ECO105 Ch. 10 Market Failure #1: Natural Monopoly

Market Failure

When markets produce outcomes that are inefficient or inequitable

Economies of scale

• Average total cost decrease as quantity of output increases

• No competition because of a huge fixed cost

• Eg. Cable TV

Natural Monopoly

• economies of scale allows only A single seller to achieve lowest average total cost

• One cause of market failure

Ways to get rid of natural monopoly

1. Public ownership

2. Rate of return regulation

Public Ownership (Crown corporations)

• Publicly owned businesses in Canada

• Achieve economies of scale, but lack of competition weaken incentives to reduce costs or innovate

Rate of return regulation

• Set price allowing regulated monopoly to just cover average total costs and normal profits

• Problem: Incentive to exaggerate reported costs guarantee to have a certain percentage back

Competition laws originated in late 1800s

1. First Anti-combines law in 1889

2. Modern Competition Act in 1986

Modern Competition Act in 1986

• "To maintain and encourage competition in Canada in order to promote the efficiency and adaptability of the Canadian Economy"

• To prevent anti-competitive business behavior

• Raises expected costs to business of price fixing relative to expected benefits

Criminal Offenses

• Price fixing, bid rigging (Eg. Quebec), false/misleading advertising

• Punish by prison time or fines etc...

Civil Offenses (Probably have positive effect to economies as whole)

• Less serious

• Mergers, abusing dominant market position, lessening competition

• Punish by Fines, legal prohibition

• Competition tribunal for civil offenses weight cost of lessening competition against benefits of increased efficiencies

• If mergers that reduce competition also provide economies of scale, maybe approved for promoting "efficiency and adaptability"

Caveat Emptor (Let the buyer beware)

• Latin Phrase

• Buyers alone is responsible for checking quality of products before buying

Certain products (Eg. Nuclear power, meds...)

Regulated by gov because average consumer cannot know product's quality

Public-interest view

• Gov. regulation eliminates waste, achieves efficiency, promotes the public interest

• Most economists agree the competition act serves the public-interest well

Capture view

• Gov. regulation benefits regulated business, not the public interest

• Evidence is mixed on gov. regulation - some support capture, some support public-interest view

Gov. Failure: when regulations fail to serve public interest

1. Market outcome, even with monopoly power, better than gov. regulation outcome if significant gov. failure

2. Gov. outcome, with public interest regulations, better than market outcome if significant market failure

Game Theory

Math tool for understanding how players make decisions, taking into account what they expect rivals to do

Prisoner's dilemma

• Game with two players who must each make a strategic choic, where results depend on the other player's choice.

• One based on lack of trust, one based on trust; both smart choice

• Each player is motivated to (cheat/confess); self-interest, both better off if they trust

Nash equilibrium

• Outcome of a game in which each player makes best choice, given the choice of the other

• Players in Prisoner's Dilemma driven to Nash equilibrium outcome where everyone cheat/confess

• Successful as detective set up properly

Collusion 共謀

- Conspiracy (陰謀) to cheat or deceive (lie) others

Cartel

- Association of suppliers formed to maintain high prices and restrict competition (goal=higher profit)

Desirable competitive behavior

Always an active attempt to increase profits and gain the market power of monopoly, is hard to distinguish from undesirable collusive (串通) behavior