Prepared by Anton Ljutic Lecture notes Prepared by Anton Ljutic

An Evaluation of Competitive Markets CHAPTER NINE An Evaluation of Competitive Markets

This Chapter Will Enable You to: Explain the benefits of perfectly competitive markets Understand the five reasons why perfect competition might fail to achieve desirable results Understand why too much of certain undesirable products might be produced by competitive markets Understand why certain desirable products might not be produced at all

Technological Improvement and Perfect Competition Bobby Brewer introduces better technology B. Brewer’s costs decline and profits rise Imitators follow B. Brewer causing brewing industry to grow Increased supply causes price to fall Older brewers must either introduce the new technology or exit the industry

Perfect Competition and Size of the Firm Plant 1 Plant 2 P AC1 MC1 MC2 AC2 Economies of scale cause plant costs to be lower at a greater output P1 Figure 9.1 Q1 Q2 Q

Plant Growth and its Effect on the Market AC1 MC1 MC2 AC2 Economies of scale lead to larger plants and lower prices P1 P2 Figure 9.2 Q1 Q3 Q2 Q

Price and Long-Run Equilibrium Plant 1 Plant 2 Plant 3 Plant 4 P=SRAC=LRAC =MC MC3 AC1 AC2 AC4 AC3 LRAC P3 Q3 Figure 9.3

Perfect Competition in the Long Run In the long run, firms in perfect competition produce an output: from the most efficient plant size for their industry (lowest LRAC) at the most efficient level for that particular plant size (Lowest SRAC) that is productively efficient and at which they make only normal profits (P=AC) that is allocatively efficient so that they are producing the right quantity of goods (P=MC)

Benefits of Competitive Markets Productive efficiency Production of an output at the lowest possible average cost (P=minimum AC) Allocative efficiency The production of the combination of products that best satisfies consumers’ demands (P=MC) Costless self-coordination Economic freedom

Market Failures (I) The defects in competitive markets that prevent them from achieving an efficient or equitable allocation of resources: INEQUALITY: the market is no guarantor of fairness, and income and wealth inequalities often seem endemic to competitive markets INSTABILITY: Competitive markets are often unstable and periodically seen to move, without warning, from an expansionary boom to a recessionary slump

Market Failures (II) SELF-DEFEATING COMPETITION: Competitive markets seem to contain the seeds of their own destruction because they easily admit forces that work to destroy competition PUBLIC GOODS: Competitive markets do not ensure the production of a number of important goods and services known as public goods EXTERNALITIES: Competitive markets often encourage the overproduction of some products and the underproduction of other products because the marketplace has difficulty in integrating what are known as externalities

Public Goods Public goods Non-excludability Non-rivalry Goods that are non-rival and non-excludable Non-excludability A feature of certain products that makes it impossible to exclude non-purchasers from enjoying the benefits of the product Non-rivalry A feature of certain goods that makes their use by one consumer no less available to another (e.g., radio-waves)

Private and Quasi-Public Goods Quasi-public goods: Private goods that are provided by the government because they involve extensive benefits for the general public Why quasi-public goods? If: Costs of collecting revenue are prohibitive Competition requires wasteful duplication There are external costs or benefits Private goods Products that can be consumed separately by each individual and are normally provided by private firms

Externalities: Costs (I) Benefits or costs of a product experienced by people who neither produce nor consume that product External costs Example: Pollution Possible solutions: Legislative controls Taxation Marketing of permits

Externalities: Costs (II) Marginal social costs (MSC) Additional costs to both the producer (internal costs) and to society (external costs) of producing additional quantities of a product Marginal private costs (MPC) Additional costs to the producer (internal) that do not take account the costs to society If MSC > MPC, there will be “overproduction”

Marginal Private Costs and Marginal Social Costs Price MSC MPC P2 Tax levied = external costs P1 Figure 9.4 D Q2 Q1 Quantity

Demand and Supply of Pollution Permits Price A fixed supply of pollution permits S 10,000 Figure 9.5 D 200 Quantity

Marginal Private Benefits and Marginal Social Benefits MSB includes private and external benefits. When external benefits are included, the equilibrium is different. Price MSC $550 $500 MSB MPB Figure 9.6 50,000 60,000 Quantity

External Benefits It occurs whenever non-users enjoy a benefit as a result of the production or consumption of a product Integrating external benefits Provision of quasi-public goods Providing subsidies Marginal social benefits: the additional benefits to both the consumer (internal benefits)n and to society (external benefits) of additional quantities of a product

Subsidizing Day-Care Operators MPC Price MPC + subsidy $500 Subsidy to day-cares = $100 $450 $400 MPB Figure 9.7 50,000 60,000 Quantity

Subsidizing Parents that use Day-Care Price MSC $500 Subsidy to parents = $100 $450 $400 MPB MPB + subsidy Figure 9.7 50,000 60,000 Quantity

Chapter Summary: What to Study and Remember the benefits of perfectly competitive markets the five reasons why perfect competition might fail to achieve desirable results why too much of certain undesirable products might be produced by competitive markets why certain desirable products might not be produced at all