higherConsumers may stop buying altogether, knowing this
16Examples of Info Problems Firestone tiresDiet drugsQuality of doctors, dentists, lawyersInitial public offeringsUsed cars
17The principal-agent problem What if you can’t watch your employees all the time to see if they’re working hard?They know the effort they are selling you, but you don’tSolutions? (write on a notecard)Here, the problem is that the person COULD be high quality, but might not put the effort out
18Externalities (spillovers) Two people exchange a good, but _______________ are also affectedIf external effects are__________, markets produce_____________ tradeIf external effects are ____________, markets produce _____________tradethird partiesharmfultoo muchbeneficialGo to the overheads again here.Some good such as pollution is unpriced in the market-- it is not bought or sold.too little
19A $3/unit negative externality social costsupply+$3/unitThe __________is thesupply cost plus theexternality costPsupply23DWL22efficientcompetitiveWith a negativeexternality, outputis ____________20Beyond output of 100, the gains from trade are less than $3, the cost to third parties.Tomaximize surplus, usethe social cost curve,not the supply curve.How would you show the effect of a positive externality on a graph?Will a firm produce too much output if it both has market power and pollutes?Extra questions:too highdemandQ100120Readings: Figure 13.5
20Examples of Externalities NegativePositiveNegativeToxic wastes (-)Car exhaust (-)Party noise next door when you want to sleep (-)PositiveHome landscaping (+)New users of a high-tech system (+)If there is extra time: what is the most confusing concept of this lecture?