1. Market Power, Market Failure, and General Competitive Equilibrium
Chapter 9

2. The Nice Assumptions No Market Power No market failure
Individuals have
Equal access to information
Equal access to the market
No market failure
Markets
Form quickly when needed
Function quickly & effectively

3. Relaxing No Market Power: The Consequences
Market Power reduces efficiency
Those with power do not have to exert themselves as much to win in the market
they have the power to “win” anyway
Those without power have little incentive to exert themselves because try as they might…they are going to “lose” anyway

4. Relaxing No Market Power The Consequences
Market Power affects equity
Those with power get a bigger share of the social product (the pie) …
Those without power get a smaller share of the social product (pie) …
Whether this is more or less “just” is a moral, not an economics question
But there is a redistribution, so equity is clearly affected.

5. Market Distribution…Perfect Competition vs. Market Power

6. Market Power – The Forms
Monopoly – a single seller
no competition on the supply side (ex. ?)
Monopsony – a single buyer
no competition on the demand side (ex. ?)
Oligopoly – collusion among a few sellers
so long as none of the colluders cheat
Oligopsony - collusion among a few buyers

7. Barriers to Entry Elements that make it hard for one to enter a market
Technology
Capital
Government restrictions
Quotas

8. Market Power…The Sources
Naturally Occurring Market Power
Artificially Created Market Power

9. Naturally Occurring Market Power
Economies of Scale can create naturally occurring market power:
If increasing scale significantly lowers the cost structure, then a BIG company can charge a very low price.
Competitors at a smaller scale and a higher cost structure can’t compete on price, so they can’t compete at all (ex. ?) …
No competition
Mkt. Power

10. Naturally Occurring Market Power - Labor Mkt. Examples
Another source of naturally occurring market power is natural talent or natural gifts.
We all have our gifts, but some are more marketable than others, and some of these enjoy a much larger market than others
To the degree you have a marketable gift that others don’t …
they can’t compete with you.
Marketable
No competition
Mkt. Power

11. Artificial Market Power - Labor Mkt. Examples
An “unnatural” way is …
Steroids
Cheating on tests/quizzes
5 hour energy??
Artificial market power may also be socialized
Gender
Race
General levels of wealth

12. Artificial Market Power
Why would someone seek market power?
The return for market power is called a “rent”
The term “rent” here goes back to Adam Smith’s assertion in The Wealth of Nations that …
“landlords, like all other men, love to reap where they never sowed, and demand a rent even for its [(the land’s)] natural produce.”

13. Rent
As Smith uses the term, rent is not a return to the landlord’s effort or productive contribution …
It is a return to the landlord’s power over the land, and thus his ability to demand a share of the product that comes from that naturally productive land

14. Rent How can you tell if a return is a rent?
Like profit …Rent is a return above and beyond opportunity cost, i.e., beyond a normal return
But unlike profit, one who enjoys a rent has the power to eliminate competitors

15. Rent So, how can you tell if a “distributive share” is a rent?
If you can take a “share” away without changing incentives in the market …it’s a rent

16. Rent
For example, ceteris paribus (e.g., independent of wealth effects), if you cut pro athletes’ salaries in half, most would continue in their current roles because they are earning far beyond a normal return on their labor and their investment in human capital … far more than their opportunity cost. They enjoy a rent.
So too…someone who makes mega bucks in other markets, e.g., Wall Street

17. Why Rent??
Because it PAY$ !

18. Artificially Created Market Power
We’ve assumed that individuals are rational, utility maximizing beings.
Doesn’t it make sense for a rational, utility maximizing person to pursue market power to get a bigger return from the market?

19. Rent Maintenance and Rent Seeking
Using resources to sustain market power is called rent maintenance
Donations to politicians
Using resources to pursue market power for the sake of a rent is called “rent seeking”
Hiring lobbyists

20. Artificially Created Market Power
A key distinction between naturally occurring market power and artificially created market power is:
Naturally…is a free gift of nature
Artificial…requires using resources to achieve or sustain the market power advantage

21. Artificially Market Power and Inefficiency
The fact that achieving or sustaining artificially created market power requires using resources adds to the inefficiency of market power
Naturally occurring power results in natural incentives or disincentives
Artificial power requires using resources to maintain the power

23. Artificially Created Market Power
Apartheid in South Africa
Resources that could have been used to nurture people, building schools, hospitals, and so on …went instead to buying bullets, batons, etc… in order to oppress people so that the white minority could maintain POWER and enjoy huge “rents”

24. Artificially Created Market Power
In South Africa society didn’t benefit from the energy and imagination and creativity of the black community, because the members of that community didn’t have the incentive to contribute their energy or the opportunity to contribute their gifts …
What did the white community gain from its power? A larger share of a smaller “pie”.
This gain was at the greater society’s expense.

25. How do the following cases reflect market power
How do the following cases reflect market power? And … what kind of power do they represent?

31. He is a doctor …
she is a nurse …
He is an executive …
she is a secretary …
she is a waitress …
He is a chef …
Rent generating power can come from social or political institutions … or both

32. Artificial Power and Limiting the Market

33. Constraining the Market
Two jobs
MS = Men’s sphere
WS = Women’s sphere
Comparable jobs
Men’s sphere has higher pay to start

35. 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

37. With Market Power
Relaxing the nice assumption of equal access to markets
If women are crowded into a certain set of jobs, excess supply – lower wages
This also restricts supply in male set of jobs – so higher wages result because of no female competition
We could use this same example with high and low skilled jobs

38. How Would the Market Look w/Power?

39. Market Power and Firms 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

40. Equity – Fairness?
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

41. Market Failure

42. Public Goods

43. Public Goods Exist to provide for what the free market may not
Benefit society
Apparent in markets that would, most likely, fail without government intervention
Not are public goods are “true” public goods

44. Defining a Public Good A “Pure” Public Good is Non-Excludable
If you provide it to anyone you are providing it to everyone, because no one can be excluded
Non-Partitionable
However much you provide to anyone is available to everyone .. you can’t control the size of the shares

45. Public Goods Military defense is an example of a pure public good
If you’re inside the defense perimeter, the safety afforded by that perimeter is non-excludable and non-partitionable

46. Problem of Public Goods
Since a public good is non-excludable and non-partitionable …Once it’s provided to anyone, everyone else gets to enjoy all its benefits without having to pay for it, so it leads to a Free Rider Problem

47. Problem of Public Goods
The initial provider bears the full burden of the cost and no one else has to contribute since they can “ride along for free”, ergo:
Free Rider Problem
Well, no private individual or firm is going to provide under this condition so even if it’s good for the public the market won’t meet that need, ergo:
Public Good Problem

48. Problem of Public Goods
If you watch public television you’ll hear pleas like: “we depend on support from viewers like you …please give today to this station.”
But you don’t hear fundraisers on the radio or TV with lines like: “we depend on support from citizens like you …please give today to the…
“U.S. Army”

49. Problem of Public Goods
As a nation we recognize that our national defense is an essential public good.
We can debate about how much is enough and what the defense priorities should be, but we fund national defense by taxing citizens because, given the free rider problem, we can’t depend on donations.

50. Problem of Public Goods
Public Goods represent a Market Failure
Here we see that when the markets fail, there may be a role for government.

51. Externalities

52. Externalities
A positive or negative effect of a private activity on nominally uninvolved individuals.
It is, therefore, a cost or benefit that private individuals or firms don’t take into account when making their activity decisions.
It is external to the concerns of these private actors and, therefore, not a part of their considerations as they make choices.

53. Externalities Examples: Other examples?
Positive – Nice music in the park
Negative – Second hand smoke
Other examples?
Positive?
Negative?

54. Externalities Source of the Externality Problem:
Failure to assign or enforce property rights
e.g.: Suppose you want to smoke in here …
If I “own” the air in this room …
If you “own” the air in this room …

55. The Price!! Externalities Now suppose…
neither of us owns or can enforce our property right to this air
No market forms … and so no market coordination signal is generated
What’s this missing signal called?
The Price!!

56. Externalities Externality as Market Failure:
Due to a failure to define or enforce property rights…
No market forms
and so no price signal is generated to coordinated choices

57. Risk Externalities Externalities that involve risks to others…
Drunk Driving
Genetic Engineering
Pollution

58. Externalities
Since private individuals or firms only consider their own private costs or benefits when making decisions, the presence of an externality means they don’t take into consideration the full costs or benefits of their choices on society.
We can represent this graphically as follows …

59. Externalities What the private actor considers
Marginal Private
Cost $
Level of
Activity
MPC
Marginal Private
Benefit
MPB LP
Optimal Level
Of Private Activity

60. Externalities: Building the Graph
Negative externalities create “external costs,” EC
These are social costs that the individual or firm doesn’t take into account
They are external to the individual’s or firm’s decision making

61. Externalities: Building the Graph
Positive externalities create “external benefits,” EB
These are social benefits that the individual or firm doesn’t take into account
They are external to the individual’s or firm’s decision making

62. Externalities: Building the Graph
When private individuals or firms ignore the full effect of their behavior, not taking externalities into account…their private calculations understate the full impact of their choices on society

63. Externalities: Building the Graph
To measure the full social effect of each successive unit an activity we add the external effect to the private effect:
For negative externalities
Marginal Social Cost: MSC=MPC+EC
For positive externalities
Marginal Social Benefit: MSB=MPB+EB

64. Externalities: Building the Graph
In the absence of any externalities:
EC=0, then MSC=MPC
EB=0, then MSB=MPB
Graphically, the absence looks like…

65. $ MPC = MSC MPB = MSB LP =LS Level of Activity EC = 0 EB = 0
Optimal Private
and Social Level
are the same
=LS LP

66. Representing a Negative Externality
MSC
= MPC + EC $
Level of
Activity
MPC EC LS
MPB = MSB
EB = 0 LP
Optimal Private
and Social Level
are different
: LP > LS

67. Representing a Negative Externality
What does LP > LS mean for society? $
Level of
Activity
MPC
MPB = MSB
EB = 0 LP
MSC LS
Optimal Private
and Social Level
are the different
+EC
= MPC + EC
: LP > LS

68. Representing a Negative Externality
LP > LS means that, due to ignoring the negative external effects, the firm is overdoing its activity because it is not considering the full costs of its activity. This is socially inefficient $
Level of
Activity
MPC
MPB = MSB
EB = 0 LP
MSC LS
Optimal Private
and Social Level
are the different
+EC
= MPC + EC
: LP > LS

69. For Symmetry: Representing a Positive Externality
MSC = MPC
EC=0 $
Level of
Activity
= MPB + EB
MSB EB LS
MPB LP
Optimal Private
and Social Level
are the different
: LP < LS

70. Positive Externality
LP < LS means that the firm is underdoing its activity, because it’s not considering the full social benefits of its activity…and that’s socially inefficient.

71. Externalities Externality as Market Failure:
Due to a failure to define or enforce property rights, no market forms and so no price signal is generated to coordinate choices…
this leads to social inefficiency …
a less than Pareto Optimal market outcome