MNOTES III
Chapter 12 - General Equilibrium and the Efficiency of
Perfect Competition
Objectives:
1. The student should understand the difference between
partial and general equilibrium analysis.
2. The student should understand the sources of market
failure.
PARTIAL EQUILIBRIUM ANALYSIS - The process of examining the
equilibrium conditions in individual markets and for households and
firms separately. - Pg 242
GENERAL EQUILIBRIUM ANALYSIS - The condition that exists when all
markets in an economy are in simultaneous equilibrium. - Pg 245
General and partial equilibrium analysis relates to positive
economics. Judging the performance of an economic system is based
on efficiency(The condition in which the economy is producing what
people want at the least possible cost-Pg 245) equity, and liberty.
1. Analyze the effects of a fall in the price of pretzels.
2. Should the Federal government put a $3.50 price ceiling on
gasoline?]
1. Economic policy should be based on partial or general
equilibrium
Pareto Efficiency – A condition in which no change is possible that
will make some members of society better off without making some other
members of society worse off. Pg 248
General Equilibrium Analysis:
I. a major technological advance
II. a shift in consumer preferences
I. Electronics industry: computers, TV's, Stereo equipment and,
Video Equipment.
Advances in technology results in lower cost of production
General Equilibrium
─────────┐
P (Electronics)
Qd(Electronics) Partial equilibrium
│
OTHER PRODUCT MARKETS AFFECTED
INPUT MARKETS AFFECTED
1. Slide Rules
1. Land, Labor, capital, and
2. Film Cameras
raw materials
3. Carburetors
4. Ledgers
│
│
│
│
│
│
─────────┘
2. [How will lower cost of production affect the short run and long
run average cost curves?]
3. [Technology and tastes change causing the demand schedule and
supply schedule of automobiles to increase. Do a partial and
general equilibrium analysis.]
4. [What is the mechanism that causes resources to be reallocated?]
5. [What
are the benefits
technology?]
6. [What are the
technology?]
costs
associated
associated
with
with
improvements
in
improvements
in
7. [How is technical and allocative efficiency achieved in the
above example?]
8. [How is equity and liberty achieved?]
II. Alcohol and Tobacco Industry
The demand for wine increased from 1965 to 1980.
9. [Show the effect of an increase in the demand schedule on price
and quantity.]
10.
[Is this general or partial equilibrium analysis?]
11.
[When households increase there demand for a product will
this increase in demand for wine affect other markets?]
12.
[Is this general or partial equilibrium analysis?]
Criteria to Evaluate Alternative Economic Policy:
1. Efficiency
Technical
Allocative(Pareto)
Pg 251
3
2. Equity
3. Liberty
Pareto efficiency: A condition in which no change is possible that
will make some members of society better off without making some other
members of society worse off. - Pg 251
13.
[Problem 7 and 11]
Some actions make some people better off while making other people
worse off.
1. Clerks in Massachusetts Pg 251
Most free market exchanges are pareto efficient
14.
[What is the cost of 500 people waiting in line for 1 hour
each
day?]
15.
[Second Hand markets such as used cars, or rummage sales
are an
example of efficiency, equity, of liberty?]
Allocative efficiency (pareto
equilibrium analysis and tariffs
optimality
Pg
251),
general
STEP #1 - The Question
Should the U.S. have tariffs on TV sets from China?
Should the U.S. have tariffs on textiles from China?
Should the U.S. have tariffs on cement from Mexico?
Should the U.S. have tariffs on sugar from Central America?
Should the U.S. have tariffs on lumber from Canada?
Should the U.S. mandate use of ethanol?
7.5 billion gallons by 2012
36 billion gallons by 2022
8/8/08 EPA Declines to Reduce Ethanol Requirements WSJ B3
5/17/04 WSJ Imported Steel WSJ 9/13/02
Should the U.S. set M.P.G.’s for cars and trucks? (WSJ 5/19/09)
STEP #2 - The Concern
U.S. Jobs - Economic efficiency
STEP #3 - Benefits and Costs of Tariffs
BENEFITS of Tariffs on TV sets from China
ASSUMPTIONS
EFFICIENCY INCREASES
Labor Market
1. Unemployment decreases (T)
2. Production of other goods
will
4
increase
decreases(T)
Product Market
EQUITY INCREASES
Overall
unemployment
3. Imperfect market structure
Consumers do not want foreign Chinese
TV=s (A)
4.
Domestic TV producers maintain or
lower cost of production and increase
quality(T)
5. Foreign T.V makers do not have a
comparative advantage in production.
6. People who want the goods the most get
them
Costs of Tariffs on T.V.=s
ASSUMPTIONS
EFFICIENCY DECREASES
Labor Market
7. Unemployment increases (T)
8. Production of other goods will not
increase(preventing U.S. from getting
outside it's production possibilities
curve. Computers, engineering other
high income jobs are reduced.
Overall unemployment increases. (T)
Product Market
EQUITY DECREASES
not get them.
9. Perfect Market structure
Consumers want Chinese TV=s (A)
10. Less competition forces TV industry
to increase price and reduce quality(T)
11.
Foreign
TV
makers
do
have
a
comparative advantage in production.
12. People who want the goods the most do
LIBERTY DECREASES
STEP #4 - Which assumptions in step #3 are most realistic?
16.
[How would this seven-step analysis differ if you used
partial equilibrium analysis?]
5
17.
[Are tariffs and quotas pareto efficient?]
Step #1 – Should the subsidize ethanol?
Step #2 – Too much reliance on imported fuel
18.
Is this a valid concern? List important assumptions
19.
Is this an efficiency, equity, or liberty concern.
Step #3
Technical efficiency increases
Assumptions
Allocative efficiency increases
Equity increases
Technical efficiency decreases
Allocative efficiency decreases
Equity decreases
Step#4 –rate your assumptions
Step #5 – Does there appear to be any bias? Does the presenter have
any incentive on one side of the issue or the other?
Step #6 – Make a decision
Perfect Competition:
Pg 262
1. resources are allocated among firms efficiently - Choice of
Technology - Ch 7 Pg 144-146
Assuming the competitive conditions apply
2. the economic system produces the things people want
P = MC the system must be producing the right things
Price for good or service A > MC for good or service A
Price for good or service A < MC for good or service A
3. final products are distributed among households equitably
Assuming the competitive conditions apply
People who want the goods and services the most get them.
My old car and new boat #9 ch 12
6
20.
[When price of a good or service is not equal to marginal
cost(assuming
competitive
conditions
apply)
is
this
allocatively efficient?] Pg 262
SOURCES OF MARKET FAILURE: Pg 263-267
Functions for Government
1. Allow business to do business as easily as possible under
competitive conditions
Establish
conditions
system-Infrastructure
for
a
market
A. Private property
Goods and services
Your labor - Draft
Savings - Inheritance
Intellectual Property-12/11/03 AThe Link Between
Patents and Prosperity@ WSJ
General accepted accounting principles
Sound financial institutions-Banking system
Legal System - Courts
Right of Contract Infrastructure and the Wealth
of nations Jan 15, 02 Economic Commentary
B. Information systems - Internet
Product Info, Health Info, Job Info, Directional
Info(GPS), Education
C. Communication systems - Internet, broadband, satellite
D. Transportation systems - Roads, Bridges, airports
2. Make sure the product price is correct- Perfect competition
consumer is getting a fair price
price reflects all costs of production
ICC and Federal trade commission
Imperfect information - FDA, Better Business Bureau,
www.wipricepoint.org
3. Correct for market failures with perfect competition
Externalites
Public goods
Natural monopolies- Economies of Scale - Page 194-200 ch 9
4. Macroeconomic issues
Economic Growth
Redistribution - Progressives tax, Social Security, Food stamp
Stabilization
Stable currency
Monetary policy
7
Fiscal policy
Adjustments to perfect market structure
Externalities - A cost or benefit resulting from some activity or
transaction that is imposed or bestowed upon parties external to the
activity or transaction. Pg 265 Pg 269 #12
Individual Benefits
Social Benefits
MPB
<
MSB
Individual Costs
Social Costs
MPC
<
MSC
21.
[List some goods that might have external costs or benefits
Hint: The EPA estimate that second hand smoke cause
approximately 3,000 lung cancer deaths in nonsmokers each
year.]
Public goods - Goods or services that bestow collective benefits on
members of society; they are, in a sense, collectively consumed.
Generally, no one can be excluded from enjoying their benefits. A
pure public good is one in which any number of people can enjoying
consuming this good at the same moment in time.
Pg 264
WSJ Napster 2/14/01
22.
[List some examples of pure public goods.]
23.
[The outcome of any free market is ultimately unfair,
because
some become rich while others remain very poor.
Comment on
this statement.]
24.
[Problem 6 and 12]
Chapter 15 - Externalities, Public Goods, and Imperfect
Information
OBJECTIVES:
1. The student should understand when free markets fail
to produce efficiency.
2. The student should understand the solutions to free
market failure.
Externalities - A cost or benefit resulting from some activity or
transaction that is imposed or bestowed upon parties external to the
8
activity or transaction.
Sometimes called spillovers or
neighborhood effects. Pg 328
The definition of an externality is a benefit or cost to a third
party as a result of a market transaction. The third party can not
be a part of the initial market transaction. A negative externality
is a cost to a third party not involved in the market decision to
buy or sell. When my daughter and I are watching "Home Improvement"
and my son enters the room singing, this is an example of a negative
externality. My daughter and I were not part of my younger son's
decision to sing and as a result of his decision (that we were not
apart of) our enjoyment was reduced. A positive externality occurs
when someone who is not part of a household or market decision is
benefit from that decision. When I make a household decision to join
my daughter when she is watching "Home Improvement" she receives a
positive externality. On the other hand, one day when I decide to
join her and her boyfriend while watching T.V. I become a negative
externality.
Negative externalities can allocative inefficiency.
25.
[What is your cost to watch any T.V. program]
26.
[What would be the cost of singing to the singer?]
27.
[What would be the cost of singing to the family?]
When the cost rises I may choose to not watch the program or not watch
all the program.
28.
[How have negative
consumption decision?]
externalities
affected
my
T.V.
When someone makes a decision to sing in the household they only
perceive the cost of singing to themselves and not to the family.
When a family member looks at individual costs not social costs the
person is likely to produce to much singing or to little singing.
The central authority usually Mom and Dad in the household tell the
young singer, if you continue to sing you must do so in your room.
29.
[Now if you asked the singer what is the cost of singing
how would they respond?]
Mom and Dad know the solution to this problem without having to take
a single course in economics. They make the singer aware of the
discomfort the family is going through as a result of his song. The
singer now recognizes all the costs of singing while people are
9
watching T.V..
The central authority now has internalized the cost of one individual
disrupting someone's activity. Mom and Dad know the solution to
negative externalities without having to take a single course in
economics.
Assume my youngest daughter is developing her reading skills. The
more books she reads the better her skills become. When my daughter
decides to make a decision to read she increases her enjoyment and
my enjoyment as well. I believe additional reading will increase her
reading skills and better reading skills will produce a better
quality of life. Most parents would prefer the highest quality of
life possible for their children. My daughters decision to read
produces a positive externality for me. Being a true economist and
a parent I offer her an additional incentive to read of 25 cents for
every book she finishes.
30.
[What are some potential problems with this solution?]
31.
[As a result of smoking the smoker develops cancer and
dies, is this an externality?]
32.
[A student smokes in class other students sitting around
him find the second hand smoke annoying. Is this an externality?
Is smoking pareto optimal?]
33.
[The smoker offers the other students $5.00 for each
cigarette he smokes. They are agree to the deal. As a result
the student smokes a cigarette. Is this pareto optimal? ]
34.
[What has happened to the marginal cost of smoking a
cigarette?]
Negative Externalities
Pollution
The problem with externalities is MSC > MPC = P
LAKE LISKA AND LAKE STEEL
35.
[What type of inefficiency is created with externality?
Technical or allocative]
The solution to externalities is to make the external cost
10
internal to the decision makers so MSC = MPC = P
36.
[List some methods to internalize the cost of pollution
to the firm.] - Pg 332-337
1. Direct Regulation (tax or subsidy)
2/28/01 ANation=s air-quality standards withstand major industry
attack@ Wis. State Journal
2. Bargaining and negotiation (Coase theorem)
3. legal rules
Cap and trade
4. public auction
ATo Cut Pollution, Dutch Pay a Dump In Brazil to Clean Up@ WSJ 8/11/05
37.
[What is the cost of reducing pollution?]
38.
[What is the benefit of pollution?]
39.
[Should pollution be reduced to zero?]
40.
[Determine the externality that is produced from each of
the following markets and explain the appropriate government
action
1. Production of electricity using coal
2. Someone buys a sports car
3. Wal-mart builds a store next to your house
4. Person buys a stereo
5. Someone smokes in a public places
6. Someone buys a gun
7. Someone buys drugs
8. Someone talks in class
9.Someone puts in a septic system next door.
10. Climbing Mt. Hood
11. Athlete takes performing enhancing drugs
Positional externalities –Solutions?
Incentives and assumptions
12. production of corn
5. Other market solutions
12/3/10
Time to Shut Down the FCC WSJ A21
Examples of negative externalities:
Solutions
Markets can solve externality problems if:
1. Basic rights are assigned
2. No impediments to bargaining
3. Only a few people are involved
Positive Externalities
MSB > MPB(P) = MC
11
41.
[What type
externality?]
of
inefficiency
results
in
a
positive
1. A person goes to college
2. My children learn to read
3. Sewage System
4. Health system
5. Questions in class
6. CPR class
8/9/08
Everyone Should Learn CPR WSJ A10
7. Good Samaritan law #895.48
Any person who renders emergency care at the scene of any emergency
or accident in good faith shall be immune from civil liability for
his or her acts or omissions in rendering such emergency care. This
immunity does not extend when employees trained in health care or
health care professionals render emergency care for compensation and
within the scope of their usual and customary employment or practice
at a hospital or other institution equipped with hospital facilities,
at the scene of any emergency or accident, enroute to a hospital or
other institution equipped with hospital facilities or at a
physician's office.
8. Fireworks
42.
[How do you get people to consume more of a good that yields
positive externalities?]
PUBLIC GOODS
Public goods - Goods or services that bestow collective benefits
on members of society; they are, in a sense, collectively consumed.
Generally, no one can be excluded from enjoying their benefits. A
pure public good is one in which any number of people can enjoying
consuming this good at the same moment in time.
Pg 329
Public Goods must exhibit two characteristics:
1. Nonrival in consumption - One person's enjoyment of the benefits
of a public good does not interfere with another's consumption of
it at the same moment in time.
Pg 337
2. Nonexcludable - Once a good is produced, no one can be excluded
from enjoying its benefits.
Pg 339
43.
[Which of the following goods or services exhibit both
nonrivalry and nonexcludability: highways, police, fire, water
12
and sewer, parks, mail, lottery tickets and a weather alert
signal.]
Optimal allocation of Public goods Pg 340-343
Vertical Summation of demand curves
Pg 342
This assumes government has perfect information about
everyone's preferences.
44.
[What inefficiency exists if society is not getting the
quantity of public goods it desires?]
Market failures with Imperfect Market structure
1. Small number of sellers
IMPERFECT INFORMATION
2. Adverse selection - When a buyer or seller enters into an
exchange with another party who has more information. As a
result of this asymmetrical information a poor market choice is
made. Pg 334
a. Doctors B 9/19/02 WSJ
11/13/02 AFederal figures compare state nursing homes@ Wis.
State Journal 98,000 people die from surgical errors 8th leading
cause of death 12/13/02
3/25/04 ADoctor >Scorecards= Are Proposed In a Health-Care
Quality Drive@ WSJ
10/19/10 Medicare Faulted on Surgery Evaluation WSJ
3/29/11
Medicare Records Reveal Troubling Trail of Surgeries WSJ A1
13
b. Used cars
34. Would someone buy a old junker?]
35. [With imperfect information would someone end up with
that old car that does not really want it?]
c. Quality products - Consumer reports
d. Fraud
e. ENRON stock
45.
of
[Would adverse selection reduce technical, allocative
efficiency or equity?] People buy the wrong goods because
poor information.
Credence goods March 06 JEL pg 5 Goods or services where an
expert knows more about the quality a consumers needs. Auto
repair, taxi cab ride in a strange city,doctors
2. Moral Hazard - One party to a contract passes the cost of his
or her behavior on to the other party to a contract. Pg 335
a. fire and car insurance
b. FDIC
Economic Commentary May 1, 2003 Information and Prices
46.
[Does moral hazard result in technical, allocative
efficiency
or equity?] People sell the wrong goods because
of poor
information.
Market failures with perfect market structure
Market Failure
Causes
Solutions
Some form of government
intervention
1. Externalities
Lack of Property Rights
Imperfect Information
2. Public Goods
Free ridership
Government
produced or subsidized
3. Economies of Scale
High fixed costs
Tax
Subsidies
Legal Rules
Public auction
Government
Limits entry
Regulation
14
4. Imperfect Market St.
Adverse selection
Moral Hazard
Imperfect Information
Improved Info
Imperfect market structure Government
Anti-trust
Action
May 1, 2003 AInformation and Prices@ Economic Commentary
Warranties and deductibles are solutions for adverse selection
and moral hazard.
4/8/11
Senators Push to Open Database on Medicare WSJ A2
Government Functions
1. Social Security
2. Medicare
3. National defense
4. homeland security
5. Other police services (FBI, CIA)
6. Judicial
7. Legislative operations
8. International diplomacy
9. Transportation
10. Energy
11. Infrastructure development
12. Education
13. Income support for the needy
14. Stabilization
Dec 2003 AFiscal and Generational Imbalances: New Budget Measures for New Budget
Priorities@ Federal Reserve Bank of Cleveland Page 3.
47.
[Classify the above government functions into a market
failure or framework. State whether it is a micro or macro
failure and the type of micro or macro failure.]
http://www.econoclass.com/whatswrongwithpicture.html
Government Failures: Pg 348-349
1. Measurement of externalities is difficult
Apply the incorrect solution
2. No precise mechanism for citizen preferences(Voting paradox)
3. Indirect economic incentives
4. Elected and appointed officials have self interest.
11/29/10
Self-Service Nation Ends at Garden State Gas Pumps WSJ A1
15
www.econlib.org/library/Columns/y2007/Robertspolitics.html
48.
[Problem 4,5,6,8,10]
Government should make markets more efficient (allocative and technical)
Government functions in a market system
A. Allow business to do business as easily and fairly as
possible Pg 6
Prerequisites for a market system Pg 6
B. Allow business to do business as fairly as possible
Perfect competition
Imperfect market structure - Governments role is to improve market structure
Perfect Market Structure
1. Large number of buyers and sellers
2. Easy entry and exit
3. Homogenous product
4. Perfect information
www.hospitalcompare.hhs.gov/
5. Economic Incentive
5/14/10
Incentives vs. Government Waste WSJ A19
C. Correct for market failures
1. Public Goods - Governments roles is to provide public goods
2. Externalities - Governments role is to internalize external costs and benefits
3. Economies of Scale - Governments roles is to create a monopoly
Natural monopolies
D. Correct for market imperfections
Adverse selection
Moral hazard
Medical care
www.wipricepoint.org
http://www.wicheckpoint.org/index.aspx
E. Provide infrastructure
3/21/11
Putting a Price on Clean Water WSJ A15
Macro Failures
1. Stabilization
- Governments role is to minimize unemployment, inflation, and encourage
economic growth
Monetary and Fiscal Policy
2. Redistribution -Government should redistribute income in accordance to societies wishes