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Chapter 16 fi_2010


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Chapter 16 fi_2010

  1. 1. Chapter 16<br />Government Regulation of Business<br />
  2. 2. 16-2<br />Market Competition & Social Economic Efficiency<br />Social economic efficiency<br />Exists when the goods & services that society desires are produced & consumed with no waste from inefficiency<br />Two efficiency conditions must be met<br />Productive efficiency<br />Allocative efficiency<br />
  3. 3. 16-3<br />Productive Efficiency<br />Exists when suppliers produce goods & services at the lowest possible total cost to society<br />Occurs when firms operate along their expansion paths in both the short-run & long-run<br />
  4. 4. 16-4<br />Allocative Efficiency<br />Requires businesses to supply optimal amounts of all goods & services demanded by society<br />And these units must be rationed to individuals who place the highest value on consuming them<br />Optimal level of output is reached when the MB of another unit to consumers just equals the MC to society of producing another unit<br />Where P = MC (marginal-cost-pricing)<br />
  5. 5. 16-5<br />Social Economic Efficiency<br />Achieved by markets in perfectly competitive equilibrium<br />At the intersection of demand & supply, conditions for productive & allocative efficiency are met<br />At the market-clearing price, buyers & sellers engage in voluntary exchange that maximizes social surplus<br />
  6. 6. 16-6<br />Efficiency in Perfect Competition (Figure 16.1)<br />
  7. 7. 16-7<br />Market Failure & the Case for Government Intervention<br />Competitive markets can achieve social economic efficiency without government regulation<br />But, not all markets are competitive, and even competitive markets can sometimes fail to achieve maximum social surplus<br />Market failure<br />When a market fails to achieve social economic efficiency and, consequently, fails to maximize social surplus<br />
  8. 8. 16-8<br />Market Failure & the Case for Government Intervention<br />Six forms of market failure can undermine economic efficiency:<br />Monopoly power<br />Natural monopoly<br />Negative (& positive) externalities<br />Common property resources<br />Public goods<br />Information problems<br />
  9. 9. 16-9<br />Market Power & Public Policy<br />Firms with market power must price above marginal cost to maximize profit (P > MC)<br />These firms fail to achieve allocative efficiency, which reduces social surplus<br />Lost surplus is a deadweight loss<br />Allocative efficiency is lost because the profit-maximizing price does not result in marginal-cost-pricing<br />At the profit-maximizing point, MB > MC<br />Resources are underallocated to the industry<br />
  10. 10. 16-10<br />Louisiana White Shrimp Market (Figure 16.2)<br />
  11. 11. 16-11<br />Market Power & Public Policy<br />When the degree of market power grows high enough, antitrust officials refer to it legally as monopoly power<br />No clear legal threshold has been established to determine when market power becomes monopoly power<br />
  12. 12. 16-12<br />Natural Monopoly & Market Failure<br /> Natural monopoly<br />When a single firm can produce total consumer demand for a good or service at a lower long-run total cost than if two or more firms produce total industry output<br />Long-run costs are subadditive<br />
  13. 13. 16-13<br />Subadditive Costs & Natural Monopoly (Figure 16.3)<br />
  14. 14. 16-14<br />Natural Monopoly & Market Failure<br />Breaking up a natural monopoly is undesirable<br />Increasing number of firms drives up total cost & undermines productive efficiency <br />Under natural monopoly, no single price can establish social economic efficiency<br />
  15. 15. 16-15<br />Regulating Price Under Natural Monopoly (Figure 16.4)<br />
  16. 16. 16-16<br />Natural Monopoly & Market Failure<br />With economies of scale, marginal-cost-pricing results in a regulated natural monopoly earning negative economic profit <br />Two-part pricing is a solution that can meet both efficiency conditions & maximize social surplus<br />
  17. 17. 16-17<br />The Problem of Negative Externality<br />Externalities<br />When actions taken by market participants create either benefits or costs that spill over to other members of society <br />Positive externalities occur when spillover effects are beneficial to society<br />Negative externalities occur when spillover effects are costly to society<br />
  18. 18. 16-18<br />The Problem of Negative Externality<br />Managers rationally ignore external costs when making profit-maximizing production decisions <br />Social cost of production:<br />Social cost = Private cost + External cost<br />Or<br /> Social cost – Private cost = External cost<br />
  19. 19. 16-19<br />Nonexcludability<br />Two kinds of market failure caused by nonexcludability:<br />Common property resources<br />Public goods<br />
  20. 20. 16-20<br />Common Property Resources<br />Resources for which property rights are absent or poorly defined<br />No one can effectively be excluded from such resources<br />Without government intervention, these resources are generally overexploited & undersupplied<br />
  21. 21. 16-21<br />Public Goods<br />A public good is nonexcludable & nondepletable<br />The inability to exclude nonpayers creates a free-rider problem for the private provision of public goods<br />
  22. 22. 16-22<br />Information & Market Failure<br />Market failure may also occur because consumers lack perfect knowledge<br />Perfect knowledge includes knowledge about product prices, qualities, and any hazards<br />Market power can emerge because of imperfectly informed consumers<br />
  23. 23. 16-23<br />Information & Market Failure<br />Consumers may over- or under-estimate quality of goods & services<br />If they over-value quality, they will demand too much product relative to the allocatively efficient amount<br />If they under-value quality, they will demand too little<br />