Week 1: An Overview of Welfare
& Industrial Economics
Francis O'Toole (fotoole@tcd.ie)
Department of Economics
Trinity College Dublin
30th September 2011
Economics: Fundamentals
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Economics: Scarcity and Choice
Scarcity: Wants > Resources (Needs < Resources?)
Choice: Optimising Behaviour, Cost-Benefit Analysis
Incentives and Institutions
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Neo-Classical Perspective (self-interested individuals,
rational or at least rationally irrational)
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Broad (political economy)
Narrow (consumers and producers + some government)
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Economic Agents & Models
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Consumers (Individuals or Households?)
Firms (Suppliers/Producers)
Government(s) (Ireland, EU?, USA, … )
Agencies (e.g. Competition Authority, ComReg, CER,
Department, … )
Consumers maximise happiness (utility, satisfaction)
subject to income constraint
Firms maximise profit (subject to cost environment)
Government(s) maximise ?
Agencies maximise ?
Economics, Political Economy, Public Choice ≠ Public
Finance
Economics: Demand &
Consumer Surplus
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Individual Consumer Demand
Quantity Demanded = F(P, Psub, Pcom, Y,
Taste, …)
Market Demand = Individual Demands
Consumer Surplus = Willingness to Pay –
Price
Consumer Surplus = “Value” – Price
Economics: Supply
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Individual Firm Supply
Quantity Supplied = F(P, Pother, w, r, …)
Market Supply = Individual Supplies
Economic Profits = Revenue – (Economic) Costs
Economic Profits ≠ Accounting Profits
Producer Surplus = Revenue – Total Variable
Costs
Long Run: Economic Profits = Producer Surplus
Economics: Societal Welfare
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Consumer Surplus
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Producer Surplus
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Societal Welfare
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Income Distribution (in “background” at
least)
Price Determination & Elasticity
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Quantity Demanded = Quantity Supplied
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Own-Price Elasticity of Demand (e.g. market
power?)
Cross-Price Elasticity of Demand (e.g. substitutes
and market definition)
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Income Elasticity of Demand
(Own-Price) Elasticity of Supply
Firm’s Costs: Short Run
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Short Run: At least one input is fixed
Diminishing Marginal Product/Returns
Total Costs (TC), Average Costs (AC)
Fixed Costs (FC), Average Fixed Costs (AFC)
Variable Costs (VC), Average Variable Costs
(AVC) (e.g. predatory pricing)
Marginal Costs (MC): Link to Supply Curve (e.g.
predatory pricing)
Firm’s Costs: Long run
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Long Run: All inputs are variable (TC =
VC)
Shape of Average Cost Curve?
Increasing Returns to Scale
Decreasing Returns to Scale
Constant Returns to Scale
Market Structure
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Perfect Competition
Monopoly
Oligopoly, Monopolistic Competition, Imperfect
Competition
Contestable Markets
Effective/Workable Competition
Structure  Conduct  Performance (SCP)?
Game Theory
Empirical Industrial Organisation
Perfect Competition:
Assumptions
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Large number of sellers and buyers
Homogeneous product
Free entry and exit
Full information about demand and supply
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Profit Maximisation (MR = MC)
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Perfect Competition:
Characteristics
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Short Run: Profits/Losses possible
Long Run: Entry or Exit until Zero
Economic (Excess, Supernormal,
Abnormal) Profits
Allocative Efficiency: P (SMB) = MC
(SMC)
Productive Efficiency: P = Min AC
Monopoly: Assumptions
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One seller, large number of buyers
Homogeneous product (by definition)
Barriers to resource transfers
Full information about demand and supply
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Profit Maximisation (MR = MC)
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Monopoly: Characteristics
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Short Run: Profits/Losses possible
Long Run: Economic Profits (subsidised losses) possible
Allocative Inefficiency: P (SMB) > MC (SMC)
Productive Inefficiency: P > Min AC (generally)
X-Inefficiency? (minimise costs?)
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Natural Monopoly (can’t compare with competition) → regulation
(narrow sense)
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Deadweight Loss: Harberger Triangle
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R & D, Profit Motivation
Oligopoly: Assumptions
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Few sellers, large number of buyers
Homogeneous or heterogeneous product
Free entry or barriers to entry
Full information about demand and supply
(usually)
Aside: Monopolistic Competition =
Oligopoly with Heterogeneous + Free Entry
Oligopoly: Characteristics?
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Cournot (1838): Quantity Competition
Bertrand (1883): Price Competition
Game Theory
Cournot: Assumptions? Results
Bertrand: Assumptions Results?
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Repeated Games  ???
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Contestable Markets:
Assumptions & Outcome
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Free entry and exit: No sunk costs
Some price rigidity (e.g. menu costs) or lags
relative to entry lag
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Perfectly competitive outcome: potential use of
hit-and-run strategy (even when n = 1)
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Policy Relevance?
Effective/Workable Competition:
Assumptions/Characteristics
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No “harmful” inhibitions on entry and exit
No “harmful” product differentiation
No “harmful” coordination (e.g. price
collusion)
No “harmful” price discrimination
Intrabrand competition, Interbrand
competition, potential competition
No Excess (Economic) Profits
Effective/Workable Competition:
Assumptions/Characteristics
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“To determine whether any industry is
workably competitive, therefore, simply
have a good graduate student write his
dissertation on the industry and render a
verdict. It is crucial, of course, that no
second graduate be allowed to study the
industry.” (Stigler 1956)
Round & Siegfried (1994) Update?