EFFICIENCY IN PERFECTLY COMPETITIVE MARKETS What is a

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 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: • 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 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 w/ restrictions $0. 26 / pound and 220 million pounds; $0. 26 • Imports: total supply (domestic plus imported) $0. 15 shifts right; $0. 12 • Supply equilibrium @ 360 Demand 12¢; • Import restrictions: total supply w/ imports restricted; • Supply curve shifts left; • Quantity decreases to 300; Total Supply • Price increases to 15¢. w/ imports 220 300 360 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 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 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. , 100 th) 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 100 th ton of paper and $3 for paper consumers not to consume the 100 th 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.