This document discusses different types of market failures that can prevent competitive markets from achieving social economic efficiency. It describes six main forms of market failure: monopoly power, natural monopoly, negative and positive externalities, common property resources, public goods, and information problems. For each type of market failure, the document explains how it undermines efficiency and decreases social surplus. It also discusses how government regulation may be needed to correct for market failures and help markets allocate resources efficiently.

1. Chapter 16 Government Regulation of Business

2. 16-2 Market Competition & Social Economic Efficiency Social economic efficiency Exists when the goods & services that society desires are produced & consumed with no waste from inefficiency Two efficiency conditions must be met Productive efficiency Allocative efficiency

3. 16-3 Productive Efficiency Exists when suppliers produce goods & services at the lowest possible total cost to society Occurs when firms operate along their expansion paths in both the short-run & long-run

4. 16-4 Allocative Efficiency Requires businesses to supply optimal amounts of all goods & services demanded by society And these units must be rationed to individuals who place the highest value on consuming them Optimal level of output is reached when the MB of another unit to consumers just equals the MC to society of producing another unit Where P = MC (marginal-cost-pricing)

5. 16-5 Social Economic Efficiency Achieved by markets in perfectly competitive equilibrium At the intersection of demand & supply, conditions for productive & allocative efficiency are met At the market-clearing price, buyers & sellers engage in voluntary exchange that maximizes social surplus

6. 16-6 Efficiency in Perfect Competition (Figure 16.1)

7. 16-7 Market Failure & the Case for Government Intervention Competitive markets can achieve social economic efficiency without government regulation But, not all markets are competitive, and even competitive markets can sometimes fail to achieve maximum social surplus Market failure When a market fails to achieve social economic efficiency and, consequently, fails to maximize social surplus

8. 16-8 Market Failure & the Case for Government Intervention Six forms of market failure can undermine economic efficiency: Monopoly power Natural monopoly Negative (& positive) externalities Common property resources Public goods Information problems

9. 16-9 Market Power & Public Policy Firms with market power must price above marginal cost to maximize profit (P > MC) These firms fail to achieve allocative efficiency, which reduces social surplus Lost surplus is a deadweight loss Allocative efficiency is lost because the profit-maximizing price does not result in marginal-cost-pricing At the profit-maximizing point, MB > MC Resources are underallocated to the industry

10. 16-10 Louisiana White Shrimp Market (Figure 16.2)

11. 16-11 Market Power & Public Policy When the degree of market power grows high enough, antitrust officials refer to it legally as monopoly power No clear legal threshold has been established to determine when market power becomes monopoly power

12. 16-12 Natural Monopoly & Market Failure Natural monopoly 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 Long-run costs are subadditive

13. 16-13 Subadditive Costs & Natural Monopoly (Figure 16.3)

14. 16-14 Natural Monopoly & Market Failure Breaking up a natural monopoly is undesirable Increasing number of firms drives up total cost & undermines productive efficiency Under natural monopoly, no single price can establish social economic efficiency

15. 16-15 Regulating Price Under Natural Monopoly (Figure 16.4)

16. 16-16 Natural Monopoly & Market Failure With economies of scale, marginal-cost-pricing results in a regulated natural monopoly earning negative economic profit Two-part pricing is a solution that can meet both efficiency conditions & maximize social surplus

17. 16-17 The Problem of Negative Externality Externalities When actions taken by market participants create either benefits or costs that spill over to other members of society Positive externalities occur when spillover effects are beneficial to society Negative externalities occur when spillover effects are costly to society

18. 16-18 The Problem of Negative Externality Managers rationally ignore external costs when making profit-maximizing production decisions Social cost of production: Social cost = Private cost + External cost Or Social cost – Private cost = External cost

19. 16-19 Nonexcludability Two kinds of market failure caused by nonexcludability: Common property resources Public goods

20. 16-20 Common Property Resources Resources for which property rights are absent or poorly defined No one can effectively be excluded from such resources Without government intervention, these resources are generally overexploited & undersupplied

21. 16-21 Public Goods A public good is nonexcludable & nondepletable The inability to exclude nonpayers creates a free-rider problem for the private provision of public goods

22. 16-22 Information & Market Failure Market failure may also occur because consumers lack perfect knowledge Perfect knowledge includes knowledge about product prices, qualities, and any hazards Market power can emerge because of imperfectly informed consumers

23. 16-23 Information & Market Failure Consumers may over- or under-estimate quality of goods & services If they over-value quality, they will demand too much product relative to the allocatively efficient amount If they under-value quality, they will demand too little