9.0 Market Power, Market Failure and General Equilibrium

9.1

Pareto optimal general competitive equilibrium

is a special case of all the possible equilibria

There are others that are possible when market power and market failure exist

Figure 9.2.1 - Distribution of Society's Endowment and Distribution of Society's Product -With and Without Power Distorts

Social Endowment Social Product

A

B

Without Power Distortions

With Power Distortions

A

B

A

B

A

B

Giving “A” market power,

the pie is smaller,

but A has a larger share of the pie

9.2.1

Exercising market power is not productive

It is exploiting an advantage that you have over the market

If you have it, it is wonderful

There are costs, though-Smaller piece for others

Makes the system less efficient

9.2.2

Monopoly – being the only seller in a market

Monopsony – being the only buyer in a market

Here, you are not a price taker

You can choose price/quantity combinations that are most advantageous

There are two sources of market power:

Naturally occurring and

Artificially created

9.2.3

Naturally occurring market power does not come from distortions within the market process

They just happen

Ex. Supermodels, Michael Jordan

Egg donation – NY Times ad

9.2.4

The naturally occurring market power might have different effects in different markets

Ex. Basketball vs. Tiddlywinks

9.2.5

Why did Michael Jordan make so much?

Huge derived demand and limited possibilities for input substitution

Best possible case for a worker

Did he work hard?

Yes - making the most of his natural gift

9.2.6

If a firm produces huge amounts of a product,

it may begin to experience economies of scale-

because of the size of your operation, you can make things much cheaper per unit

A firm that experiences large economies of scale

call kill off all competition by virtue of this “head start”

It will be able to underprice any new entrant

Economies of scale can be a barrier to entry to a market

This can lead to a natural monopoly -

a single supplier with no competition

9.2.7

Natural advantages may slip away

Bodies get older,

firms face new technologies, etc

9.2.8 Artificially created market power

Patents – don’t occur in nature, come from governments

Firms sometimes buy up patents to protect their market power

9.2.9

Rent-maintenance – the exploitation of institutional power to sustain a market advantage

Ex. Donations to Congress or other rules-makers to prevent competition for your firm

9.2.10

Sometimes it’s not just about sustaining your advantage

Rent-seeking is when you try to create an advantage that isn’t there now

Lobbyists also do this

9.2.11

Smith pointed to rent-maintenance and rent-seeking

as threats to the market system in Great Britain

9.2.12

Artificial market power can be created through political institutions,

but social institutions can also factor into our perceptions of what is appropriate for

certain genders or races

9.2.13

Not only may social forces alter your own perceptions about what you may become,

they may also affect those who hire/admit you

This is a powerful, yet almost invisible, constraint that yields artificial market power for the privileged

9.2.14

Two jobs

MS = Men’s sphere

WS = Women’s sphere

Comparable jobs

Men’s sphere has higher pay to start

WS MS

Figure 9.2.2 - Market Pictures: Two Comparable Jobs, No Market Power

p

p0

Q

p

D

Q

S

p0

D

S

What happens with no market power?

Workers enter MS market, supply shifts out

As people leave WS, supply shifts back

Wage falls until all advantage is gone

Figure 9.2.3 - Market Pictures: Two Comparable Jobs, No Market Power - Adjustment

p

D

p1

p0

S1 S0

Q

p

D

p1

p0

Q

WS MS

S1S0

9.2.15

Relaxing the nice assumption of equal access to markets

If women are crowded into a certain set of jobs, excess supply – lower wages

AndThis also restricts supply in male set of jobs – so

higher wages result because of no female competition

9.2.16

Market power lessens efficiency

Firms don’t have to be totally efficient because perfect competition isn’t forcing them to do so

Pareto optimality is not reached

Equity – fairness – is another matter

Those with market power can alter the distribution of benefits to their advantage

Is that fair?

Maybe or maybe not, but it is a different yardstick

9.2.17

Apartheid in South Africa

Whites were a minority, but had a vast majority of the wealth

Limiting opportunities for Blacks preserved that power advantage

Education, or a lack thereof, had economic consequences

9.2.18

High skill versus low skill jobs

Without market power

HS LS

Figure 9.2.4 - Market Pictures: High Skill vs. Low Skill Jobs without Market Power

p

Q

p

Q

p0

S

D

D

p0

S

With market power of apartheid

Figure 9.2.5 - Market Pictures: High Skill vs. Low Skill Jobs with Market Power

p

Q

p

Q

p0

S

D

( S )

p '

p0

S

D

( S )

p '

DashedLines ReflectCase Without

Power

LSHS

9.2.19

Limits on education weren’t the only ones

Limits on mobility – passes

Limits on access to markets

All were “legal” – enforced by police and military

9.2.20

South Africa paid a price for this system

Loss of efficiency

Most of the population’s energy and creativity is blocked out

Pie could have been larger

Resources spent on rent-maintenance could have been better spent

Figure 9.2.6 - Distribution of South Africa's "Pie"

WITH POWER FAIR RACE

B

W

W

B

9.2.21

The price of maintaining that advantage grew more and more expensive

Popular revolt – more jails and jailers

International sanctions hurt

Eventually Mandela goes from jail to President

Just changing laws is not the only change to make it a fair society

9.2.22 Conclusion on market power

It often existsIt reduces efficiency and changes the equity of the

market systemUnderstanding the effects of market power enriches

our analysis of the worldWe have a much more realistic model

9.3.1 Market Failure

We assume markets will form to quickly coordinate choices

If the market doesn’t form, or can’t coordinate well, we have a case of market failureThere are several types of market failure:

9.3.2 Public Goods

a public good is non-partitionable and non-excludable

Ex. National Defense

9.3.3

Public goods suffer from the free rider problemIf you believe you will get the benefit without

paying, you might not payEx. PBS - public television, National Public RadioIf everyone behaves as a free rider, the good might

disappear

9.3.4

Another type of market failure is an externalityThis occurs when property rights can not be assigned

or enforced

9.3.5

Air rightsAir can be used for breathing, or as a place to

dispose wasteEx. Smoking or pollutingA firm which pollutes has a consequence to others,

butits effect is external to its own assessment of the cost

of the activities

9.3.6 - 9.3.11

The problem becomes that there is no market for airthere is no price signalThere is no way to quantify the external effect on

others caused by their activity

These two examples are callednegative externalities because there is an external

cost to others

It is also possible to have a positive externality which adds an external benefit to others

Ex. Beekeeper -

pollinates local plants, too

Piano lesson -

music spills over to others

In the case of a negative externality,

the Marginal Social Cost = Marginal Private Cost + Marginal External Cost

MSC = MPC + MEC

or MEC = MSC - MPC

If there is no externality, MEC = 0 and

MPC=MSC

In the case of a positive externality,

the Marginal Social Benefit = Marginal Private Benefit + Marginal External Benefit

MSB = MPB + MEB

or MEB = MSB- MPB

If there is no externality, MEB = 0 and

MPB=MSB

Since society as a whole must consider

all costs and benefits when determining an optimum,

from a societal point of view, one should produce where

MSB=MSC

However,

a private firm has its own decision rule

they produce where MPC=MPB

If no externalities exist,

then private optimization means social optimization

this is not always the case when you have market failure

Graphical representation - Negative Externality

Output

MPB=MSB

MPCMEC

MSC = MPC +MEC

LpLs

With negative externalities,

firms tend to overproduce because

the market failure means the market does not allow

them to realize the extra “bad” that they do

Output

MPC = MSC

MPB

MEBMSB = MPB +MEB

Lp Ls

Graphical representation - positive externality

With positive externalities,

firms tend to underproduce because

the market does not reflect the extra “goodness” they do

9.3.12

Risk eternality - creating an unintended risk for others

Ex. Drunk driving

9.3.13

Risk externalities and technologyScientific experiments sometimes create unintended

consequences

9.3.14

Firms and individuals act in self-interest, butunintended costs and benefits affect othersMarket failure is why this happensLack of property rights, no price signal, etc. What happens when markets fail?Some feel this is is where government should get

involved