Chapter 8 - Markets and Government Intervention

Question 1

Whether a purely competitive industry is one of constant or increasing costs, in the final long run equilibrium how will it be represented?

Answer 1

Everything is equal MR=P=MC= Minimum AC

Question 2

What does it mean if average cost is at a minimum?

Answer 2

The most efficient known technology is being used and producing output at the lowest average cost

Question 3

What does the equality of price and marginal cost indicate?

Answer 3

That resources are being allocated in accordance with consumer preferences.

Question 4

What does allocative efficiency equal?

Answer 4

Price = Marginal Cost. Resources allocated to achieve maximum consumer satisfaction. That is resources are allocated in the right mix most wanted by consumers.

Question 5

What does productive efficiency equal?

Answer 5

Minimum average cost (AC), that is that the least cost production method is used, the minimum amount of resources are used and costs are limited to those costs essential to product production.

Question 6

What is marginal benefit?

Answer 6

It is the margin received based on product price at equilibrium

Question 7

What is marginal cost?

Answer 7

It is the cost sacrifice to society of other goods in using resources to produce more of product X.

Question 8

What does P>MC mean?

Answer 8

Under allocation - under competition a company will produce up to where P=MC, as to produce less means resources are under allocated and maximum profits cannot be achieved.

Question 9

What does P<MC mean?

Answer 9

Over allocation - this means resources are being used to produce X when society values Y more highly.

Question 10

What does the long-run position of minimum AC mean when looking at competitive firms?

Answer 10

That they will use the most efficient technology available.

Question 11

The competitive price system will reallocate resources in response to what?

Answer 11

• change in consumer tastes
• technology
• resource supplies.

Question 12

Pure competition results in what?

Answer 12

productive efficiency and allocative efficiency

Question 13

Because society values additional units of a monopolised product more highly than alternative products that those resources produce, what occurs?

Answer 13

The monopolist’s maximising output results in an under allocation of resources because it is more profitable to restrict output and therefore employ fewer resources than are justified from society’s standpoint, and charge a higher price.

Question 14

This restriction of output causes what?

Answer 14

allocative inefficiency as is evidenced by the fact that price exceeds marginal cost. This is common in a monopolised industry.

Question 15

Why do monopoly’s tend to increase income inequality?

Answer 15

Due to concentration of the payment of economic profits to a few individuals.

Question 16

Why are the costs of monopolists and a competitive industry different?

Answer 16

Because unlike a competitive industry a monopoly may be affected by X-inefficiency.

Question 17

What is X-inefficiency?

Answer 17

It is the failure to produce any given output at the lowest average and total cost possible.

Question 18

Why does X-inefficiency occur in a monopoly?

Answer 18

• There is not constant pressure from rivals

* Management may be motivated by different (non-profit) goals.

Question 19

What is dynamic efficiency?

Answer 19

It is the ability to develop the most efficient production techniques over time.

Question 20

What is the challenge for a competitive firm in regards to innovation?

Answer 20

They are driven to the most efficient KNOWN production techniques but lack of economic profit reduces innovation budgets

Question 21

what is the challenge for a monopolist in regards to innovation?

Answer 21

They have the economic profit to innovate but may not have the drive.

Question 22

What is one reason why a monopolist may choose to innovate?

Answer 22

To help create a barrier to entry for others or to avoid falling prey to new competitors who attack the fringe.

Question 23

What is excess capacity and when does it occur?

Answer 23

It is when firms produce at a higher cost than minimum ATC at equilibrium. The result is under utilised plants with consumers penalised through higher than competitive prices.

Question 24

What is the trade off for society for the higher prices because of the under utilisation of monopolists?

Answer 24

product differentiation

Question 25

What is an oligopoly?

Answer 25

The situation when the number of firms in an industry is so small that each must consider the reactions of rivals in formulating its price

Question 26

Why is an oligopoly similar to a monopoly?

Answer 26

Because neither allocative or productive efficiency occurs.

Question 27

Why do some people argue that an oligopoly is more desirable than a monopoly?

Answer 27

Because a monopoly may be subject to government regulation, and although informal collusion may occur to give similar results, the oligopoly maintains the appearance of several independent firms.

Question 28

What are the two views of dynamic efficiency in regards to an oligopoly?

Answer 28

1 - competition drives companies to be technologically progressive for short term projects and long term survival.
2 - Schumpter-Galbraith view suggests developing productive techniques is expensive and that barriers to entry give the oligopolist assurance that they will realise profit rewards before others do.

Question 29

What does analysis show in relation to the Schumpter-Galbraith view?

Answer 29

That it does not hold true with two thirds of basic inventions this century coming from small to medium sized firms.

Question 30

What are the two major cases of market failure?

Answer 30

When the competitive price system either:

1) produces the wrong amounts of goods and services, or
2) fails to allocate any resources at all to the production of certain goods and services whose output is economically justified.

Question 31

When does a spillover or externality occur and what is it?

Answer 31

It occurs when some of the benefits or costs associated with the production or consumption of a good or service that flow on to parties external to the market transaction.

Question 32

How would spillover costs be drawn on a graph?

Answer 32

A shift of the supply curve left, as resources are over allocated to production. So the cost is inflicted on some third party without compensation, for example environmental pollution.

Question 33

What are spillover benefits and how are they drawn?

Answer 33

They cause an under allocation of resources in that optimum output exceeds the equilibrium output, so a third party gets a benefit they did not pay for. Eg vaccines and education.

Question 34

What is the problem of the commons?

Answer 34

That there are some resources which no one has clear rights to which results in their overuse or misallocation, eg air and water.

Question 35

Describe private goods?

Answer 35

They are divisible in that they come in small enough units to be bought by individuals and they are subject to the exclusion principle.

Question 36

What is the exclusion principle?

Answer 36

This is when those who do not pay for a product are excluded from its benefit.

Question 37

Describe what public goods are?

Answer 37

They are goods and services that are not provided by the market system, as they are indivisible and often not bound by the exclusion principle.

Question 38

What are pure public goods?

Answer 38

Those goods and services that are both indivisible and not subject to the exclusion principle, eg a lighthouse.

Question 39

What is the free-rider problem?

Answer 39

Where people can receive benefits from the consumption of a good or service without directly contributing to its costs.

Question 40

How is the free rider problem drawn on a graph?

Answer 40

The individual demand curve is not high enough, so doesn’t intersect the supply curve. So we need to add all the social demand for the public good together, this gives us a Demand curve that is higher and would cross the supply curve.

Question 41

What is quasi-public goods?

Answer 41

Those large externalities that occur with the provision of government services such as medical care and education. In these cases both public and private versions exist.

Question 42

What are the three basic types of corrective action common for correcting spillover costs?

Answer 42

1) legislation that prohibits the spillover cost eg ban on pollution, this will shift the supply curve left bringing it back to equilibrium
2) Specific taxes - less direct, the govt applies a tax to increase firms costs therefore shifting the supply curve left and back towards equilibrium
3) property rights and individual bargaining.

Question 43

Where does Coase theorem suggest government intervention is not required?

Answer 43

Where

• property ownership is clearly defined
• the number of people involved is small
• bargaining costs are neglible

Question 44

Instead of government intervention for property rights, what does coase theorem suggest?

Answer 44

Bargaining between the owner of the property and the party causing the spillover. A settlement should result which will increase the firms costs and therefore shift the supply curve left and equilibrium is restored. Where there are large numbers of people, individual bargaining is unlikely to work.

Question 45

How can spillover benefits be corrected?

Answer 45

By subsidies to producers or government provision.

Question 46

How would a subsidy work to remove spillover benefits?

Answer 46

They encourage a greater demand for the product that is generating the positive eternality, therefore increasing the allocation of resources to its production and leading to an output level that is closer to that of the social optimum.

Question 47

What does subsidising the buyers achieve?

Answer 47

increases demand by effectively making the product cheaper.

Question 48

What does subsidising the producers encourage?

Answer 48

more production of the item

Question 49

How does the government achieve a reallocation of resources from the private to the public sector in order to provide public and other goods and services?

Answer 49

Achieved through the collection of taxes, which reduces private investment and consumption expenditure.

Question 50

What are the benefits and shortcomings of cost-benefit analysis?

Answer 50

It can provide useful guidance as to the economic desirability and most efficient scope of public goods output, but is limited due to difficulties in measuring the value of certain costs and benefits in practice

Question 51

What is the performance of any economic system judged on?

Answer 51

efficiency - the bigger the cake the better, and

equity - how the cake is split up and distributed