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19/12/2019

CHAPTER 14
A Manager’s Guide to Government in the Learning Objectives
Marketplace 1. Identify four sources of market failure.
2. Explain why market power reduces social welfare, and identify two
types of government policies aimed at reducing deadweight loss.
3. Show why externalities can lead competitive markets to provide
socially inefficient quantities of goods and services; explain how
government policies, such as the Clean Air Act, can improve resource
allocation.
4. Show why competitive markets fail to provide socially efficient levels
of public goods; explain how the government can mitigate these
inefficiencies.
5. Explain why incomplete information compromises the efficiency of
markets, and identify five government policies aimed at mitigating
these problems.
6. Explain why government attempts to solve market failures can lead
to additional inefficiencies because of “rent-seeking” activities.
7. Show how government policies in international markets, such as
quotas and tariffs, impact the prices and quantities of domestic
goods and services.
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Market Failure Market Failure


Market Power Welfare and Deadweight
• The socially efficient quantity in a market occurs Loss Under Monopoly In Action
where price equals marginal cost. This quantity Price
maximizes the sum of consumer and producer Social welfare
surplus.
– This socially efficient price and quantity arise naturally in MC
a perfectly competitive market. 𝑃𝑀

• When a firm in a market produces an output that is Deadweight loss


less than the socially efficient level because it
charges a price that exceeds marginal cost, the firm
has market power.
– The value to society of producing another unit is greater MR
Demand
than the cost to produce another unit.
– Government may intervene in the market in attempt to 𝑄𝑀 Quantity
increase social welfare.
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Market Failure Market Failure

Antitrust Policy Antitrust Policy: Sherman Act, Section 1


• The purpose of antitrust policy is to eliminate • The cornerstone of U.S. antitrust policy are Sections
the deadweight loss of monopoly by making it 1 and 2 of the Sherman Antitrust Act of 1890:
– Section 1: Every contract, combination in the form of
illegal for manager to engage in activities that trust or otherwise, or conspiracy, in restraint of trade or
foster monopoly power. commerce among the several states, or with foreign
nations, is hereby declared to be illegal. Every person
who shall make any such contract or engage in any such
combination or conspiracy shall be deemed guilty of a
felony, and, on conviction thereof, shall be punished by
fine not exceeding five thousand dollars (one million
dollars if a corporation, or, if an other person, one
hundred thousand dollars) or by imprisonment not
exceeding one (three) years, or by both said
punishments, in the discretion of the court.
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Market Failure Market Failure


Antitrust Policy: Sherman Act, Section 2 Antitrust Policy: Rule of Reason
– Section 2: Every person who shall monopolize, or • Interpretation of antitrust policy is shaped by the
attempt to monopolize, or combine or conspire with courts, which rule on ambiguities in the law and
any person or persons, to monopolize any part of previous cases.
the trade or commerce among the several States, or • In the Supreme Court’s ruling on Standard Oil Trust,
with foreign nations, shall be deemed guilty of a the Court defined a new rule of reason, which
felony, and, on conviction thereof, shall be punished effectively stipulates
by fine not exceeding five thousand dollars (one – that not all trade restraints are illegal; rather, only those
million dollars if a corporation, or, if any other that are “unreasonable” are prohibited.
person, one hundred thousand dollars) or by • Problems with the rule of reason:
imprisonment not exceeding one (three) years, or – It is difficult for managers to know in advance whether
both said punishments, in the discretion of the particular pricing strategies or other actions used to
court. enhance profits are in fact violations of the law.

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Antitrust Policy: Market Failure Market Failure


Antitrust Policy: Clayton Act
Clayton and Robinson-Patman Acts
• To make more precise what actions are deemed • Illegal actions for firms under the Clayton Act:
illegal in antitrust law the U.S. Congress passed – Hide kickbacks as commissions or brokerage fees.
the Clayton Act (1914) and Robinson-Patman – Use rebates unless they are made available to all
Act (1936). customers.
– These acts make price discrimination – aimed to – Engage in exclusive dealings with a supplier unless the
substantially lessen competition or tend to create a supplier adds to the furnishing of the buyer and/or
monopoly in the line of commerce, or injure, offers to make like terms to all other potential suppliers.
destroy, or prevent competition – illegal.
– Fix prices or engage in exclusive contracts if such a
– Price discrimination is permitted under these acts practice will lead to lessening of competition or
when monopoly.
• it arises because of cost or quality differences.
– Acquire one or more other firms if such an acquisition
• it is necessary to meet a competitor’s price in a market.
will lead to a lessening of competition.
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Market Failure
Antitrust Policy: Market Failure

Antitrust Policy: Celler-Kefavuer Act


Horizontal Merger Guidelines
• The Celler-Kefavuer Act (1950) strengthened the • Horizontal Merger Guidelines
Clayton Act by making it more difficult for firms – Merger that increases HHI by less than 100 or leads to an
to engage in mergers and acquisitions without unconcentrated market (post-merger 𝐻𝐻𝐼 < 1,500) is
violating the law. typically permitted.
– Markets are considered moderately concentrated when the
• Merger policy was furthered changed when new post-meger results in: 1,500 < 𝐻𝐻𝐼 < 2,500
horizontal merger guidelines were written in • Mergers with an HHI in this range and increase the HHI by more than
1982; amended in 1984, and revised in 1992, 100 points potentially raise antitrust concerns.
– Markets are considered highly concentrated when the post-
1997, and 2010. merger 𝐻𝐻𝐼 > 2,500.
– Guidelines based on the Herfindahl-Hirschman • Mergers with an HHI in this range and increase the HHI between 100
index (HHI): 𝐻𝐻𝐼 = 10,000 𝑁 2
𝑖=1 𝑤𝑖 , where 𝑤𝑖 is
and 200 points potentially raise antitrust concerns.
firm 𝑖’s market share. – If a merger increases the HHI by more than 200 points and
leads to a highly concentrated market, it is presumed to
enhance market power.
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Market Failure Market Failure

Hart-Scott-Rodino Antitrust Hart-Scott-Rodino Antitrust


Improvement Act Improvement Act
• The Hart-Scott-Rodino Act (1976) requires that • Following this premerger notification, the
the parties to an acquisition notify both the parties of the merger must wait 30 days before
Department of Justice (DOJ) and Federal Trade they may complete the merger transaction.
Commission (FTC) of their intent to merge, – If the DOJ and FTC determine that further
provided that the dollar value of the transaction examination is warranted, a second request is issued
exceeds a certain threshold (currently about $80 that extends the waiting period. Once the additional
information is requested, the government has
million).
another 30 days to review the information and file a
complaint to block the merger or permit it to move
forward.
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Market Failure Market Failure


Price Regulation Regulating a Monopolist’s Price at
• The presence of large scale economies may the Socially Efficient Level
Price
make it desirable for a single firm to service an
entire market.
– In these instances, government may permit a MC
𝑃𝑀
monopoly to exist, but regulate its price in effort to
reduce the deadweight loss. 𝑃𝐶 Regulated price

Effective demand
Demand
MR

𝑄𝑀 𝑄𝐶 Quantity

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Market Failure Market Failure

Regulating a Monopolist’s Price A Case Where Drives the


Below the Socially Efficient Level Monopolist Out of Business
Price Price
Deadweight loss
after regulation MC ATC

MC
𝑃𝑀 𝑃𝑀

Deadweight loss 𝑃𝐶 Regulated price


before regulation

𝑃∗ Regulated price
Demand Demand
MR MR

𝑄𝑅 𝑄𝑀 𝑄∗ Quantity 𝑄𝑀 𝑄𝐶 Quantity

Shortage
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Market Failure Market Failure


Externalities The Socially Efficient Equilibrium in
• Negative externalities exist when costs are the Socially
Presence of External Costs
Price Marginal cost to society of
borne by parties who are not involved in the of efficient producing steel
steel equilibrium (internal and external costs)
production or consumption of a good or service.
𝑁
𝑃𝑆 C 𝑆= 𝑖=1 𝑀𝐶𝑖 (internal costs)
• The reason externalities cause a “market B
𝐶
Free market
failure” is the absence of well-defined property 𝑃 equilibrium Marginal cost of
pollution to society
rights. (external costs)

• The failure is often resolved when a government A

defines itself to be the owner of the Demand


environment, and uses its power to induce the
socially efficient levels of output and pollution. 0 𝑄𝑆 𝑄𝐶 Output of steel

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Externalities: The Clean Air Act


Market Failure
Impact of the Market Failure

• To solve the externality problem caused by


Clean Air Act In Action
pollution, the U.S. Congress passed the Clean Air Price

Act in 1970 and made sweeping changes with 𝑆𝑢𝑝𝑝𝑙𝑦1


amendments in 1990.
• Firms that operate in industries that release over 10 𝑃1
Due to reduction in
output by all firms
tons per year, or 25 tons per year of a combination 𝑆𝑢𝑝𝑝𝑙𝑦0
of pollutants, on a specified list are required to
obtain a permit to emit pollution into the 𝑃0

environment.
• The Clean Air Act causes firms to internalize the Demand

cost of emitting pollutants since the permits are


costly to acquire. 0 𝑄1 𝑄0 Market output

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Market Failure Market Failure

Public Goods Public Goods and Inefficiencies


• A public good is another type of good that leads • Public goods leads the market to provide
to a market failure. inefficient quantities since everyone gets to
• A public good is: consume a public good once it is available, but
– A good that is nonrival and nonexclusionary in individuals have little incentive to purchase the
nature, and therefore, benefit persons other than good; they prefer others to pay for it.
those who buy the goods. – When a group of individuals rely on the efforts or
• Nonrival goods: the consumption of the good by one payments of others to provide a good, we say there
person does not preclude other people from also is a free-rider problem.
consuming the good.
• Nonexclusionary good: once provided, no one can be
excluded from consuming the good.

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Market Failure Market Failure

Demand for a Public a Good The Free-Rider Problem


Price Price
Price
60
90

𝑀𝐶 of
54 𝑀𝐶of streetlights 54 streetlights A’s consumer
surplus from = $85.50
free-riding
Total demand for streetlights Total demand
30 by B and C
30
27 27
Individual consumer surplus = $72
30 A’s demand
B’s and C’s for streetlights
18 Individual demand for streetlights individual demand

0 3 30 Quantity 3 30 Quantity
0 12 30 Quantity of of streetlights of streetlights
streetlights
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Market Failure Market Failure


Incomplete Information Government Policies Dealing
• Efficiently functioning markets require with Asymmetric Information
participants to have reasonably good • Rules against insider trading
information about prices, quality, available • Certification
technologies, and the risks associated with
working particular jobs or consuming particular • Truth in lending
products. • Truth in advertising
– Market inefficiencies result when participants have • Enforcing contracts
incomplete information.
– One severe source of market failure is asymmetric
information, where some market participants have
better information than others.
• Implication: buyers may refuse to purchase from sellers.
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Rent Seeking Rent Seeking

Rent Seeking Incentives to Engage in


• Government policies can improve the allocation Rent-Seeking Activities
Price
of resources to alleviate market failures.
• These policies, however, generally benefit some C
parties at the expense of others. 𝑃𝑀
– Implications: lobbyists spend considerable sums in A B
𝑃𝐶 MC = AC
attempt to influence government policy; a process
known as rent seeking.
Demand
MR

𝑄𝑀 𝑄𝐶 Quantity

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Government Policy and International Markets Government Policy and International Markets
Quotas The Impact of a Foreign Import Quota
• A quota is a government restriction that limits on the Domestic Market
Price 𝑆 𝐹 Quota 𝑆𝐹𝑜𝑟𝑒𝑖𝑔𝑛
the quantity of imported goods that can legally
enter the country. 𝑆 𝐷𝑜𝑚𝑒𝑠𝑡𝑖𝑐
𝑆 𝑄𝑢𝑜𝑡𝑎
– Implications: E
Market supply
after quota
• Reduces competition in domestic market 𝑃𝐷 M 𝑆 𝐹+𝐷
𝑃𝑄𝑢𝑜𝑡𝑎 Market supply
A K
• Higher domestic prices 𝑃𝐹+𝐷
before quota

• Higher profits for domestic firms


B
• Lower consumer surplus for domestic consumers G
Demand
– Conclusion: Domestic producers benefit at the
expense of domestic consumers and foreign 𝑄𝑢𝑜𝑡𝑎 𝑄𝐷 𝑄𝑄𝑢𝑜𝑡𝑎 𝑄𝐹+𝐷 Quantity in the
domestic market
producers
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Government Policy and International Markets Government Policy and International Markets
Tariffs Impact of a Lump-Sum Tariff on a
• A tariff is designed to limit foreign competition Foreign Firm
Price
in the domestic market to benefit domestic Average cost
After lump-sum tariff
Average cost MC AC2
producers, which accrue at the expense of before
lump-sum tariff
domestic consumers and foreign producers. AC1
– Lump-sum tariff: fixed fee that foreign firms must 𝑃2
pay the domestic government to be able to sell in
the domestic market. 𝑃1

– Excise (per-unit) tariff: the fee an importing firm


must pay to the domestic government on each unit
it brings into the country. 𝑞1 𝑞2
Quantity of
individual
foreign firm’s
output
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Government Policy and International Markets Government Policy and International Markets
Impact of a Lump-Sum Tariff on Impact of an Excise Tariff on Market
Market Supply Supply
Price 𝑆𝐹𝑜𝑟𝑒𝑖𝑔𝑛 Price 𝑆 𝐹+𝑇
𝑆𝐹
𝐷𝑜𝑚𝑒𝑠𝑡𝑖𝑐
Supply after
𝑆 excise tax
𝑆𝐷
𝑆 𝐹+𝐷
A
𝑆 𝐹+𝐷+𝑇
𝑃2
E 𝑆 𝐹+𝐷
C
Market supply curve H
after lump-sum tariff
𝐸 B
Demand
Market supply curve Supply before
before lump-sum tariff A excise tax
Quantity in the Quantity in the
domestic market domestic market

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