EFFICIENCY IN PERFECTLY COMPETITIVE MARKETS What is a Perfectly Competitive Market? A market in which no buyer or seller has the power to influence priceA market in which no buyer or seller has the power to influence price

There are a large number of small buyers and sellers.There are a large number of small buyers and sellers. Why Can’t Buyers or Sellers Influence the Price? The output produced by all firms in the market is identical.The output produced by all firms in the market is identical. Buyers and sellers have perfect information.Buyers and sellers have perfect information.

MARKET EFFICIENCY A market is efficient if it executes all potential transactions that would benefit a buyer, a seller, and any third parties affected by the transactions. A market is efficient if it executes all potential transactions that would benefit a buyer, a seller, and any third parties affected by the transactions. A market is inefficient if, once market equilibrium is reached, there is an additional transaction that would benefit a buyer, a seller, and any third parties affected by the transactionA market is inefficient if, once market equilibrium is reached, there is an additional transaction that would benefit a buyer, a seller, and any third parties affected by the transaction

MARKET SPILLOVER If there are no spillovers, there are no third parties who would be affected by market transactions.If there are no spillovers, there are no third parties who would be affected by market transactions. The market is efficient if there are no additional transactions that would benefit a buyer or a seller.The market is efficient if there are no additional transactions that would benefit a buyer or a seller.

Price of Syrup ($ per pint) Pints of Syrup per week (thousands) 4 7 DEMAND SUPPLY Buyer's profit (consumer surplus) Seller's profit (producer surplus)

Price of Syrup ($ per pint) Pints of Syrup per week (thousands) 4 7 DEMAND SUPPLY Buyer's profit (consumer surplus) Seller's profit (producer surplus)

The Invisible Hand Instead of using a bureaucrat to coordinate the actions of everyone in the market, we can only rely on the actions of individual consumers and producers, each guided only by self-interest. Instead of using a bureaucrat to coordinate the actions of everyone in the market, we can only rely on the actions of individual consumers and producers, each guided only by self-interest.

GOVERNMENT INTERVENTION Price Ceiling -- If a government passes a law that sets a maximum price below the equilibrium price.Price Ceiling -- If a government passes a law that sets a maximum price below the equilibrium price. Price ceiling example: Rent ControlPrice ceiling example: Rent Control Maximum Price Effects:Maximum Price Effects: - Decrease in quantity supplied, since fewer suppliers are able to cover costs; - Decrease in quantity supplied, since fewer suppliers are able to cover costs; - Reduced quality to help lower costs as revenue is declining; - Reduced quality to help lower costs as revenue is declining; - Fewer market transactions than if free market left to prevail. - Fewer market transactions than if free market left to prevail.

PRICE: Rent$$ $ QUANTITY: Number of Apartments Apartments Supply Demand i $360 MaximumPrice $420 MAXIMUM PRICE Creates inequality between Creates inequality between quantity supplied and demanded, and: quantity supplied and demanded, and: decreases quantity supplied; decreases quantity supplied; increases quantity demanded; increases quantity demanded; creates unsatisfied demand; creates unsatisfied demand; consumers limited to consumers limited to quantity supplied; quantity supplied; for amount supplied, for amount supplied, consumers now willing consumers now willing to pay more than to pay more than equilibrium price. equilibrium price.

GOVERNMENT INTERVENTION Price Floor - Imposition of minimum price which may be accepted for a specific good or service.Price Floor - Imposition of minimum price which may be accepted for a specific good or service. Example: Agricultural Price Support Programs;Example: Agricultural Price Support Programs; Minimum Price Effects:Minimum Price Effects: - Increased quantity supplied and reduced quantity demanded, creating surplus; - Increased quantity supplied and reduced quantity demanded, creating surplus; - Government typically buys surplus; - Government typically buys surplus; - Corporate farmers receive greatest support, while family farmers receive least support; - Corporate farmers receive greatest support, while family farmers receive least support; - Landowners enjoy appreciated land prices; - Landowners enjoy appreciated land prices; - Consumers pay artificially inflated product prices and pay for program with taxes. - Consumers pay artificially inflated product prices and pay for program with taxes.

Price per ton $100 1,000 QUANTITY: Tons of Corn Supply $110 Minimum Price MINIMUM PRICE Creates inequality between Creates inequality between quantity supplied & quantity quantity supplied & quantity demanded; demanded; Encourages farmers to Encourages farmers to produce more; produce more; Causes consumers to buy Causes consumers to buy less; less; Government buys surplus; Government buys surplus; Consumer pays higher price Consumer pays higher price ($110) and pays taxes to cover ($110) and pays taxes to cover government support government support (400 x $110 = $44,000). (400 x $110 = $44,000). 1, Demand

GOVERNMENT IMPOSED QUANTITY CONTROLS LICENSINGLICENSING Limits the number of firms, increases the price and decreases the quantity consumed. Limits the number of firms, increases the price and decreases the quantity consumed. IMPORT RESTRICTIONSIMPORT RESTRICTIONS Tariffs, quotas or other devices which reduce imports -- market supply from outside the country. Tariffs, quotas or other devices which reduce imports -- market supply from outside the country.

LICENSING Intended to protect consumers from high prices and low quality goods and services; Intended to protect consumers from high prices and low quality goods and services; –Requires fee from producer or service provider; Examples: Taxi service; building contractors; dry cleaners, tobacco farms, liquor stores, appliance repairers, dog groomers, etc...Examples: Taxi service; building contractors; dry cleaners, tobacco farms, liquor stores, appliance repairers, dog groomers, etc... Effects of Licensing:Effects of Licensing: - Lower quantity supplied; - Lower quantity supplied; - because of fewer products or providers, consumers will pay higher rates; - because of fewer products or providers, consumers will pay higher rates; - because licensing moves market away from equilibrium, it causes inefficiency. - because licensing moves market away from equilibrium, it causes inefficiency.

$3.00 1,000 QUANTITY: Miles of taxi service per hour Supply Demand Price per mile LICENSING Each driver provides 10 Each driver provides 10 miles of service per hour; miles of service per hour; originally 100 drivers: originally 100 drivers: 1,000 miles at $3.00; 1,000 miles at $3.00; licensing limits number of licensing limits number of drivers to 80; drivers to 80; limits miles to 800 / hour; limits miles to 800 / hour; consumers now willing to consumers now willing to pay $3.60 for each mile; pay $3.60 for each mile; providers willing to offer 800 providers willing to offer 800 miles for $2.60 / hour. miles for $2.60 / hour. 800 $3.60 $2.60

IMPORT RESTRICTIONS Devices established to support domestic industry by reducing competition from foreign producers.Devices established to support domestic industry by reducing competition from foreign producers. Examples: Tariffs, quotas, etc....Examples: Tariffs, quotas, etc.... Effects of Import Restrictions:Effects of Import Restrictions: - reduce quantity of imports; - reduce quantity of imports; - reduce quantity total market supply; - reduce quantity total market supply; - raise price of good; - raise price of good; - raise price of total market supply. - raise price of total market supply.

$ QUANTITY: Millions of pounds of Sugar per day Domestic (U.S.) Supply Demand Price per pound No imports: supply / No imports: supply / demand demand $0.26 / pound and 220 $0.26 / pound and 220 million pounds; million pounds; Imports: total supply Imports: total supply (domestic plus imported) (domestic plus imported) shifts right; shifts right; Supply 360 Supply 360 and 12¢; and 12¢; Import restrictions: total Import restrictions: total supply w/ imports restricted; supply w/ imports restricted; Supply curve shifts left; Supply curve shifts left; Quantity decreases to 300; Quantity decreases to 300; Price increases to 15¢. Price increases to 15¢. Total Supply w/ imports 360 $0.12 Total Supply w/ restrictions $ Import Restrictions

SPILLOVER PRINCIPLE For some goods, the associated costs or benefits are not confined to the individual or organization that decides how much of the good to produce or consume.

PUBLIC vs PRIVATE GOODS PUBLIC GOODS -PUBLIC GOODS - A good available to everyone to consume, regardless of who pays and who doesn’t. A good available to everyone to consume, regardless of who pays and who doesn’t. - Spillover benefits; - Spillover benefits; - Non-rival in consumption and non- excludable; - Non-rival in consumption and non- excludable; EXAMPLES: national defense, law enforcement; EXAMPLES: national defense, law enforcement; PRIVATE GOODS -PRIVATE GOODS - A good consumed by a single person or household; A good consumed by a single person or household; - No spillover benefits; - No spillover benefits; - Rival in consumption and excludable; - Rival in consumption and excludable; EXAMPLES: food and drink; EXAMPLES: food and drink;

FREE-RIDER PROBLEM If everyone tries to get a free ride, no one will contribute any money to support the public good, so it won’t be provided.If everyone tries to get a free ride, no one will contribute any money to support the public good, so it won’t be provided. The flip side of the free-rider problem is the chump problem: no one wants to be the chump (the person who gives free rides to other people), so no one contributes any money.The flip side of the free-rider problem is the chump problem: no one wants to be the chump (the person who gives free rides to other people), so no one contributes any money.

FREE-RIDER PROBLEM The problem with using voluntary contributions to support public goods. Each person will try to get the benefits of a public good without paying for it. Each person will try to get a free ride at the expense of others. The free-rider problem suggests that the replacement of taxes with voluntary contributions would force the government to cut back or eliminate many programs.

SPILLOVER COSTS Costs acquired by those who do not produce a product, nor benefit from the production of a product. May appear in the form of environmental destruction as a result of producing a good or service. Example: Pollution of streams and rivers with paper processing run-off.

Even though paper market may operate at equilibrium, inefficiency occurs because of spillover costs:Even though paper market may operate at equilibrium, inefficiency occurs because of spillover costs: Paper production requires cities downstream from mill to have added water-treatment costs. Paper production requires cities downstream from mill to have added water-treatment costs. If paper production decreased by one ton, water-treatment costs would be reduced by $20. If paper production decreased by one ton, water-treatment costs would be reduced by $20. SPILLOVER COSTS AND MARKET INEFFICIENCY IN PAPER MARKET

SPILLOVER COSTS AND MARKET INEFFICIENCY IN THE PAPER MARKET SUPPLY DEMAND Price / Ton of Paper Quantity: Tons of Paper per day I MarketEquilibrium

SPILLOVER COSTS AND MARKET INEFFICIENCY IN THE PAPER MARKET If the city agreed to pay paper producers $1 for unproduced ton of paper :If the city agreed to pay paper producers $1 for unproduced ton of paper : Paper producer revenue would be reduced by same amount as costs would be reduced --$60. The one dollar paid by the city would be incentive enough to produce one less ton of paper. Paper producer revenue would be reduced by same amount as costs would be reduced --$60. The one dollar paid by the city would be incentive enough to produce one less ton of paper.

SPILLOVER COSTS AND MARKET INEFFICIENCY IN THE PAPER MARKET SUPPLY DEMAND Price / Ton of Paper Quantity: Tons of Paper per day I j MarketEquilibrium

SPILLOVER COSTS AND MARKET INEFFICIENCY IN THE PAPER MARKET If the city agreed to pay the paper consumers $3 for consumption of one less ton of paper.If the city agreed to pay the paper consumers $3 for consumption of one less ton of paper. While paper consumer would receive $2 less benefit by not consuming the last (i.e., 100th) ton of paper, the dollar exceeding this cost, paid by the city, would be incentive enough for purchasers to purchase one less ton of paper. While paper consumer would receive $2 less benefit by not consuming the last (i.e., 100th) ton of paper, the dollar exceeding this cost, paid by the city, would be incentive enough for purchasers to purchase one less ton of paper.

SPILLOVER COSTS AND MARKET INEFFICIENCY IN THE PAPER MARKET If the city agreed to pay the paper producers $1 not to produce the 100th ton of paper and $3 for paper consumers not to consume the 100th ton of paper:If the city agreed to pay the paper producers $1 not to produce the 100th ton of paper and $3 for paper consumers not to consume the 100th ton of paper: City dwellers would have to pay $4 more in taxes to cover the incentive payments to the paper producer and paper consumer. City dwellers would have to pay $4 more in taxes to cover the incentive payments to the paper producer and paper consumer. However, city dwellers have $20 less to pay for water treatment. However, city dwellers have $20 less to pay for water treatment.

ROLE OF GOVERNMENT IN MARKET WHERE SPILLOVER COSTS ARE GENERATED POLLUTION TAX - Tax imposed on each unit of waste generated: force firms to pay for waste they generate.POLLUTION TAX - Tax imposed on each unit of waste generated: force firms to pay for waste they generate. REGULATIONS -- Direct control of pollution generated by specific firms, requiring installation of abatement equipment and decrease in volume of waste generated.REGULATIONS -- Direct control of pollution generated by specific firms, requiring installation of abatement equipment and decrease in volume of waste generated. MARKETABLE POLLUTION PERMITS -- Issue of a fixed number of pollution permits, allowing firms to buy and sell permits.MARKETABLE POLLUTION PERMITS -- Issue of a fixed number of pollution permits, allowing firms to buy and sell permits.