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Session 2
Delivered by
2016
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Business-Government
Relationships
Cooperation Conflict
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Social policies
Examples:
CSR-related policies
Work place safety-related policies
Drug price control policies
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Regulation
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What else?
Public goods
Asymmetric information
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Monopoly
What is a monopoly?
One firm supplies the whole market.
Natural Monopoly
What is a natural monopoly?
The dominant feature of natural monopoly is the existence of
huge sunk costs.
In case of a natural monopoly the economies of scale are so
substantial that a single firm can produce total business output at
a lower unit cost, and thus more efficiently than two or more
firms.
After one player has entered the market and created the requisite
infrastructure and system for operation, it will be inefficient for a
second player to enter the market.
The huge sunk costs act as an entry barrier.
Natural monopoly thus poses the difficult dilemma of how to
organize these industries so as to gain the advantages of
production by a single firm, while minimizing all the vices
resulting from non-competitive markets.
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Contd
Examples of Natural Monopoly?
Electricity
An electric company is a classic example of a natural
monopoly, where competition may lead to an inefficient
market outcome. Once the huge sunk cost involved with
power generation and power lines are paid, each additional
unit of electricity costs very little. Having two electric
companies split electricity production, each with its own
power source and power lines, would lead to a near
doubling of price.
Railways
Oil & gas pipelines, etc.
Externalities
What is externality?
The uncompensated impact of one persons actions on
the well-being of a bystander.
Negative externality
Impact on the bystander is adverse
Cost to society (of producing a good) is larger than the
cost to the producers of the good
Positive externality
Impact on the bystander is beneficial
Social benefit is higher than private benefit
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Market Failure
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Public goods
A public good requires two conditions:
Non-rival consumption: One person consuming the good
does not prevent other people from consuming the good or does
not reduce the availability of the good for consumption by others.
Non-excludable consumption: Those who are not willing to
pay for it cannot be excluded from the consumption of the good.
It causes Free riders problem:
Free riders are those who consume public goods, but do not pay
for it.
Examples of public goods?
Clean air, street lights.
Since businesses cannot restrict consumption of the public goods by
non-payers, hence, private businesses undersupply public goods.
Hence the need for government intervention.
Asymmetric information
Asymmetric information refers to a situation where either the
buyer or the seller has more information than the other party.
Asymmetric information may occur in markets, where
consumers have difficulty inspecting the good or service.
Some producers could provide low-quality, defective, or even
harmful goods in such situations.
Consumers can also sometimes exploit asymmetric
information to get undue advantage from business.
Government can regulate markets with asymmetric
information to protect the buyers and/or sellers.
Examples of regulation in cases of asymmetric
information?
Product standards
License of doctors
Rules governing insurance claims
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