Social welfare is maximum in case of imperfect competition
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Social welfare is maximum in case of imperfect competition

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  • 1. •Contents:•What is social welfare in Economics.•Two approaches of social economics•Perfect & Imperfect competition.•A Perfection Benchmark to the rescue.
  • 2.  Welfare economics is a branch of economics that uses microeconomic techniques to evaluate economic well-being, especially relative to competitive general equilibrium within an economy as to economic efficiency and the resulting income distribution associated with it. Social welfare refers to the overall welfare of society. With sufficiently strong assumptions, it can be specified as the summation of the welfare of all the individuals in the society. Welfare may be measured either cardinally in terms of "utils" or dollars, or measured ordinals in terms of Pareto efficiency.
  • 3.  The cardinal method in "utils" is seldom used in pure theory today because of aggregation problems that make the meaning of the method doubtful, except on widely challenged underlying assumptions. In applied welfare economics, such as in cost-benefit analysis, money- value estimates are often used.
  • 4.  There are two mainstream approaches to welfare economics: the early Neoclassical approach and the New welfare economics approach. The early Neoclassical approach was developed by Edgeworth, Sidgwick, Marshall, and Pigou. It assumes that: Utility is cardinal, that is, scale-measurable by observation or judgment. Additional consumption provides smaller and smaller increases in utility (diminishing marginal utility).
  • 5.  The New Welfare Economics approach is based on the work of Pareto, Hicks, and Caldor and Prof. T Scitovsky. It explicitly recognizes the differences between the efficiency aspect of the discipline and the distribution aspect and treats them differently. Questions of efficiency are assessed with criteria such as Pareto efficiency and the Kaldor-Hicks compensation tests, while questions of income distribution are covered in social welfare function specification.
  • 6.  Further, efficiency dispenses with cardinal measures of utility, replacing it with ordinal utility, which merely ranks commodity bundles (with an indifference-curve map, for example). Scitovsky derived a third version to the Compensation Principle in his novel A note on the Welfare Proposition in Economics called the Scitovsky Paradox or Reversal Test.
  • 7.  PERFECT COMETITION:- perfect competition describes markets such that no participants are large enough to have the market power to set the price of a homogeneous product. Because the conditions for perfect competition are strict, there are few if any perfectly competitive markets. Still, buyers and sellers in some auction-type markets, say for commodities or some financial assets, may approximate the concept. Perfect competition serves as a benchmark against which to measure real-life and imperfectly competitive markets
  • 8. 1. Large number of buyers and sellers.2. Homogeneous product.3. Free entry and exit of firms.4. Perfect knowledge.5. Perfect mobility of the factors of production.6. Absence of transport costs.7. Government non-intervention8. Only one price
  • 9.  Markets or industries with two or more sellers and buyers that fail to match the criteria of perfect competition. The most noted examples of imperfect competition are the two market structures with selling-side control--monopolistic competition and oligopoly. Lesser known market structures with buying-side control--monopsonistic competition and oligopsony--are also considered as imperfect competition. Facing no competition, monopoly and monopsony are not included. Most real world markets can be considered imperfect competition.
  • 10.  Imperfect competition is the general term for competitive markets that do not match the criteria of perfect competition. They are competitive, but they are imperfect. Market structures with no competition--monopoly and monophony--are excluded
  • 11.  This is where the benchmark of perfect competition is most important. By comparing specific, real world, imperfectly competitive markets with perfect competition, the degree of inefficiency can be indicated. If a monopolistically competitive market has a price of $10,001 and a quantity of 9,999,999, while the comparable price and quantity for perfect competition are $10,000 and 10,000,000, then inefficiency exists, but the problem is relatively small. Undertaking imperfect corrective government actions is likely to make matters worse.
  • 12.  In contrast, if an oligopolistic market has a price and quantity of $20,000 and 5,000,000, compared to a price and quantity for perfect competition of $10,000 and 10,000,000, then inefficiency also exists, and this inefficiency IS DEFINITELY more severe. Even imperfect corrective government policies have a good chance of improving upon this inefficiency. In real world, inefficiency problems and the need for corrective government policies are extremely diverse. And with this diversity comes differences of opinion and controversy. In fact, a number of the more interesting economic discussions involve questions about what, if any, actions government should take to correct the inefficiencies of imperfect competition.
  • 13.  Imperfectcompetition is when a firm has too much control over the market of a particular good or service and can therefore charge more than its market value. When the market for a certain good or service doesnt have very many competitors, the sole or few firms control the market. For example, suppose you need to get gas and the only place around is XYZ corporation and you dont have enough to get to the next station. They can charge you more than the market value, even $10 per gallon, because theres no competing gas station that you can buy from instead.
  • 14.  Some forms of imperfect competition are good for society. One of these is a "natural monopoly"; this occurs when the government grants a certain company sole market power over a specific area for a certain service. The government does this for services when the marginal costs of providing the particular service are really high with just a few customers; because of this, the government ensures that the particular company has enough customers to drive down the companys average costs without having to charge too low of a price so that theyll still find it profitable to provide the service. Otherwise, if companies stand to lose more than gain, certain services will be under-provided. For example, you may have noticed that most people where you live all use the same gas and electric company. Thats an example of a desirable situation of imperfect competition.
  • 15. There are different ways of defining perfect competition : however, for our purposes in this chapter, we can pick out two important features:(a) all agents are price takers,(b) prices adjust to equate desired supply and demand. When we say that agents are price takers, we mean that they treat the „market price‟ as given, they believe that they have no ability to influence the market price. Thus, when perfectly competitive firms decide how much output to produce, they treat the price as given and choose the output that equates supply with demand. This decision defines their supply function, which tells us how much they wish to supply at different prices. Similarly with consumers in deciding demand. When we say that prices adjust to equate supply and demand, we mean that the market price is determined (somehow!), at the point where the supply and demand curves intersect at point E in
  • 16.  Figure, at price p* and quantity x*. One of the most important points to note about the competitive equilibrium is that it is in some senses a socially optimal outcome (in the absence of externalities etc.). In particular, we can say that it maximize s the sum of consumer and producer surplus or more simply maximize s total surplus
  • 17.  Figure, at price p* and quantity x*. One of the most important points to note about the competitive equilibrium is that it is in some senses a socially optimal outcome (in the absence of externalities etc.). In particular, we can say that it maximize s the sum of consumer and producer surplus or more simply maximize s total surplus
  • 18.  To see this, note that if we consider the competitive equilibrium in Figure, the producer surplus, which is best thought of as profits, is given by the area between the horizontal price line p=p* and the supply curve, represented by the triangle between points ABE.
  • 19.  The consumer surplus is given by the triangle ACE, the area between the demand curve and the horizontal price line p=p*. Total surplus is then the triangle BEC. From the point of view of social welfare, the net gain to an additional unit of output is the vertical distance or „gap‟ at that output between the demand curve (which represents the marginal value of output) and the marginal cost curve (which represents the marginal cost of output): at xa this gap is GF. The total loss in surplus when we compare xa to x* is the triangle GEF.
  • 20.  Now let us consider an imperfectly competitive equilibrium, for example a monopoly. A monopolist will set its price as some mark-up over marginal cost. For example, assume the profit maximizing price of the monopolist is pm , with resultant output xm. As can be seen if we compare Figure a and Figure b, the monopoly outcome involves a loss in total surplus as compared to the competitive outcome: the net gain in producer surplus to the monopolist is more than offset by the loss of consumer surplus.
  • 21. The total loss is the triangle GEF in Figure b, which is often called the „social cost of monopoly‟. Thus if we compare the monopoly outcome to the competitive outcome, we observe that in comparison to the competitive outcome (a ) the level of economic activity is lower, and (b) the level of welfare is lower. However the difference does not end there: if for some reason the output is increased beyond xm, then of course total surplus will increase. For example, if output increases to x in figure b, then the gain in total surplus will be the shaded area GFKJ. Thus if we start from an imperfectly competitive equilibrium, then an increase in output will increase welfare.
  • 22.  Hence we can see that there are two fundamental differences between the perfectly competitive equilibrium and the monopolistic equilibrium. First,the monopolistic equilibrium involves a lower level of welfare than the perfectly competitive equilibrium. Second starting from the monopolistic equilibrium, an increase in output increases welfare, a reduction reduces welfare.
  • 23.  Whilst the analysis of this section has been cast in terms of simple microeconomics, its lessons will carry over into macroeconomics. The extra dimension added in macroeconomics is that the approach is general equilibrium: we have to consider equilibrium of all of the markets in the economy, and how they interact
  • 24.  To get More of Social welfare in Economics please refer to book “Economic Efficiency & social welfare”By E.J. Mishan.THANK YOU.