EFFICIENCY IN PERFECTLY
COMPETITIVE MARKETS
What is a Perfectly
Competitive Market?
• A market in which no
buyer or seller has the
power to influence price
Why Can’t Buyers or
Sellers Influence the
Price?
• There are a large number of
small buyers and sellers.
• The output produced by all
firms in the market is
identical.
• Buyers and sellers have
perfect information.
MARKET EFFICIENCY
•
A market is efficient if it executes all potential
transactions that would benefit a buyer, a seller,
and any third parties affected by the transactions.
• A market is inefficient if, once market equilibrium
is reached, there is an additional transaction that
would benefit a buyer, a seller, and any third
parties affected by the transaction
MARKET SPILLOVER
• If there are no spillovers, there are no third
parties who would be affected by market
transactions.
• The market is efficient if there are no
additional transactions that would benefit a
buyer or a seller.
6.00
Buyer's profit
(consumer surplus)
Price of
Syrup 5.00
($ per
4.00
pint)
SUPPLY
3.00
2.00
1.00
Seller's profit
(producer surplus)
3
4
5
6
DEMAND
7
Pints of Syrup per week (thousands)
6.00
Buyer's profit
(consumer surplus)
Price of
Syrup 5.00
($ per
4.00
pint)
SUPPLY
3.00
2.00
1.00
Seller's profit
(producer surplus)
3
4
5
6
DEMAND
7
Pints of Syrup per week (thousands)
The Invisible Hand
Instead of using a bureaucrat to
coordinate the actions of everyone
in the market, we can only rely on
the actions of individual
consumers and producers, each
guided only by self-interest.
GOVERNMENT INTERVENTION
• Price Ceiling -- If a government passes a law that
sets a maximum price below the equilibrium
price.
• Price ceiling example: Rent Control
• Maximum Price Effects:
- Decrease in quantity supplied, since fewer
suppliers are able to cover costs;
- Reduced quality to help lower costs as
revenue is declining;
- Fewer market transactions than if free
market left to prevail.
MAXIMUM PRICE
PRICE:
• Creates inequality between
quantity supplied and
Rent
Supply
demanded, and:
$$
• decreases quantity
$420
i
supplied;
Demand
$400
• increases quantity
$360
demanded;
• creates unsatisfied demand;
• consumers limited to
Maximum
quantity supplied;
Price
• for amount supplied,
760
800
880
consumers now willing
to pay more than
QUANTITY: Number of
equilibrium price.
Apartments
GOVERNMENT INTERVENTION
• Price Floor - Imposition of minimum price which
may be accepted for a specific good or service.
• Example: Agricultural Price Support Programs;
• Minimum Price Effects:
- Increased quantity supplied and reduced
quantity demanded, creating surplus;
- Government typically buys surplus;
- Corporate farmers receive greatest support,
while family farmers receive least support;
- Landowners enjoy appreciated land prices;
- Consumers pay artificially inflated product
prices and pay for program with taxes.
MINIMUM PRICE
Price
per ton
Minimum Price
Supply
• Creates inequality between
quantity supplied & quantity
$110
demanded;
• Encourages farmers to
$100
produce more;
• Causes consumers to buy
less;
• Government buys surplus;
• Consumer pays higher price
Demand
($110) and pays taxes to cover
800 1,000 1,200
government support
QUANTITY: Tons of Corn
(400 x $110 = $44,000).
GOVERNMENT IMPOSED
QUANTITY CONTROLS
• LICENSING
Limits the number of firms, increases the
price and decreases the quantity
consumed.
• IMPORT RESTRICTIONS
Tariffs, quotas or other devices which
reduce imports -- market supply from
outside the country.
LICENSING
• Intended to protect consumers from high prices
and low quality goods and services;
– Requires fee from producer or service
provider;
• Examples: Taxi service; building contractors; dry
cleaners, tobacco farms, liquor stores, appliance
repairers, dog groomers, etc...
• Effects of Licensing:
- Lower quantity supplied;
- because of fewer products or providers,
consumers will pay higher rates;
- because licensing moves market away from
equilibrium, it causes inefficiency.
LICENSING
Price
• Each driver provides 10
per mile
miles of service per hour;
$3.60
• originally 100 drivers:
• 1,000 miles at $3.00;
• licensing limits number of $3.00
drivers to 80;
• limits miles to 800 / hour; $2.60
• consumers now willing to
pay $3.60 for each mile;
• providers willing to offer 800
miles for $2.60 / hour.
Supply
Demand
800 1,000
QUANTITY: Miles of
taxi service per hour
IMPORT RESTRICTIONS
• Devices established to support domestic
industry by reducing competition from
foreign producers.
• Examples: Tariffs, quotas, etc....
• Effects of Import Restrictions:
- reduce quantity of imports;
- reduce quantity total market supply;
- raise price of good;
- raise price of total market supply.
Import Restrictions
Price
Domestic (U.S.) Supply
• No imports: supply /
per pound
demand equilibrium @
Total Supply
$0.26 / pound and 220
w/ restrictions
million pounds;
$0.26
• Imports: total supply
(domestic plus imported)
$0.1
shifts right;
5
$0.12
• Supply equilibrium @ 360
Demand
and 12¢;
• Import restrictions: total
supply w/ imports restricted;
• Supply curve shifts left;
• Quantity decreases to 300;
Total Supply
• Price increases to 15¢.
w/ imports
220 30 360
0
QUANTITY: Millions of
pounds of Sugar per day
SPILLOVER PRINCIPLE
For some goods, the associated costs or
benefits are not confined to the individual
or organization that decides how much of
the good to produce or consume.
PUBLIC vs PRIVATE GOODS
• PUBLIC GOODS A good available to everyone to consume,
regardless of who pays and who doesn’t.
- Spillover benefits;
- Non-rival in consumption and non- excludable;
EXAMPLES: national defense, law enforcement;
• PRIVATE GOODS A good consumed by a single person or
household;
- No spillover benefits;
- Rival in consumption and excludable;
EXAMPLES: food and drink;
FREE-RIDER PROBLEM
• If everyone tries to get a free ride, no
one will contribute any money to
support the public good, so it won’t be
provided.
• The flip side of the free-rider problem
is the chump problem: no one wants
to be the chump (the person who
gives free rides to other people), so no
one contributes any money.
FREE-RIDER PROBLEM
The problem with using voluntary
contributions to support public goods.
Each person will try to get the benefits of a
public good without paying for it.
Each person will try to get a free ride at the
expense of others.
The free-rider problem suggests that the
replacement of taxes with voluntary
contributions would force the government
to cut back or eliminate many programs.
SPILLOVER COSTS
Costs acquired by those who do not produce
a product, nor benefit from the production
of a product.
May appear in the form of environmental
destruction as a result of producing a good
or service.
Example: Pollution of streams and rivers with
paper processing run-off.
SPILLOVER COSTS AND MARKET
INEFFICIENCY IN PAPER MARKET
• Even though paper market may operate at
equilibrium, inefficiency occurs because of
spillover costs:
Paper production requires cities
downstream from mill to have added
water-treatment costs.
If paper production decreased by one ton,
water-treatment costs would be reduced
by $20.
SPILLOVER COSTS AND MARKET
INEFFICIENCY IN THE PAPER MARKET
Price / Ton
of Paper
SUPPLY
I
60
Market
Equilibrium
DEMAND
100
Quantity: Tons of Paper
per day
SPILLOVER COSTS AND MARKET
INEFFICIENCY IN THE PAPER MARKET
• If the city agreed to pay paper producers $1
for unproduced ton of paper :
Paper producer revenue would be reduced
by same amount as costs would be
reduced --$60. The one dollar paid by the
city would be incentive enough to produce
one less ton of paper.
SPILLOVER COSTS AND MARKET
INEFFICIENCY IN THE PAPER MARKET
Price / Ton
of Paper
SUPPLY
j
62
60
I
Market
Equilibrium
DEMAND
99 100
Quantity: Tons of Paper
per day
SPILLOVER COSTS AND MARKET
INEFFICIENCY IN THE PAPER MARKET
• If the city agreed to pay the paper
consumers $3 for consumption of one less
ton of paper.
While paper consumer would receive $2
less benefit by not consuming the last (i.e.,
100th) ton of paper, the dollar exceeding
this cost, paid by the city, would be
incentive enough for purchasers to
purchase one less ton of paper.
SPILLOVER COSTS AND MARKET
INEFFICIENCY IN THE PAPER MARKET
• If the city agreed to pay the paper
producers $1 not to produce the 100th ton
of paper and $3 for paper consumers not to
consume the 100th ton of paper:
City dwellers would have to pay $4 more in
taxes to cover the incentive payments to
the paper producer and paper consumer.
However, city dwellers have $20 less to pay
for water treatment.
ROLE OF GOVERNMENT IN MARKET WHERE
SPILLOVER COSTS ARE GENERATED
• POLLUTION TAX - Tax imposed on each
unit of waste generated: force firms to pay
for waste they generate.
• REGULATIONS -- Direct control of pollution
generated by specific firms, requiring
installation of abatement equipment and
decrease in volume of waste generated.
• MARKETABLE POLLUTION PERMITS -Issue of a fixed number of pollution
permits, allowing firms to buy and sell
permits.