Chapter 9: Market Power and Market Failure

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Chapter 9 Market Power and Market Failure

• Purpose of chapter a detailed examination of
  how Pareto Optimality can be distorted in a
  market economy by Market Power and Market
  Failure.
• Leads to Distortions between shares of the Social
  Endowment and Social Product of members of a
  society.

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Market Power

• Market Power the process of exploiting an
  advantage to give an individual some control in
  the market.
• -- Distributes a larger share of the
• social product (production) of the
• economy to the powerful.
• -- Makes the economy less
• efficient, producing less social
• product than under GCE.

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Naturally Occurring Market Power

• Naturally Occurring Market Power market power
  resulting from either the consumers initial
  endowment (gifts, talents, attributes), or the
  natural competitive process of business.
• Natural part of an economy.

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Naturally Occurring Market Power in the Labor
Market

• Consider a labor market with a very high demand
  for a certain attribute.
• Now consider individuals who have this attribute
  more than anyone else (and it doesnt have to be
  a lot more).
• The result a large amount of market power for
  these individuals, and a very wage for them.
• E.G. Michael Jordan, Julia Roberts.

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Naturally Occurring Market Power in
Industry

• Take an industry which undergoes great Economies
  of Scale large purchases of physical capital,
  leading to a large region of downward sloping
  Average Cost (AC)
• Significant increases in efficiency, lower
  average costs for high volume of production as a
  result.
• Drives many other businesses out.
• Creates Barriers to Entry difficult for other
  businesses to enter to grab some of the positive
  economic profit.

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The Extreme Case

• Monopoly industry characterized by one
  producer.
• Producer has driven everyone else out through
  economies of scale, significant barriers to entry
  make it very difficult for firms to enter in.
• Illegal in US (early 20th Century).

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Naturally Occurring Market Power Not Permanent

• Consumers tend to lose attribute of being 1 in
  these highly competitive markets.
• New technologies arise and produce superior
  products, bringing down original firms
  (e.g. IBM and Microsoft).

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Artificially Occurring Market Power

• Artificially Occurring Market Power market
  power stemming from institutional restrictions or
  social perceptions.
• Most dangerous threat to competitive economy
  (Adam Smith).
• Can be long-term, not eroded naturally.

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Rent-Seeking and
Rent-Maintenance

• Rent-Seeking an attempt to seek market power by
  achieving an artificially created advantage.
• Rent-Maintenance an attempt to maintain market
  power by maintaining an artificially created
  advantage.
• Application Is this occurring through lobbying
  by special-interest groups in Congress?

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Examples of Market Power

• Key protection or benefit of a segment of
  society at the expense of the competitive economy
  as a whole.
• -- patents for inventors
• -- tariffs and trade restrictions
• -- laws to keep industries out of
• villages (e.g. Wal-Mart)
• -- discrimination (institutional laws and
• social perceptions)

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Discrimination and Gender
Pay Inequity

• Consider two labor markets, with the same labor
  demand and requiring roughly equal human capital.
• One is man-sphere jobs (MS).
• Other is woman-sphere jobs (WS).
• Equilibrium wage in WS jobs (WWS)
• 
  (WMS).

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Discrimination and Gender
Pay Inequity

• No discrimination (institutional or social
  perception) ? migration from low-paying WS jobs
  to high-paying MS jobs.
• Supply of labor decreases in WS market ? WWS?.
• Supply of labor increases in MS market ? WMS?.
• Continues until WWS WMS.

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Discrimination and Market Power

• Discrimination either prevents this adjustment
  from happening by law (institutional), or
  discourages it from happening (social
  perception).
• Rent-Maintenance done by group imposing
  discrimination.

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Market Failure

• Market Failure a market either doesnt form
  when needed, or it doesnt work smoothly and
  quickly to make necessary adjustments.

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Market Failure and Public
Goods

• Public Good a good which is non-partitionable
  (cannot be split up into pieces or degrees), and
  non-excludable (cannot exclude anyone from using
  it).
• Examples national defense, fire protection,
  police protection.

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The Free Rider Problem

• Free Rider Problem since public goods are
  non-excludable, and non-partitionable, people can
  get full coverage for free. Therefore, everyone
  waits for someone else to pay for it. As a
  result, a market doesnt form (market failure).

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Market Failure and
Externalities

• Externality when the actions of one economic
  unit (consumer, firm) affect another economic
  unit.
• Positive Externality affects in a positive way.
• Negative Externality affects in a negative way.

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Externalities and (Lack of)
Property Rights

• Underlying reason for externalities actions
  affect shared community resource where property
  rights cant be assigned (e.g. air, water,
  environment).
• Example second-hand smoke from cigarettes.

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Externalities External Costs
and Benefits

• Negative Externality imposes an external cost
  to society, due to spillover harm on other
  members.
• Positive Externality produces an external
  benefit to society, due to spillover benefit on
  other members.

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Marginal Private Benefit and Marginal Private
Cost

• Marginal Private Benefit (MPB) the benefit to
  an individual person of doing one more unit of an
  activity (similar to marginal utility).
• Marginal Private Cost (MPC) the cost to an
  individual person of doing one more unit of an
  activity (all economic costs).

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Marginal Social Benefit and Marginal Social Cost

• Marginal Social Benefit (MSB) the benefit to
  society of the person doing one more unit of an
  activity (similar to marginal utility).
• Marginal Social Cost (MSC) the cost to society
  of the person doing one more unit of an activity
  (all economic costs).

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Characteristics of MPB,
MPC, MSB, and MSC

• All are measured in dollars ().
• MSB MPB EB, where EB are External Benefits
  associated with a positive externality involving
  the action.
• MSC MPC EC, where EC are External Costs
  associated with a negative externality involving
  the action.

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Negative Externality A Graphical Representation

• Negative externality implies that External Costs
  0 and MSC MPC.
• MSC curve represented by an upward shift of the
  MPC curve.
• Socially optimal level of activity (LS) Privately optimal level of activity (LP).

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Negative Externality Conclusion

• Inefficiency due to Market Failure.
• Too much undesirable activity, shifts social
  costs to bystanders.

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Positive Externality A Graphical Representation

• Positive externality implies that External
  Benefits 0 and MSB MPB.
• MSB curve represented by an upward shift of the
  MPB curve.
• Socially optimal level of activity (LS)
  Privately optimal level of activity (LP).

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Positive Externality Conclusion

• Inefficiency due to Market Failure.
• Too little desirable activity.

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Negative Externalities
and Firms

• Inherent problem in production.
• Examples
• -- acid rain and the environment.
• -- dumping chemicals in lakes,
• contaminating water supply
• -- noise pollution
• -- bars, adult places, and crime

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Risk Externalities

• Risk Externality externality resulting from
  creating an unintended risk for innocent
  bystanders.
• Example -- DWI.
• Technology to reduce incidence of risk
  externality breathalyzer/starter lock for car.

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Market Power and Market Failure The Next Step

• Creates inefficiencies in society, deviation from
  GCE.
• Very realistic and common.
• What can government do to remedy these problems?
• When should government not try to remedy these
  problems?
• Topic of next chapter.