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Chapter 11 Introduction to Imperfect Markets

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Here the assumptions of perfect competition will be relaxed to yield more realistic models. ... But real consumers and businesses rarely have perfect information. ... – PowerPoint PPT presentation

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Title: Chapter 11 Introduction to Imperfect Markets


1
Chapter 11Introduction to Imperfect Markets
2
Extending the Basic Competitive Model
  • Here the assumptions of perfect competition will
    be relaxed to yield more realistic models.
  • In the basic competitive model we assumed
  • There are many buyers and sellers they are price
    takers.
  • In real markets firms have some market power.
  • Kodak can charge a slightly higher price than
    Fuji.

3
Homogeneity and Perfect Information Assumptions
  • In the basic competitive model we assumed
  • Goods were homogenous, or identical
  • In modern economies brands exist.
  • Consumers and firms have perfect information.
  • But real consumers and businesses rarely have
    perfect information.
  • Consumers may not have perfect information about
    the quality of goods like used cars.
  • Firms do not have perfect information on the
    productivity of workers.

4
Private Costs Assumption
  • In the basic competitive model we assumed
  • Firms and consumers bear all the consequences of
    their actions so that there is no effect on
    others.
  • Externalitiesactions by a consumer or firm that
    have an effect on others for which the actor
    neither pays nor is paid compensationexist in
    real life.
  • What you do does affects others.
  • Hiker who litters deep in the woods
  • Messy roommate
  • Pollution

5
Rivalrous Goods Assumption
  • In the basic competitive model we assumed
  • All goods were rivalrous when one consumer buys
    a gallon of gasoline that gallon is unavailable
    for others.
  • Public goods exist they represent extreme cases
    of positive externalities.
  • Public goods are non-rivalrous one's use does
    not limit others' use.
  • Public goods are non-excludable there are very
    high costs to preventing others from using them.
  • Example national defense

6
Market Failures
  • Imperfect competition, imperfect information,
    externalities, and public goods lead to market
    failures.
  • These failures may permit a role for government
    intervention to improve economic efficiency.

7
Monopoly
  • Monopoly A single seller of a product
  • Example is a local electrical company.
  • Barriers to entry usually exist.

8
Oligopoly
  • Oligopoly A few, usually large sellers of a
    product
  • Example is the U.S. auto industry.
  • There is some degree of competition.
  • Firms take into account their rivals' actions.

9
Monopolistic Competition
  • Monopolistic competition many firms, each with
    some monopoly power due to brand loyalty.
  • Laptop computersDell, Gateway, Compaq, HP,
    Apple, Sony, and Toshiba
  • Products are different enough to limit
    competition somewhat.
  • A firm can raise its price and not lose all of
    its customers to rivals due to loyalty.

10
Perfect Competition
  • If a firm raises its price it loses all of its
    customers firms are price takers.
  • Price is constant to a competitive firm.
  • A soybean farmer cannot influence the price of
    soybeans.
  • Firm can always sell the next unit at the going
    price
  • MR Price
  • Profit maximization P MC
  • Consumers pay the true cost of making the good.

11
Imperfect Competition
  • Imperfect competition a market structure where
    firms have some ability to influence or set the
    price
  • To sell one more unit, the firm must lower its
    price.
  • The firm gains from the sale but loses a small
    amount on each of the previous units sold.
  • p MR and since profit maximization requires MR
    MC
  • We have p MC
  • This means consumers pay more than the true cost
    of producing the product
  • This is inefficient.
  • In addition, if the price is too high, then too
    little is produced and consumed.

12
Government Policy
  • Inefficiency in imperfectly competitive markets
    means government policies may play a role in
    achieving efficiency.
  • Government may act to limit market power.
  • U.S. vs. Microsoft
  • Windows operating system gives the company unfair
    market power.
  • Solutions include breaking up the company,
    regulating its prices, or overseeing its business
    practices.
  • Government may permit a monopoly to exist, then
    regulate its pricemonopolies like cable TV,
    electric utilities, and telephone services.

13
The Information Problem
  • Do consumers and firms have all the information
    they need?
  • Did you know when applying to college how much
    you would enjoy or benefit from college?
  • Do firms know their workers' productivity?
  • Does a model of imperfect information provide a
    better description of modern economies?

14
How Prices Convey Information
  • Prices convey the scarcity of goods or inputs.
  • Steel companies need not know how much iron ore
    is left in the ground, the costs of refining, or
    other details they need only know the price.
  • When the price of iron ore rises, steel companies
    conserve iron ore.

15
Markets for Information
  • Information is exchanged in markets for
    information.
  • Information has value since people are willing to
    pay for it.

16
Information is a Public Good
  • One person's knowledge of the information does
    not reduce anyone else's your learning in
    lecture does not prevent other students from
    learning.
  • However, unlike other goods and services, you
    cannot test drive information once revealed to
    you, it cannot be withdrawn.

17
Government Policies
  • Consumer protection legislation makes deceptive
    trade practices illegal.
  • Important information may not stand out.
  • It may be drowned by other information.
  • In advertising there is no clear distinction
    between persuasion and deception.
  • The SEC prosecuted executives of Enron and the
    accounting company Arthur Andersen for making
    misleading financial statements.

18
Externalities
  • Firms and individuals do not bear all of the
    consequences or reap all of the rewards of their
    actions.
  • Externalities may be positive or negative.
  • A positive externality
  • A neighbor maintains a pretty flower garden.
  • Positive externalities are undersupplied in free,
    private markets.
  • Your neighbor pays all of the costs but does not
    receive all of the benefits.
  • A negative externality
  • Pollution
  • Negative externalities are oversupplied in free,
    private markets.

19
Steel Mill Example
  • A steel mill produces steel and pollution.
  • Production reflects only the private costs of
    iron ore, labor, energy, and so on.
  • Production does not reflect the social costs of
    polluting the environment.
  • If the social costs were internalized (i.e. paid)
    by the steel mill, less steel and less pollution
    would be produced.

20
Government Policies toward Externalities
  • Impose a tax equal to the social harm.
  • Firms would pay the social costs of their
    actions.
  • Since goods and services that generate positive
    externalities are in undersupply, the government
    could act to enlarge the supply.

21
Public Goods (a)
  • Public goods are non-rivalrous and
    non-excludable.
  • A pure public good
  • The marginal cost of supplying the good to
    another person is zero while the marginal cost of
    excluding someone from enjoying it is very high.
  • National defense
  • Streetlights
  • Public goods are undersupplied.
  • Public goods are an extreme case of positive
    externalities.

22
Public Goods (b)
23
The Free-Rider Problem
  • A lighthousea good thing for sailors at night or
    in fog.
  • Suppose all the sailors decide to chip in to
    build a lighthouse.
  • Any one sailor has an incentive to renege on her
    contribution.
  • She figures the lighthouse will be built anyway
    with the contributions of others.
  • If she reneges on her contribution, she can save
    money.
  • Since all the sailors have the same incentives,
    contributions will be less than expected and the
    lighthouse may not get built.
  • The free-rider problem leads to an undersupply of
    public goods by private markets.
  • Government has a role in supplying these kinds of
    goods.
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