9.0 Market Power, Market Failure and General Equilibrium

1. 9.0 Market Power, Market Failure and General Equilibrium

2. 9.1 Pareto optimal general competitive equilibrium is a special case of all the possible equilibria There are others that are possible when market power and market failure exist

4. Giving “A” market power, the pie is smaller, but A has a larger share of the pie

5. 9.2.1 Exercising market power is not productive It is exploiting an advantage that you have over the market If you have it, it is wonderful There are costs, though- Smaller piece for others Makes the system less efficient

6. 9.2.2 Monopoly – being the only seller in a market Monopsony – being the only buyer in a market Here, you are not a price taker You can choose price/quantity combinations that are most advantageous

7. There are two sources of market power: Naturally occurring and Artificially created

8. 9.2.3 Naturally occurring market power does not come from distortions within the market process They just happen Ex. Supermodels, Michael Jordan Egg donation – NY Times ad

9. 9.2.4 The naturally occurring market power might have different effects in different markets Ex. Basketball vs. Tiddlywinks

10. 9.2.5 Why did Michael Jordan make so much? Huge derived demand and limited possibilities for input substitution Best possible case for a worker Did he work hard? Yes - making the most of his natural gift

11. 9.2.6 If a firm produces huge amounts of a product, it may begin to experience economies of scale- because of the size of your operation, you can make things much cheaper per unit

12. A firm that experiences large economies of scale call kill off all competition by virtue of this “head start” It will be able to underprice any new entrant Economies of scale can be a barrier to entry to a market This can lead to a natural monopoly - a single supplier with no competition

13. 9.2.7 Natural advantages may slip away Bodies get older, firms face new technologies, etc

14. 9.2.8 Artificially created market power Patents – don’t occur in nature, come from governments Firms sometimes buy up patents to protect their market power

15. 9.2.9 Rent-maintenance – the exploitation of institutional power to sustain a market advantage Ex. Donations to Congress or other rules-makers to prevent competition for your firm

16. 9.2.10 Sometimes it’s not just about sustaining your advantage Rent-seeking is when you try to create an advantage that isn’t there now Lobbyists also do this

17. 9.2.11 Smith pointed to rent-maintenance and rent-seeking as threats to the market system in Great Britain

18. 9.2.12 Artificial market power can be created through political institutions, but social institutions can also factor into our perceptions of what is appropriate for certain genders or races

19. 9.2.13 Not only may social forces alter your own perceptions about what you may become, they may also affect those who hire/admit you This is a powerful, yet almost invisible, constraint that yields artificial market power for the privileged

20. 9.2.14 Two jobs MS = Men’s sphere WS = Women’s sphere Comparable jobs Men’s sphere has higher pay to start

22. What happens with no market power? Workers enter MS market, supply shifts out As people leave WS, supply shifts back Wage falls until all advantage is gone

24. 9.2.15 Relaxing the nice assumption of equal access to markets If women are crowded into a certain set of jobs, excess supply – lower wages And This also restricts supply in male set of jobs – so higher wages result because of no female competition

25. 9.2.16 Market power lessens efficiency Firms don’t have to be totally efficient because perfect competition isn’t forcing them to do so Pareto optimality is not reached

26. Equity – fairness – is another matter Those with market power can alter the distribution of benefits to their advantage Is that fair? Maybe or maybe not, but it is a different yardstick

27. 9.2.17 Apartheid in South Africa Whites were a minority, but had a vast majority of the wealth Limiting opportunities for Blacks preserved that power advantage Education, or a lack thereof, had economic consequences

28. 9.2.18 High skill versus low skill jobs Without market power

30. With market power of apartheid

32. 9.2.19 Limits on education weren’t the only ones Limits on mobility – passes Limits on access to markets All were “legal” – enforced by police and military

33. 9.2.20

34. South Africa paid a price for this system Loss of efficiency Most of the population’s energy and creativity is blocked out Pie could have been larger Resources spent on rent-maintenance could have been better spent

36. 9.2.21 The price of maintaining that advantage grew more and more expensive Popular revolt – more jails and jailers International sanctions hurt Eventually Mandela goes from jail to President Just changing laws is not the only change to make it a fair society

37. 9.2.22 Conclusion on market power It often exists It reduces efficiency and changes the equity of the market system Understanding the effects of market power enriches our analysis of the world We have a much more realistic model

38. 9.3.1 Market Failure We assume markets will form to quickly coordinate choices If the market doesn’t form, or can’t coordinate well, we have a case of market failure There are several types of market failure:

39. 9.3.2 Public Goods a public good is non-partitionable and non-excludable Ex. National Defense

40. 9.3.3 Public goods suffer from the free rider problem If you believe you will get the benefit without paying, you might not pay Ex. PBS - public television, National Public Radio If everyone behaves as a free rider, the good might disappear

41. 9.3.4 Another type of market failure is an externality This occurs when property rights can not be assigned or enforced

42. 9.3.5 Air rights Air can be used for breathing, or as a place to dispose waste Ex. Smoking or polluting A firm which pollutes has a consequence to others, but its effect is external to its own assessment of the cost of the activities

43. 9.3.6 - 9.3.11 The problem becomes that there is no market for air there is no price signal There is no way to quantify the external effect on others caused by their activity

44. These two examples are called negative externalities because there is an external cost to others It is also possible to have a positive externality which adds an external benefit to others Ex. Beekeeper - pollinates local plants, too Piano lesson - music spills over to others

45. In the case of a negative externality, the Marginal Social Cost = Marginal Private Cost + Marginal External Cost MSC = MPC + MEC or MEC = MSC - MPC If there is no externality, MEC = 0 and MPC=MSC

46. In the case of a positive externality, the Marginal Social Benefit = Marginal Private Benefit + Marginal External Benefit MSB = MPB + MEB or MEB = MSB- MPB If there is no externality, MEB = 0 and MPB=MSB

47. Since society as a whole must consider all costs and benefits when determining an optimum, from a societal point of view, one should produce where MSB=MSC

48. However, a private firm has its own decision rule they produce where MPC=MPB

49. If no externalities exist, then private optimization means social optimization this is not always the case when you have market failure

50. Graphical representation - Negative Externality MSC = MPC +MEC MEC MPC MPB=MSB Ls Lp Output