Copyright © 2008 Pearson Addison-Wesley. All rights reserved. Chapter 12 Economic Efficiency and...

Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

Chapter 12

Economic Efficiency and Public Policy

12-2Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

In this chapter you will learn to

1. Describe the distinction between productive and allocative efficiency.

4. Describe the goals and results of U.S. antitrust policy.

3. List the alternative methods for regulating a natural monopoly.

2. Explain why perfect competition is allocatively efficient, whereas monopoly is allocatively inefficient.


Full employment of resources does not guarantee efficiency:

1. firms may not use least-cost methods of production

2. marginal costs may not be equated across firms in an industry

3. too much of one product and too little of another product may be produced.

Productive and Allocative Efficiency


Table 12.1 Review of Four Market Structures


Productive Efficiency

Productive efficiency for a firm requires costs to be minimized for any given level of output (recall chapter 8).

Productive efficiency for an industry requires the MC to be the same for every firm.

If all industries are productively efficient, then the economy is on the production possibilities boundary.


Figure 12.1 Productive Efficiency for the Industry


Figure 12.2 Productive Efficiency and the Production Possibilities Boundary


Figure 12.3 Allocative Efficiency and the Production Possibilities Boundary


What is the Amount of Steel and Wheat to Produce?


Which Market Structures Are Efficient?

Profit-maximizing, competitive firms are productively efficient.

If they interact in competitive markets, the outcome will be allocatively efficient (p = MC).

On the other hand, monopoly is productively efficient, but allocatively inefficient (since p > MC).


Figure 12.4 Consumer and Producer Surplus in a Competitive Market


Figure 12.5 The Allocative Efficiency of Perfect Competition


Figure 12.6 The Deadweight Loss of Monopoly

The deadweight loss is shown by area = 3 + 5.

A monopolist generates a deadweight loss by restricting output below the competitive level.


Allocative Efficiency and Market Failure

Market failures:

• when the free market fails to generate allocative efficiency

• several causes — discussed in Chapter 16

• public policies — discussed in Chapters 17 and 18

Under some circumstances government action can “correct” the market failure and improve the efficiency of market outcomes.


Economic Regulation to Promote Efficiency

Regulation of Natural Monopolies

Natural monopoly: a situation where costs decline over the whole range of market output.

room for only one firm to achieve MES

Two policy responses:

- public ownership

- regulation


Three Approaches to Regulating Natural Monopolies

1. Marginal-cost pricing (set p = p1)

D

MC

ATC

Q2 Q1

c1

p1

p2

Output

Pri

ce

Co

s ts

•••

Marginal-cost pricing is allocatively efficient, but the firm will incur losses.


Figure 12.7 Pricing Policies for Natural Monopolies with Falling Costs


2. A two-part tariff can be used to cover costs.

– fixed monthly charge

– charge that varies with the actual amount consumed

This policy allows customers pay one price to gain access to the product and a second price for each unit consumed:

For example: Electric bill

Tariff


3. Average-cost pricing (set p = p2)

D

MC

ATC

Q2 Q1

c1

p1

p2

Output

Pri

ce

Co

s ts

•••

Average-cost pricing results in zero profits, but it is allocatively inefficient because p > MC.

Average-Cost Pricing


The allocatively efficient pricing system would determine output by setting prices equal to MC in the short run.

It would also adjust capacity in the long run until the long-run MC is equal to the price.

(Average-cost pricing generally leads to inefficient long-run investment decisions.)

In the very long run, technological changes may create or destroy natural monopolies.

Long Run Adjustment


Regulation of Oligopolies

There is growing skepticism about regulators’ ability to improve the behaviour of oligopolistic industries.

• Regulation often reduced competition

• Public ownership was not clearly more efficient

• Globalization led to more international competition

- reduced need for regulation?

Advanced industrial countries pushed toward deregulation and privatization when it was realized that:


U.S. Antitrust Policy

The Framework of Antitrust Policy

The antitrust law prohibits:

• collusive behavior

• mergers that reduce competition

• Monopolization of an industry

Sherman Act of 1890, Section 1: illegal to restrain trade

Sherman Act of 1980, Section 2: illegal to monopolize

Clayton Act of 1914: prohibited other anticompetitive practices


APPLYING ECONOMIC CONCEPTS 12.1

Does Nineteenth Antitrust Policy Still Work in the Twenty-First Century?

Antitrust Policy in the 21th Century


Evolution of Antitrust Policy and Recent Developments

Over time, there has been considerable variation in the aggressiveness of antitrust enforcement and in the interpretation of exactly what type of behavior is illegal.

• U.S. v. Socony-Vacuum Oil Co. (1940): price fixing was found illegal regardless of the consequences

• ALCOA (1945): company was ruled an illegal monopoly despite no evidence of “unreasonable behavior”

• Be the mid-1970s, a more balanced antitrust approach was adopted, particularly in merger policy.


Looking Forward

History suggests that U.S. antitrust policy will continue to change.

– technological changes

– Globalization

Factors that will affect antitrust issues include:

Copyright © 2008 Pearson Addison-Wesley. All rights reserved. Chapter 12 Economic Efficiency and...

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