1. Prepared by Anton Ljutic
Lecture notes
Prepared by Anton Ljutic

2. An Evaluation of Competitive Markets
CHAPTER NINE
An Evaluation of Competitive Markets

3. 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

4. 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

5. 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

6. 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

7. 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

8. 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)

9. 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

10. 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

11. 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

12. 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)

13. 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

14. 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

15. 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”

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

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

18. 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

19. 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

20. 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

21. 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

22. 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