Chapter 11 - imperfect markets

market power
anti-trust legislation
assymetric information
externalities
public goods

Until now, we have talked about the case of perfect competition - ie a market where there are many suppliers and many demanders and the price and quantity are determined by the market. Economists generally consider perfect competition to be a case where the price determined by the market is the most efficient price and therefore the best price to ensure that markets function properly.

What makes a market competitive:

1. many buyers and seller, so no actor can set the price. In other words buyers and sellers take p as given. (p is given and consumers determine q by setting p=MB, while producers determine q by setting p=MC.)

2. Both consumers and producers have full information about the product.

We have seen examples (price ceilings and floors as well as taxes and import tariffs) where the market outcome is bypassed and have seen that this generally has unintended consequences in the form of lost consumer and producer surplus (dead weight loss) as well as sometimes creating other problems, such as higher prices and/or shortages/surpluses in the market. While economists think these outcomes are not optimal and should be avoided, policy makers/citizens etc. may still opt for these, in part because of equity considerations, in part because of the relative political power of various actors. In the next classes we will be talking about four examples where market prices are no longer efficient. These include:

market power - When the price is no longer given. Eg, the firm has the power to set the price, rather than taking price as given. p > MC

Market power may result in:

monopoly - a single firm supplying the entire market
oligopoly - a small number of firms
monopolistic competition - more firms than in the case of an oligopoly but fewer than necessary for pc.

Anti-trust legislation can be used to combat market power.

assymetric information - if buyers have different information than sellers

ex: employer doesn't know how hard working a future employee may be. Remember how we talked about a college degree is a signal. If this is the case, then education provides information, without actually increasing productivity.

Sometimes lack of information can be solved by the market, but at other times government intervention may be needed. Consumer protection legislation is one example.

externalities - this is the case where producers and/or consumers create something which they either do not have to pay for, or do not benefit from. These may be negative or positive, but they imply that either the costs of benefits that determine the S/D curve are inaccurate.

The government may impose a tax, or subsidize an activity. They may also ban some activities or try to restrict them through quotas.

public goods - this is the case of goods which everybody benefits from, and no one can be excluded from. As such, people may not be willing to pay what the good is worth to them.

Government generally needs to supply public goods, since the market will fail to do so.