Chapter 12

1. Chapter 12 Economic Efficiency and Public Policy

2. In this chapter you will learn to 1. Describe the distinction between productive and allocative efficiency. 2. Explain why perfect competition is allocatively efficient, whereas monopoly is allocatively inefficient. 3. List the alternative methods for regulating a natural monopoly. 4. Describe the goals and results of U.S. antitrust policy.

3. Productive and Allocative Efficiency Full employment of resources does not guarantee efficiency: 1. firms may not use least-cost methods of production 2. marginal costs may not be equated across firms in an industry 3. too much of one product and too little of another product may be produced.

4. Table 12.1 Review of Four Market Structures

5. Productive Efficiency Productive efficiency for a firm requires costs to be minimized for any given level of output (recall chapter 8). Productive efficiency for an industry requires the MC to be the same for every firm. If all industries are productively efficient, then the economy is on the production possibilities boundary.

6. Figure 12.1 Productive Efficiency for the Industry

7. Figure 12.2 Productive Efficiency and the Production Possibilities Boundary

8. Figure 12.3 Allocative Efficiency and the Production Possibilities Boundary

9. What is the Amount of Steel and Wheat to Produce?

10. Which Market Structures Are Efficient? Profit-maximizing, competitive firms are productively efficient. If they interact in competitive markets, the outcome will be allocatively efficient (p = MC). On the other hand, monopoly is productively efficient, but allocatively inefficient (since p > MC).

11. Figure 12.4 Consumer and Producer Surplus in a Competitive Market

12. Figure 12.5 The Allocative Efficiency of Perfect Competition

13. Figure 12.6 The Deadweight Loss of Monopoly A monopolist generates a deadweight loss by restricting output below the competitive level. The deadweight loss is shown by area = 3 + 5.

14. Allocative Efficiency and Market Failure • Market failures: • when the free market fails to generate allocative efficiency • several causes — discussed in Chapter 16 • public policies — discussed in Chapters 17 and 18 Under some circumstances government action can “correct” the market failure and improve the efficiency of market outcomes.

15. Economic Regulation to Promote Efficiency Regulation of Natural Monopolies Natural monopoly: a situation where costs decline over the whole range of market output.  room for only one firm to achieve MES Two policy responses: - public ownership - regulation

16. Three Approaches to Regulating Natural Monopolies 1. Marginal-cost pricing (set p = p1) Price Costs Marginal-cost pricing is allocatively efficient, but the firm will incur losses. p2 • ATC c1 • p1 • MC D Output Q2 Q1

17. Figure 12.7 Pricing Policies for Natural Monopolies with Falling Costs

18. Tariff 2. A two-part tariff can be used to cover costs. This policy allows customers pay one price to gain access to the product and a second price for each unit consumed: For example: Electric bill • fixed monthly charge • charge that varies with the actual amount consumed

19. Average-Cost Pricing 3. Average-cost pricing (set p = p2) Price Costs Average-cost pricing results in zero profits, but it is allocatively inefficient because p > MC. p2 • ATC c1 • p1 • MC D Output Q2 Q1

20. Long Run Adjustment The allocatively efficient pricing system would determine output by setting prices equal to MC in the short run. It would also adjust capacity in the long run until the long-run MC is equal to the price. (Average-cost pricing generally leads to inefficient long-run investment decisions.) In the very long run, technological changes may create or destroy natural monopolies.

21. Regulation of Oligopolies There is growing skepticism about regulators’ ability to improve the behaviour of oligopolistic industries. Advanced industrial countries pushed toward deregulation and privatization when it was realized that: • Regulation often reduced competition • Public ownership was not clearly more efficient • Globalization led to more international competition • - reduced need for regulation?

22. U.S. Antitrust Policy The Framework of Antitrust Policy The antitrust law prohibits: • collusive behavior • mergers that reduce competition • Monopolization of an industry Sherman Act of 1890, Section 1: illegal to restrain trade Sherman Act of 1980, Section 2: illegal to monopolize Clayton Act of 1914: prohibited other anticompetitive practices

23. Antitrust Policy in the 21th Century APPLYING ECONOMIC CONCEPTS 12.1 Does Nineteenth Antitrust Policy Still Work in the Twenty-First Century?

24. Evolution of Antitrust Policy and Recent Developments Over time, there has been considerable variation in the aggressiveness of antitrust enforcement and in the interpretation of exactly what type of behavior is illegal. • U.S. v. Socony-Vacuum Oil Co. (1940): price fixing was found illegal regardless of the consequences • ALCOA (1945): company was ruled an illegal monopoly despite no evidence of “unreasonable behavior” • Be the mid-1970s, a more balanced antitrust approach was adopted, particularly in merger policy.

25. Looking Forward History suggests that U.S. antitrust policy will continue to change. Factors that will affect antitrust issues include: • technological changes • Globalization