Download Basic Concepts

Managerial Economics 2016-17
Topic 11
Answers
Basic Concepts
1.
Producer and Consumer Surplus in the Market Equilibrium
Price
Supply
Consumer
Surplus
Producer
Surplus
Demand
Quantity
An allocation of resources is (economically) efficient if it maximises the sum
of producer and consumer surpluses.
2.
The invisible hand of the market place refers to the atomistic and selfinterested actions of market participants which result, by means of market
exchange, in economically efficient production, exchange and consumption
activities.
3.
‘Market failure’ refers to the inability of the system of private enterprise to
achieve allocative efficiency across the economy. Allocative efficiency occurs
when no one person can be made better off without making someone else
worse off. In such a situation, the marginal net benefit or return to society on
all scarce resources in every use is the same. Private markets are not perfectly
efficient since many goods and services involve jointness and technological
constraints in production (externalities, natural monopolies) and consumption
(public goods). The system of private property rights cannot ensure the
provision of goods if producers cannot recover their cost and make a normal
profit or when consumers pay for the provision of a good or a service but are
prevented from consuming it. However, imperfect markets may still be
superior to some non-market alternatives (e.g., equally imperfect public
regulation).
4.
The Effect of a Negative Externality in Production
Price
Social Cost
Supply
(private cost)
Demand
Qs
Qm
Quantity
Qs - social equilibrium
Qm – market equilibrium
5.
It is possible to internalise some externalities without government
intervention. We do it all the time by being considerate, benevolent or smart.
There are also more complex private arrangements (e.g. restrictive covenants
or agreements) whereby individuals agree to follow some code of behaviour
that ensures a reasonable outcome for all parties to an agreement.
6.
A public good has two salient characteristics. First, it is non-excludable. This
means it is consumed collectively i.e., once provided, no one can be prevented
from sharing in the consumption of it. Second, it is non-rival. This means that
additional users or consumers do not diminish the amount available to existing
users/consumers. Example: wireless broadcasting.
Pure public goods cannot be provided through the private market as suppliers
would not be able to use the price mechanism to recover costs. Every one
would free ride. But some goods that have a strong ‘public’ content may be
provided commercially. Example: commercial television, where the cost is
recovered through advertising.
7.
See 6 above.
8.
A merit good is a good deemed by the government to be intrinsically desirable
for people who would not otherwise buy it, e.g., national defence for pacifists.
9.
Example, advertising. Producers may compete on quality as well as price in
which case they have a vested interest in providing information on the product
specification and quality attributes. Consumers may pay agents to search for
and analyse information for them (e.g., good food guides).
10.
Natural monopolies occur when a sole supplier in a particular market provides
the product at a lower cost than would two or more sellers. This is because the
cost structure is such that the unit cost of supply/production decreases as
output increases throughout the output range within existing market demand.
Example, electricity transmission, cable networks, railway tracks.
11.
Governments regulate and often prohibit mergers between large firms because
they do not want markets to be dominated by large monopolistic suppliers,
especially those who may set barriers to entry.
12.
For example, you may come to some agreement by bargaining (trading) or by
paying compensation to the ‘injured party.’ As long as the cost of ‘transacting’
an agreement is not excessive, you should be able to come to some
understanding between you. Otherwise one of you would have to leave or you
could resort to less economic means of exchange such as violence.
13.
See Section 9.6 above.
14.
Suppose that the natural monopolist’s marginal cost, MC, is below its average
cost, as shown below. If price, P = MC, it would make losses and would have
to leave the industry or, alternatively, the government would have to pay it a
subsidy. Also, by making P=MC, there is no incentive to innovate to reduce
cost.
Price,
Cost
Demand
Unit loss
Price
15.
Average Cost
Marginal Cost
Quantity
A positive consequence: the combined (post-merger) firm may reduce its unit
cost as it may achieve larger volumes of output. Also, it may be in a stronger
position to innovate and engage in a global competition.
A negative consequence: the post-merger firm may dominate the market and
take advantage of its monopoly power.