BD HOMEWORK 2
9233ASD
Chapter_14.pptxA Manager’s Guide to Government in the Marketplace
© 2017 by McGraw-Hill Education. All Rights Reserved. Authorized only for instructor use in the classroom. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Chapter 14
Learning Objectives
Identify four sources of market failure.
Explain why market power reduces social welfare, and identify two types of government policies aimed at reducing deadweight loss.
Show why externalities can lead competitive markets to provide socially inefficient quantities of goods and services; explain how government policies, such as the Clean Air Act, can improve resource allocation.
Show why competitive markets fail to provide socially efficient levels of public goods; explain how the government can mitigate these inefficiencies.
Explain why incomplete information compromises the efficiency of markets, and identify five government policies aimed at mitigating these problems.
Explain why government attempts to solve market failures can lead to additional inefficiencies because of “rent-seeking” activities.
Show how government policies in international markets, such as quotas and tariffs, impact the prices and quantities of domestic goods and services.
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2
Market Power
The socially efficient quantity in a market occurs where price equals marginal cost. This quantity maximizes the sum of consumer and producer surplus.
This socially efficient price and quantity arise naturally in a perfectly competitive market.
When a firm in a market produces an output that is less than the socially efficient level because it charges a price that exceeds marginal cost, the firm has market power.
The value to society of producing another unit is greater than the cost to produce another unit.
Government may intervene in the market in attempt to increase social welfare.
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14-3
Market Failure
3
Welfare and Deadweight Loss Under Monopoly In Action
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14-4
Market Failure
Price
Quantity
Demand
MR
MC
Deadweight loss
Social welfare
4
Antitrust Policy
The purpose of antitrust policy is to eliminate the deadweight loss of monopoly by making it illegal for manager to engage in activities that foster monopoly power.
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14-5
Market Failure
5
Antitrust Policy: Sherman Act, Section 1
The cornerstone of U.S. antitrust policy are Sections 1 and 2 of the Sherman Antitrust Act of 1890:
Section 1: Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several states, or with foreign nations, is hereby declared to be illegal. Every person who shall make any such contract or engage in any such combination or conspiracy shall be deemed guilty of a felony, and, on conviction thereof, shall be punished by fine not exceeding five thousand dollars (one million dollars if a corporation, or, if an other person, one hundred thousand dollars) or by imprisonment not exceeding one (three) years, or by both said punishments, in the discretion of the court.
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14-6
Market Failure
6
Antitrust Policy: Sherman Act, Section 2
Section 2: Every person who shall monopolize, or attempt to monopolize, or combine or conspire with any person or persons, to monopolize any part of the trade or commerce among the several States, or with foreign nations, shall be deemed guilty of a felony, and, on conviction thereof, shall be punished by fine not exceeding five thousand dollars (one million dollars if a corporation, or, if any other person, one hundred thousand dollars) or by imprisonment not exceeding one (three) years, or both said punishments, in the discretion of the court.
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14-7
Market Failure
7
Antitrust Policy: Rule of Reason
Interpretation of antitrust policy is shaped by the courts, which rule on ambiguities in the law and previous cases.
In the Supreme Court’s ruling on Standard Oil Trust, the Court defined a new rule of reason, which effectively stipulates
that not all trade restraints are illegal; rather, only those that are “unreasonable” are prohibited.
Problems with the rule of reason:
It is difficult for managers to know in advance whether particular pricing strategies or other actions used to enhance profits are in fact violations of the law.
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14-8
Market Failure
8
Antitrust Policy: Clayton and Robinson-Patman Acts
To make more precise what actions are deemed illegal in antitrust law the U.S. Congress passed the Clayton Act (1914) and Robinson-Patman Act (1936).
These acts make price discrimination – aimed to substantially lessen competition or tend to create a monopoly in the line of commerce, or injure, destroy, or prevent competition – illegal.
Price discrimination is permitted under these acts when
it arises because of cost or quality differences.
it is necessary to meet a competitor’s price in a market.
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Market Failure
9
Antitrust Policy: Clayton Act
Illegal actions for firms under the Clayton Act:
Hide kickbacks as commissions or brokerage fees.
Use rebates unless they are made available to all customers.
Engage in exclusive dealings with a supplier unless the supplier adds to the furnishing of the buyer and/or offers to make like terms to all other potential suppliers.
Fix prices or engage in exclusive contracts if such a practice will lead to lessening of competition or monopoly.
Acquire one or more other firms if such an acquisition will lead to a lessening of competition.
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Market Failure
10
Antitrust Policy: Celler-Kefavuer Act
The Celler-Kefavuer Act (1950) strengthened the Clayton Act by making it more difficult for firms to engage in mergers and acquisitions without violating the law.
Merger policy was furthered changed when new horizontal merger guidelines were written in 1982; amended in 1984, and revised in 1992, 1997, and 2010.
Guidelines based on the Herfindahl-Hirschman index (HHI): , where is firm ’s market share.
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14-11
Market Failure
11
Antitrust Policy: Horizontal Merger Guidelines
Horizontal Merger Guidelines
Merger that increases HHI by less than 100 or leads to an unconcentrated market (post-merger is typically permitted.
Markets are considered moderately concentrated when the post-meger results in:
Mergers with an HHI in this range and increase the HHI by more than 100 points potentially raise antitrust concerns.
Markets are considered highly concentrated when the post-merger .
Mergers with an HHI in this range and increase the HHI between 100 and 200 points potentially raise antitrust concerns.
If a merger increases the HHI by more than 200 points and leads to a highly concentrated market, it is presumed to enhance market power.
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Market Failure
12
Hart-Scott-Rodino Antitrust Improvement Act
The Hart-Scott-Rodino Act (1976) requires that the parties to an acquisition notify both the Department of Justice (DOJ) and Federal Trade Commission (FTC) of their intent to merge, provided that the dollar value of the transaction exceeds a certain threshold (currently about $80 million).
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Market Failure
13
Hart-Scott-Rodino Antitrust Improvement Act
Following this premerger notification, the parties of the merger must wait 30 days before they may complete the merger transaction.
If the DOJ and FTC determine that further examination is warranted, a second request is issued that extends the waiting period. Once the additional information is requested, the government has another 30 days to review the information and file a complaint to block the merger or permit it to move forward.
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2-14
Market Failure
Price Regulation
The presence of large scale economies may make it desirable for a single firm to service an entire market.
In these instances, government may permit a monopoly to exist, but regulate its price in effort to reduce the deadweight loss.
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14-15
Market Failure
15
Regulating a Monopolist’s Price at the Socially Efficient Level
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14-16
Market Failure
Price
Quantity
Demand
MR
MC
Regulated price
Effective demand
16
Regulating a Monopolist’s Price Below the Socially Efficient Level
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14-17
Market Failure
Price
Quantity
Demand
MR
MC
Regulated price
Shortage
Deadweight loss
before regulation
Deadweight loss
after regulation
17
A Case Where Drives the Monopolist Out of Business
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14-18
Market Failure
Price
Quantity
Demand
MR
MC
Regulated price
ATC
18
Externalities
Negative externalities exist when costs are borne by parties who are not involved in the production or consumption of a good or service.
The reason externalities cause a “market failure” is the absence of well-defined property rights.
The failure is often resolved when a government defines itself to be the owner of the environment, and uses its power to induce the socially efficient levels of output and pollution.
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14-19
Market Failure
19
The Socially Efficient Equilibrium in the Presence of External Costs
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14-20
Market Failure
Output of steel
Price
of
steel
(internal costs)
0
Demand
Marginal cost to society of
producing steel
(internal and external costs)
Marginal cost of
pollution to society
(external costs)
A
B
Free market
equilibrium
C
Socially
efficient
equilibrium
20
Externalities: The Clean Air Act
To solve the externality problem caused by pollution, the U.S. Congress passed the Clean Air Act in 1970 and made sweeping changes with amendments in 1990.
Firms that operate in industries that release over 10 tons per year, or 25 tons per year of a combination of pollutants, on a specified list are required to obtain a permit to emit pollution into the environment.
The Clean Air Act causes firms to internalize the cost of emitting pollutants since the permits are costly to acquire.
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14-21
Market Failure
21
Impact of the Clean Air Act In Action
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14-22
Market Failure
Market output
Price
0
Demand
Due to reduction in
output by all firms
22
Public Goods
A public good is another type of good that leads to a market failure.
A public good is:
A good that is nonrival and nonexclusionary in nature, and therefore, benefit persons other than those who buy the goods.
Nonrival goods: the consumption of the good by one person does not preclude other people from also consuming the good.
Nonexclusionary good: once provided, no one can be excluded from consuming the good.
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14-23
Market Failure
23
Public Goods and Inefficiencies
Public goods leads the market to provide inefficient quantities since everyone gets to consume a public good once it is available, but individuals have little incentive to purchase the good; they prefer others to pay for it.
When a group of individuals rely on the efforts or payments of others to provide a good, we say there is a free-rider problem.
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14-24
Market Failure
24
Demand for a Public a Good
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14-25
Market Failure
Quantity of
streetlights
Price
0
of streetlights
Individual demand for streetlights
Individual consumer surplus = $72
Total demand for streetlights
25
The Free-Rider Problem
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14-26
Market Failure
Quantity
of streetlights
0
Price
Price
Quantity
of streetlights
of
streetlights
Total demand
by B and C
B’s and C’s
individual demand
A’s demand
for streetlights
A’s consumer
surplus from
free-riding
= $85.50
30
30
26
Incomplete Information
Efficiently functioning markets require participants to have reasonably good information about prices, quality, available technologies, and the risks associated with working particular jobs or consuming particular products.
Market inefficiencies result when participants have incomplete information.
One severe source of market failure is asymmetric information, where some market participants have better information than others.
Implication: buyers may refuse to purchase from sellers.
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14-27
Market Failure
27
Government Policies Dealing with Asymmetric Information
Rules against insider trading
Certification
Truth in lending
Truth in advertising
Enforcing contracts
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14-28
Market Failure
28
Rent Seeking
Government policies can improve the allocation of resources to alleviate market failures.
These policies, however, generally benefit some parties at the expense of others.
Implications: lobbyists spend considerable sums in attempt to influence government policy; a process known as rent seeking.
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14-29
Rent Seeking
29
Incentives to Engage in Rent-Seeking Activities
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14-30
Rent Seeking
Price
Quantity
Demand
MR
MC = AC
C
A
B
30
Quotas
A quota is a government restriction that limits the quantity of imported goods that can legally enter the country.
Implications:
Reduces competition in domestic market
Higher domestic prices
Higher profits for domestic firms
Lower consumer surplus for domestic consumers
Conclusion: Domestic producers benefit at the expense of domestic consumers and foreign producers
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14-31
Government Policy and International Markets
31
The Impact of a Foreign Import Quota on the Domestic Market
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14-32
Government Policy and International Markets
Price
Demand
G
E
Market supply
before quota
K
Quota
A
B
M
Market supply
after quota
Quantity in the
domestic market
32
Tariffs
A tariff is designed to limit foreign competition in the domestic market to benefit domestic producers, which accrue at the expense of domestic consumers and foreign producers.
Lump-sum tariff: fixed fee that foreign firms must pay the domestic government to be able to sell in the domestic market.
Excise (per-unit) tariff: the fee an importing firm must pay to the domestic government on each unit it brings into the country.
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14-33
Government Policy and International Markets
33
Impact of a Lump-Sum Tariff on a Foreign Firm
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14-34
Government Policy and International Markets
Price
Quantity of
individual
foreign firm’s
output
MC
AC2
AC1
Average cost
before
lump-sum tariff
Average cost
After lump-sum tariff
34
Impact of a Lump-Sum Tariff on Market Supply
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14-35
Government Policy and International Markets
Price
Quantity in the
domestic market
A
Market supply curve
before lump-sum tariff
Market supply curve
after lump-sum tariff
35
Impact of an Excise Tariff on Market Supply
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14-36
Government Policy and International Markets
Price
Demand
E
H
A
B
C
Quantity in the
domestic market
Supply before
excise tax
Supply after
excise tax
36
