Market Inefficiencies and Market Failures.pdf
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This document discusses the concepts of efficiency, demand, supply, consumer surplus, producer surplus, and market failures in competitive markets. It provides examples of how perfect competition leads to an efficient allocation of resources where marginal social benefit equals marginal social cost. However, it also notes several situations that can cause market failures and prevent efficient outcomes, such as externalities, public goods, imperfect information, taxes/subsidies, and monopoly power.
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Economic-Efficiency and Equity
Describe the alternative methods of allocating scarce resources
Explain the connection between demand and marginal benefit and define consumer surplus; and explain the connection between supply and marginal cost and define producer surplus
Explain the conditions under which markets are efficient and inefficient
Explain the main ideas about fairness and evaluate claims that markets result in unfair outcomes
Perfect competition
Perfect competition requires: firms are price takers, many sellers/buyers, free entry/exit, identical products, complete information. In short-run, individual firms maximize profits where marginal cost (MC) equals marginal revenue (MR). Market supply is the sum of individual firm MC curves. In long-run, zero economic profits are achieved as new entry drives prices down until MC equals average costs.
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1) Mark-up pricing which calculates costs and adds a desired profit margin.
2) Target return pricing which sets a price to achieve a desired profit on investment.
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Students should be able to:
Understand the assumptions of perfect competition and be able to explain the behaviour of firms in this market structure.
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Imperfect competition.pptx
Imperfect competition is an economic concept used to describe marketplace conditions that render a market less than perfectly competitive, creating market inefficiencies that result in losses of economic value.
In the real world, markets are nearly always in a condition of imperfect competition to some extent. However, the term is typically only used to describe markets where the level of competition among sellers is substantially below ideal conditions.A situation of imperfect competition exists whenever one of the fundamental characteristics of perfect competition is missing. When there is perfect competition in a market, prices are controlled primarily by the ordinary economic factors of supply and demand.
Notably, the stock market may be viewed as a continually imperfect market because not all investors have ready access to the same level of information regarding potential investments.
Imperfect competition commonly exists when a market structure is in the form of monopolies, duopolies, oligopolies, or monopsony (very rare)
Market structures that effectively render competition imperfect are most often characterized by a lack of competitive suppliers. Imperfect competition often exists as a result of extremely high barriers to entry for new suppliers. For example, the airline industry has high barriers to entry due to the extremely high cost of aircraft.
The most extreme condition of imperfect competition exists when the market for a particular good or service is a monopoly, one in which there is a sole supplier. A supplier that has a monopoly on the provision of a good or service essentially has complete control over prices.
Because it has no competition from other suppliers, the sole supplier can essentially set the price of its goods or services at any level it desires. Monopolies often charge prices that provide them with significantly higher profit margins than most companies operate with.
A duopoly is a market structure in which there are only two suppliers. Although duopolies are somewhat more competitive than monopolies, the level of competition is still far from perfect, as the two suppliers still have significant control of marketplace prices.
An example of a duopoly exists in the United Kingdom’s detergent market, where Procter & Gamble (NYSE: PG) and Unilever (NYSE: UL) are virtually the only suppliers. The two suppliers in a duopoly often collude in price setting.
Oligopolies are much more common than either monopolies or duopolies. In an oligopoly, there are several – but a small, limited number – of suppliers. The market for cell phone service in the United States is an example of an oligopoly, as it is essentially controlled by just a handful of suppliers. The small number of suppliers, which limits buying choices for consumers, provides the suppliers with substantial, although not complete, control over pricing.
A rare form of imperfect competition is monopsony. A monopsony is a single buyer, rather than any supplier.
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Describe the alternative methods of allocating scarce resources
Explain the connection between demand and marginal benefit and define consumer surplus; and explain the connection between supply and marginal cost and define producer surplus
Explain the conditions under which markets are efficient and inefficient
Explain the main ideas about fairness and evaluate claims that markets result in unfair outcomes
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Perfect competition requires: firms are price takers, many sellers/buyers, free entry/exit, identical products, complete information. In short-run, individual firms maximize profits where marginal cost (MC) equals marginal revenue (MR). Market supply is the sum of individual firm MC curves. In long-run, zero economic profits are achieved as new entry drives prices down until MC equals average costs.
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The document discusses various methods for setting prices, including:
1) Mark-up pricing which calculates costs and adds a desired profit margin.
2) Target return pricing which sets a price to achieve a desired profit on investment.
3) Perceived value pricing which bases price on how customers value both tangible and intangible benefits.
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Perfect Competition
Students should be able to:
Understand the assumptions of perfect competition and be able to explain the behaviour of firms in this market structure.
Understand the significance of firms as price-takers in perfectly competitive markets. An understanding of the meaning of shut-down point is required. The impact of entry into and exit from the industry should be considered.
Imperfect competition.pptx
Imperfect competition is an economic concept used to describe marketplace conditions that render a market less than perfectly competitive, creating market inefficiencies that result in losses of economic value.
In the real world, markets are nearly always in a condition of imperfect competition to some extent. However, the term is typically only used to describe markets where the level of competition among sellers is substantially below ideal conditions.A situation of imperfect competition exists whenever one of the fundamental characteristics of perfect competition is missing. When there is perfect competition in a market, prices are controlled primarily by the ordinary economic factors of supply and demand.
Notably, the stock market may be viewed as a continually imperfect market because not all investors have ready access to the same level of information regarding potential investments.
Imperfect competition commonly exists when a market structure is in the form of monopolies, duopolies, oligopolies, or monopsony (very rare)
Market structures that effectively render competition imperfect are most often characterized by a lack of competitive suppliers. Imperfect competition often exists as a result of extremely high barriers to entry for new suppliers. For example, the airline industry has high barriers to entry due to the extremely high cost of aircraft.
The most extreme condition of imperfect competition exists when the market for a particular good or service is a monopoly, one in which there is a sole supplier. A supplier that has a monopoly on the provision of a good or service essentially has complete control over prices.
Because it has no competition from other suppliers, the sole supplier can essentially set the price of its goods or services at any level it desires. Monopolies often charge prices that provide them with significantly higher profit margins than most companies operate with.
A duopoly is a market structure in which there are only two suppliers. Although duopolies are somewhat more competitive than monopolies, the level of competition is still far from perfect, as the two suppliers still have significant control of marketplace prices.
An example of a duopoly exists in the United Kingdom’s detergent market, where Procter & Gamble (NYSE: PG) and Unilever (NYSE: UL) are virtually the only suppliers. The two suppliers in a duopoly often collude in price setting.
Oligopolies are much more common than either monopolies or duopolies. In an oligopoly, there are several – but a small, limited number – of suppliers. The market for cell phone service in the United States is an example of an oligopoly, as it is essentially controlled by just a handful of suppliers. The small number of suppliers, which limits buying choices for consumers, provides the suppliers with substantial, although not complete, control over pricing.
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Perfect competition is a market structure with many small firms, homogeneous products, perfect information and free entry and exit. In the short run, firms maximize profits where marginal cost (MC) equals marginal revenue (MR). Abnormal profits attract new firms, lowering prices to normal profits when MC equals average cost (AC). Allocative efficiency occurs where MC equals average revenue (AR). In the long run, productive, allocative and profit maximizing efficiencies are achieved at the same output level.
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· Using prices in markets to allocate scarce resources is one of many alternative methods of allocating scarce resources.
· Tools such as consumer surplus and producer surplus help evaluate efficiency.
· The outcomes from the various methods used to allocate scarce resources, especially markets, can be examined in terms of both their efficiency and fairness.
I.
Resource Allocation Methods
Resources are scarce, so they somehow must be allocated. Different methods of allocating resources include:
· Market price: The people who are willing and able to buy a resource get the resource.
· Command: a command system allocates resources by the order (command) of someone in authority. A command system works well in organizations with clear lines of authority but does not work well at allocating resources in the entire economy.
· Majority rule: resources are allocated in accordance with majority vote. Majority rule works well when the allocation decisions being made affect a large number of people and self-interest leads to bad decisions.
· Contest: resources are allocated to the winner. Contests work well when the efforts of the players are hard to measure, such as top managers being in a contest to be named CEO of a company.
· First-come, first-serve: resources are allocated to those who are first in line. This allocation method works well when the resource can serve just one user at a time in a sequence, as is the case with, say, a bank teller or an ATM.
· Lottery: resources are allocated to the people who pick the winning number, choose the lucky card, etc. Lotteries work best when there is no effective way to distinguish among potential users of a scarce resource.
· Personal characteristics: resources are allocated to people with the “right” characteristics.
· Force: resources are allocated to those who can forcibly take the resources.
II.
Benefit, Cost, and Surplus
Demand, Willingness to Pay, and Value
· The value of one more unit of a good or service is its marginal benefit. Marginal benefit is the maximum price that people are willing to pay for another unit of a good or service. And the willingness to pay for a good or service determines the demand for it. Consequently the demand curve for a good or service is also its marginal benefit curve.
· The market demand curve is the horizontal sum of the individual demand curves and is formed by adding the quantities demanded by all the individuals at each price.
· The demand curve in the figure shows that the maximum price a person is willing to pay for the 6 millionth gallon of milk per month is $3, so $3 is the marginal benefit of this gallon.
· MSB curve: In the absence of externalities, which will be discussed later, the market demand curve is also the economy’s marginal social benefit (MSB) curve. It reflects the number of dollars’ worth of other goods and services willingly given up to obtain one more unit of a good.
· The figure shows that the ...
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This document provides an introduction to competition economics for a university law school course. It outlines how economics can provide insights into competition law and discusses key economic concepts like demand and supply, perfect competition, monopoly, and market power. The document presents models of perfect competition and monopoly to illustrate how firm behavior and market outcomes differ. It also previews topics to be covered in the next lecture, including game theory, price and quantity competition models, and other applied competition topics.
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· Using prices in markets to allocate scarce resources is one of many alternative methods of allocating scarce resources.
· Tools such as consumer surplus and producer surplus help evaluate efficiency.
· The outcomes from the various methods used to allocate scarce resources, especially markets, can be examined in terms of both their efficiency and fairness.
I.
Resource Allocation Methods
Resources are scarce, so they somehow must be allocated. Different methods of allocating resources include:
· Market price: The people who are willing and able to buy a resource get the resource.
· Command: a command system allocates resources by the order (command) of someone in authority. A command system works well in organizations with clear lines of authority but does not work well at allocating resources in the entire economy.
· Majority rule: resources are allocated in accordance with majority vote. Majority rule works well when the allocation decisions being made affect a large number of people and self-interest leads to bad decisions.
· Contest: resources are allocated to the winner. Contests work well when the efforts of the players are hard to measure, such as top managers being in a contest to be named CEO of a company.
· First-come, first-serve: resources are allocated to those who are first in line. This allocation method works well when the resource can serve just one user at a time in a sequence, as is the case with, say, a bank teller or an ATM.
· Lottery: resources are allocated to the people who pick the winning number, choose the lucky card, etc. Lotteries work best when there is no effective way to distinguish among potential users of a scarce resource.
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2) Monopoly power can be measured by the Lerner Index, which is the excess of price over marginal cost as a proportion of price. Monopoly power is greater when demand is less elastic.
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- Under perfect competition, there are many small producers and consumers of a standardized product, while a monopoly has a single producer and no close substitutes. Monopolistic competition features product differentiation and free entry/exit of many firms. Oligopoly has a small number of interdependent producers controlling the market.
- Profit maximization occurs where marginal revenue equals marginal cost under perfect competition and monopolistic competition. A monopoly chooses output where marginal revenue is zero. Pricing strategies depend on market structure and include cost-plus, penetration, skimming, and prestige pricing.
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1. The document discusses market structures, specifically monopoly, including monopoly assumptions, barriers to entry, production decisions, and profit maximization.
2. A monopoly faces the entire market demand curve and can set price above marginal cost to earn profits in both the short- and long-run.
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Demand and supply determine the market price of goods. According to the laws of demand and supply, buyers demand more of a product when prices fall and less when prices rise, while producers supply more when prices are higher and less when prices are lower. When supply exceeds demand, a surplus occurs, and when demand exceeds supply, a shortage results. Market structures include perfect competition, monopolistic competition, oligopoly, and monopoly.
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The market is made up of buyers and sellers who conduct exchange transactions. Markets can be classified based on area, the nature of transactions, volume, time period, and level of competition. Under perfect competition, there are many small firms and homogeneous products. Individual firms are price takers and maximize profits where marginal revenue equals marginal cost. Monopolies have single firms and differentiated products, allowing them to be price makers that also set output at the point where marginal revenue equals marginal cost. Oligopolies feature a few interdependent firms, and pricing may involve price leadership or tacit collusion to coordinate prices.
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This document discusses monopolistic competition, which lies between perfect competition and monopoly. Under monopolistic competition:
- There are many firms selling differentiated but substitutable products.
- There are few barriers to entry in the long run.
- Individual firms have some monopoly power over their differentiated product and face downward-sloping demand curves. However, in the long run competition limits profits to zero as new firms can easily enter the market.
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The document defines and discusses different types of markets. A market brings buyers and sellers into contact and enables an exchange to take place. Markets can be classified by area, nature of transactions, volume of business, time period, and status of sellers. Competition in a market depends on substitutability, interdependence, and ease of entry. Equilibrium price is where quantity demanded equals quantity supplied. Under perfect competition, firms are price takers and quantity supplied equals marginal cost. Monopolies have a single seller and influence price. Monopolistic competition involves differentiated products, while oligopolies have few dominant sellers.
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A monopoly market is characterized by a single seller and no close substitutes for the product. Definitions provided state that a pure monopoly exists when there is only one producer for a product with no direct competitors. Reasons for monopoly include ownership of key resources, government franchises, and intellectual property protections like patents.
Key features of monopoly markets are that there is a single seller with complete control over supply, no close substitutes, barriers to entry, and the monopolist is a price maker. Monopolies may exist in different forms like perfect, imperfect, public, or discriminating monopolies. Monopolists determine price and output levels by analyzing marginal revenue, marginal cost, total revenue and total cost curves to find the
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- 1. Efficiency MB 5006 BUSINESS ECONOMICS Ana Noveria
- 2. Single-price Monopoly’s Output and Price Decision
- 3. Single-price Monopoly’s and Competition Compared
- 4. Single-price Monopoly’s and Competition Compared
- 5. Single-price Monopoly’s and Competition Compared
- 6. Efficiency in Perfect Competition
- 7. Single-price Monopoly’s and Competition Compared The figure shows the efficiency of a monopoly Because price exceeds marginal social cost, marginal social benefit exceed marginal social cost, and a deadweight loss arise
- 8. Single-price Monopoly’s and Competition Compared
- 9. Single-price Monopoly’s and Competition Compared
- 10. Resource allocation methods Scarce resources might be allocated by using any or some combination of the following methods: • Market price • Command • Majority rule • Contest • First-come, first-served • Sharing equally • Lottery • Personal characteristics • Force
- 11. Demand and Marginal Benefit • The relationship between the price of a good and the quantity demanded by one person is called individual demand. • Market demand curve is the sum of individual demand curves • Demand, Willingness to Pay and Value • Value is what we get, price is what we pay • The value of one more unit of a good or service is its marginal benefit (MB) • We measure value as the maximum price a person is willing to pay (WTP). • WTP for a good or service determines demand. • A demand curve is a marginal benefit curve.
- 12. Demand and Marginal Benefit
- 13. Demand and Marginal Benefit
- 14. Consumer Surplus Assume the price = £1.00 •Consumer surplus Area under the demand curve and above the price line.
- 15. • Assume the price = £1.50 • Consumer surplus Area under the demand curve and above the price line. Demand and Marginal Benefit
- 16. Supply and Marginal Cost Supply, Cost and Minimum Supply-Price Cost is what the producer gives up, price is what the producer receives. The cost of one more unit of a good or service is its marginal cost. Marginal cost is the minimum price that a firm is willing to accept. Minimum supply-price determines supply. A supply curve is a marginal cost curve.
- 17. Individual Supply and Market Supply • The relationship between the price of a good and the quantity supplied by one producer is called individual supply. • Market supply is the sum of individual firms’ supply curves. • Supply curve = MC curve. • Supply curve shows: •At any price, how much will the firm produce. •At any quantity, what is each firm’s MC Supply and Marginal Cost
- 18. At any price, how much will the firm produce: At £15; QS= 100 At any quantity, what is the firm’s MC. At QS= 100; MC = £15 Supply and Marginal Cost
- 19. Producer Surplus Producer receives gain in excess of marginal cost • Assume the price = £15 • Producer Surplus Area above the supply curve and below the price line.
- 20. • Assume the price = £10 • Producer Surplus •Area above the supply curve and below the price line. Producer Surplus
- 21. Is the competitive market efficient? Efficiency of Competitive Equilibrium Efficient allocation of resources where: QD= QS MSB = MSC In equilibrium, total surplus is maximized.
- 22. Market Failure • Markets do not always achieve an efficient outcome. • We call a situation in which a market delivers an inefficient outcome one of market failure. Market failure can occur due to: • Underproduction • Overproduction Is the competitive market efficient?
- 23. Underproduction
- 24. Overproduction
- 25. Market failures
- 26. Is the competitive market efficient? Sources of market failures 1. Externalities 2. Public goods (e.g. National defence, roads) and common resources 3. Imperfect information, or information asymmetry 4. Taxes and subsidies 5. Price and quantity regulations 6. Monopoly 7. High transaction costs
- 27. Imperfect information Adverse selection • Recruiting an employee, people in job interviews • Buying insurance • Telemarketing investment advice • Selling used cars Moral hazard • Government’s promise to bails out loss-making banks
- 28. Public goods and common resources When resources are commonly owned, they will be overused. The tragedy of the commons strikes when no one has the right to exclude • Overfishing • Over-grazing • Commonly shared secretary • Fixed-fee internet pricing plan