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 16Government Regulation of Business

2. 16-2Market Competition & Social Economic EfficiencySocial economic efficiencyExists when the goods & services that society desires are produced & consumed with no waste from inefficiencyTwo efficiency conditions must be metProductive efficiencyAllocative efficiency

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

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

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

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

7. 16-7Market Failure & the Case for Government InterventionCompetitive markets can achieve social economic efficiency without government regulationBut, not all markets are competitive, and even competitive markets can sometimes fail to achieve maximum social surplusMarket failureWhen a market fails to achieve social economic efficiency and, consequently, fails to maximize social surplus

8. 16-8Market Failure & the Case for Government InterventionSix forms of market failure can undermine economic efficiency:Monopoly powerNatural monopolyNegative (& positive) externalitiesCommon property resourcesPublic goodsInformation problems

9. 16-9Market Power & Public PolicyFirms with market power must price above marginal cost to maximize profit (P > MC)These firms fail to achieve allocative efficiency, which reduces social surplusLost surplus is a deadweight lossAllocative efficiency is lost because the profit-maximizing price does not result in marginal-cost-pricingAt the profit-maximizing point, MB > MCResources are underallocated to the industry

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

11. 16-11Market Power & Public PolicyWhen the degree of market power grows high enough, antitrust officials refer to it legally as monopoly powerNo clear legal threshold has been established to determine when market power becomes monopoly power

12. 16-12Natural Monopoly & Market Failure Natural monopolyWhen 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 outputLong-run costs are subadditive

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

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

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

16. 16-16Natural Monopoly & Market FailureWith 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. 16-17The Problem of Negative ExternalityExternalitiesWhen 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 societyNegative externalities occur when spillover effects are costly to society

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

19. 16-19NonexcludabilityTwo kinds of market failure caused by nonexcludability:Common property resourcesPublic goods

20. 16-20Common Property ResourcesResources for which property rights are absent or poorly definedNo one can effectively be excluded from such resourcesWithout government intervention, these resources are generally overexploited & undersupplied

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

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

23. 16-23Information & Market FailureConsumers may over- or under-estimate quality of goods & servicesIf they over-value quality, they will demand too much product relative to the allocatively efficient amountIf they under-value quality, they will demand too little