Lecture 16: Market Structure and Public Policy

Outline:

1. Economic efficiency : Productive efficiency and allocative efficiency

2. Comparing monopoly and perfect competition in terms of economic efficiency

3. Economic efficiency and market failure

i. Types of market failure

ii. Public Policy issues

4. Public Policy Towards Monopoly and Oligopoly

i. Regulation

ii. Anti-trust policy

5. Public Policy Issues

i. Deregulation

ii. Privatization

iii. Recent Anti-trust cases

6. Dollars and Sense - Article 21

7. New Field Guide: 9.12

1. Economic efficiency:

* With its focus on scarcity - neoclassical economics has been concerned with how an economy can get the most output from its resources.

* The concept of efficiency is used in neoclassical economics to determine whether the maximum output is being produced from given resources.

* The meaning of efficiency in economics is: Resources are not wasted.

Two aspects: i. Resources are fully employed

ii. Resources cannot be reallocated in any way that results in more output being produced.

Two components of economic efficiency:

1. Productive efficiency:

* Firms produce at the lowest cost

* The economy is on the PPF rather than inside it

* Can't produce more of one good without producing less of another good

2. Allocative efficiency:

* Firms produce where P=MC

* The economy is at a specific point on the PPF

* Can't change the allocation of resources to make one person better off without making someone else worse off

2. Comparing Perfect Competition and Monopoly in terms of economic efficiency:

PC: Is productively efficient since firms produce at lowest cost

Is allocatively efficient since firms produce where P=MR=MC (P=MC)

Monopoly: Is productively efficient since the firm produces at lowest cost

Is NOT allocatively efficient since the firm produces where P>MR=MC (P>MC)

GRAPH - showing the PC price and output and the Monopoly price and output

Note: Compared with the allocatively efficient level of output and price, the Monopolist produces too little output at too high a price.

Bottom line: PC markets are economically efficient but monopoly markets are not.

3. Economic efficiency and market failure:

Market failure: Occurs when markets fail to produce economically efficient outcomes.

Sources of market failure:

1. monopoly power*

2. externalities

3. public goods

4. asymmetric information

* In this lecture we only focus on monopoly power as a source of market failure - the others will be dealt with in more detail in a later lecture.

Significance of market failure:

* There is a case for government intervention in the economy to try to correct for the failure of the market to achieve efficient outcomes.

* The public policy issue that arises from this is not should the government intervene, but rather how should the government intervene.

* This necessitates evaluating government policies in terms of their effectiveness at dealing with market failures.

4. Public Policy toward monopoly and oligopoly:

Two public policy approaches to the problems associated with monopoly power:

1. Direct Regulation:

* The government may determine the industry's pricing policy.

* The government may determine certain operating conditions in the industry.

Example: Electricity.

2. Anti-trust policy

* Laws designed to create conditions under which firms will compete with one another rather than monopolize.

Example: Sherman Antitrust Act 1890.

5. Recent Public Policy Issues:

1. Regulation vs. Deregulation

* Regulation sometimes has the effect of reducing competition

* Since 1980's many industries have been deregulated - banks, airlines, long distance telephone service

* Problem with deregulation - there is usually an initial burst of competition, but then the market becomes more concentrated as some firms are driven out of business and firms settle back into their oligopolistic behavior

* The savings and loan crisis - an example of bad deregulation.

2. Nationalization vs. Privatization

* One way that most governments dealt with monopolies was to nationalize them and operate them publically - generally not motivated by profit maximization.

* Since the 1980's there has been a huge trend toward privatization of these monopolies

* One of the problems with nationalization was that these firms had no incentive to operate efficiently

* One of the problems with privatization is that profit considerations can have negative effects in terms of access to the product and/or quality of the product.

* Privatization of electricity in New Zealand - an example of bad privatization.

3. Recent anti-trust cases

* Microsoft and its Internet explorer - attempt to monopolize -- an upcoming law suit undertaken by the Justice Department (newspaper article)

* ADM (Archer Daniels Midland - "supermarket to the world" - convicted of "price-fixing" a couple of years ago in a law suit by the Justice Department (newspaper article)

* Ticketmaster -- Pearl Jam argued that Ticketmaster's exclusive contracts represented a monopoly in the distribution of concert tickets leading to excessively high prices and service charges (p. 276-277 in your textbook).