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Similar to Class 15 market equilibrium 100330
Similar to Class 15 market equilibrium 100330 (20)
Class 15 market equilibrium 100330
- 1. 18:36:04
- 2. Market Equilibrium and the wonders of perfect competition Ideological concepts? 18:36:04
- 3. Big IDEAS In a perfectly competitive market, equilibrium in price and quantity maximizes the sum of consumer and producer surplus. If a perfectly competitive market maximizes social welfare, then government regulations must make things worse. But markets are never perfectly competitive; and they always have problems: externalities, maldistribution of income, monopolistic behavior. . 18:36:04
- 4. Social Welfare is the Sum of Consumer and Producer Surplus The difference between costs (sum of MC) and benefits (sum of MU). 18:36:04
- 5. Perfect competition and market equilibrium: Enjoy it if you can Supply = demand and everyone is as happy as possible. 18:36:04
- 6. Monopoly reduces total surplus It doesn’t produce some units where MU>MC. It also redistributes consumer surplus to producers. 18:36:04
- 7. Perfectly Competitive markets maximize net welfare. If and only if : 1. Externalities are included in MC; 2. Income is distributed fairly, so that demand reflects real social MU; 3. There is no nonmarket production; 4. P erfect competition, producers sell at MC=MU. 18:36:04
- 8. Under these extreme circumstances, We will be in EQUILIBRIUM Prices will be such that no one wants to produce more, or consume less. There are no opportunities to increase welfare by changing the output level. 18:36:04
- 9. In perfect competition, market equilibrium, the right amount is produced Where MU> MC: produce. Where MU<MC: don’t This happens spontaneously, no need for inefficient social planners! So why do we get junk like this? 18:36:04
- 10. In equilibrium: No one could be made better off except by making someone else worse off. Everyone is satisfied with their situation given the prices they face. We owe this way of thinking to Vilfredo Pareto (1848-1923). 18:36:04
- 11. They would be happier if they were richer, younger, prettier. Or if they lived in Paris. Or Amherst. But life is hard. 18:36:04
- 12. These are pretty strong assumptions Easily violated Externalities Nonmarket production Income Distribution Monopoly 18:36:04
- 13. Perfect competition rewards productivity and innovation With better technology, productive firms can earn extra profits – rents on their innovations. 18:36:04
- 15. Capitalists do not profit from creating value; profits come from scarcity . No profit from goods that are universally available. Capitalists profit by walling off access so they can charge. This is called private property. 12:52:02 18:36:04
- 16. Examples: Microsoft and Hollywood Software and other digital materials (e.g. movies and music) cost nothing to transfer – their natural price, socially optimal price, is zero . But Microsoft, the RIAA (Record Industry Association of America) and others encode and put expiration into their materials to prevent free exchange so they can force you to pay. You pay twice: once for their profits, and once for the inefficiency. 12:52:02 18:36:04
- 18. Companies try to maintain distinctiveness and rents They try to hold customers with brand names. They try to remain aggressive and innovative 18:36:04
- 20. Instead of innovating, companies spend to control the market Xerox sued everyone for patent infringement. Sometimes they even won some money. After a decade of litigation, IBM paid $25 million. The Record Industry sues everyone. 12:52:03 18:36:04
- 21. As a society we would be better off if companies would innovate rather than litigate 12:52:03 18:36:04
Editor's Notes
- Goods should be produced wherever benefits exceed the cost. On this graph, the benefits, or the Marginal Utility, exceeds costs, the Marginal Costs, wherever the demand curve is above the supply curve. The optimal level of production is where Demand = Supply because until this point someone receives benefits greater than the cost of production. Surplus is the difference between MU and MC; it is the area between the curves up to the level of output. Surplus is divided between consumers (Consumer Surplus) and producers (Producer Surplus). Given any level of output, when prices change, surplus is redistributed between consumers and producers; higher prices means more goes to producers, lower prices leave more for consumers.
- Perfectly competitive firms will produce at the socially optimal level because they produce where MU=MC. They do this because they produce where P=MC and P, or the demand curve, comes from MU
- Monopolists reduce total surplus because they reduce production below the socially optimal level where MU=MC. Instead, monopolists recognize that the marginal revenue received by the producer is less than the price, less than MU, and they produce at a lower level of output where MU > MC.
- Even with perfect competition, the market will produce social optimum only under very restrictive conditions: where externalities are included in the market, where income is distributed fairly, and where all output is distributed through the market.
- Market production rewards technological progress because firms that produce at lower costs can profit at the market price because they can produce more cheaply. The excess profits they earn are called “rent” because they are selling at a higher, market price. Eventually, either they will drive others out of business and become a monopolist or other firms will adopt their new technology and prices will fall to reflect the better production techniques.
- Capitalists do not benefit from everyone having things; they benefit from people paying for things. Capitalists do not want to extend markets to their social optimum where MU=MC; they want lower levels of output and higher prices.
- Companies can maintain monopoly power and rents by creating new and exciting products – such as Xerox copiers and the IPOD. Or, they can use legal strategies – such as Xerox or RIAA. We would prefer that they do the former; but they often do the latter.