ECON 2540 - CH.9: Competition and Coordination: The Invisible Hand (PART 2)

What are the benefits of the market

-Allocates goods/services through price change
-Distribution Among Society

What are the motivations that markets provide to consumers and sellers?

Encourages consumers to try and meet their needs with goods that cost less than other goods that could also meet the same need, and encourages sellers to economize on the use of inputs by constantly seeking lower-cost inputs that will do the job

How do consumers and sellers pursuing their own individual interests affect society?

Since society need to produce what it wants using no more of resources than necessary, society benefits when individuals or firms make such decisions to buy the cheapest cost of input or product.

What are the problems with the market?

-Needs may not be met (voting w/ dollars)
-Prisoner Dilemma
-Tragedy of Commons
-When prices are not "right" (Externalities)
-Monopoly as a Market Failure
-Economies of scale

Needs may not be met (voting w/ dollars)

Sees markets as an election, where consumers "vote" with their dollars for commodities they want, and the more votes a commodity gets will be the one to be produced more often. However, if 1 dollar = 1 vote, people with high income will vote more times than others. Essentially, market distribution of income, people with less money will not have their needs met since they dont have enough "votes" to contribute to a commodity.

Problem of Inter-generational Social Mobility

The conditions in which a person grows up will heavily affect their adult life. therefore, those who grow up poor will likely be poor in their adult-life

How to solve the problem of inter-generational social mobility?

Government provision, which makes governments takeover certain services to ensure those who are poor get the service they need
Income Redistribution, and this is where income is redistributed throughout society to lessen the income inequality in a country.

What are the two coordination problems of the Market?

Prisoner's Dilemma and Tragedy of Commons

Prisoner's Dilemma

a paradox in decision analysis in which two individuals acting in their own self-interests do not produce the optimal outcome

Nash Equilibrium

a situation in which economic participants interacting with one another each choose their own best strategy given the strategies that all the others have chosen

Dominant Strategy

The preferred option for both individuals (the option that both sides maximize their benefits, however there is risk to it because they're unsure if the other will also choose that option)

What is the big takeaway from prisoner's dilemma?

People who pursue individual maximization tend to lead society to be worse off. They actually don't maximize themselves, and they are rather sub-optimal.

How to spot prisoner's dilemma?

1. Identify the Dominant strategy

2. Take the Dominant Strategy, and apply the Nash Equilibrium (if no nash equilibrium, than no prisoner's dilemma)

3. Nash Equilibrium must be sub-optimal

How to solve the Prisoner's dilemma?

Make the strategies NOT voluntarily and enforce these strategies instead

Tragedy of Commons

situation in which people acting individually and in their own interest use up a commonly available but limited resources, creating disaster for the entire community
(example, a lake with fish)

Solution of Tragedy of Commons

social regulation or private ownership of common resource

Social regulation of the commons

People can come together in a society and regulate the access of the common property (set the usage limits, equal benefits, and more)

Private ownership of the commons

Private individual or company owns the common property. The firm or person who owns the common industry will limit the use, due to not wanting the common resource to be depleted so fast.

Externalities

when a market failure occurs because the commodity has costs or benefits to those that are neither the producer or the consumer.

What are the two types of externalities?

Positive and Negative Externalities

Negative externality

When a commodity has a negative outcome to those that are neither the producer or consumer. (Ex buying gasoline)

Positive externality

When a commodity has a positive/beneficial outcome to those that are neither the producer or consumer. (Ex buying college education)

What are the solutions to negative externalities?

Tax the equal amount to the cost of the externality or use
Regulation (Have governments regulate transactions between buys and sellers and aim to not have any externalities outside of the transaction)

How are monopolies a market failure?

Since a monopoly means a single firm with no actual or potential competitors in a market, this single firm allows them to drastically increase price without having them to worry about customers switching to another firm. The lack of competition is which the "invisible hand" relies on, and it cant work because producers can not charge more than the marginal cost of producing a particular commodity

Solutions to monopoly as a market failure

Encourage competition, government regulation (set restrictions), and government ownership (buy out monopolized firms)

Economies of scale as a market failure

An industry with large up-front costs and marginal cost is constant, or at least not rising. This becomes a problem when companies start producing more units as the distribution of the up-front cost is spread out among a larger number of units, hence the cost becomes relatively low, and then firms can charge a cost higher than the up-front. (causes monopoly)

What's the central point of the article "What markets can, and cannot do"?

Markets not only allocate and distribute income, they also shape our human development and create a structure of power

An example of market's influencing an individual's personality

Labour market determines an individual's worth because it is what provides your income. Also, if you are an assembly worker, you only work on specific skills related to that job. In the case of an assembly worker, you focus on skills such as attention to detail, hand-eye coordination, and so on. Since you're practicing these skills 8 hours/day, these will reflect on your life outside work. Also, there are skill you don't prioritize in work and therefore lose out on these skills outside of your work.

What are the two ways that markets can affect individuals' personalities?

Endogenous and Exogenous

Endogenous

influences produced from within; due to internal causes (personal interest)

Exogenous

influences produced from without; due to external causes (interests outside of personal, such as those around you)

Contested Exchange

When two interests of each party in an incomplete contract contradict each other.

What are the two types of contracts

complete and incomplete

Incomplete contract

A contract in which one of the parties can take ongoing actions that negatively impact the other party because its not specified in the contract.

Complete Contract

A contract in which there is no ongoing action and both parties understand all actions specified in the contract.

Example of incomplete contract

a labour contract (employment contract) is a _________ contract because the employer does not get a set amount of "work" guaranteed from the employee whom they are about to hire. They hire this employee for several months or even years (which makes it ongoing), and they expect work efficiency of 100% on their end. However, this is not stated in the contract and therefore employees may put in minimum effort

Example of complete contract

A consumer goes to the store, and buys carrots, and leaves. Since the consumer is free to do whatever after the purchase, such as never return to the store again, or worry about the person at the cashier, or isn't restricted in any sorts, this is a complete contract. There is no on-going action AFTER the transaction has been made

How to combat contested exchange in contracts?

one of the parties need to have short side power

Short-side Power

Those on the short-side are individuals who are willing to do the least amount of business, therefore, are the ones who determine the amount of business that will actually get done. long side are the ones who want to do business the most, and therefore will go on the basis of the short-side individuals

What are the 4 typology of markets consisting of exogenous/endogenous and complete/incomplete contracts?

Groceries
Credit Market
Labour Market
Real Estate Market

Groceries

A market that is exogenous and a complete contract

Credit market

A market that is exogenous and an incomplete contract

Labour market

A market that is endogenous and incomplete contract

Real estate market

a market that is endogenous and complete contract

Albert Hirschman propose what two options for firms to do when market failure comes into play?

Exit and Voice

Exit

the ability to walk away - and choose other competing options.
(Strives in markets)

Voice

without leaving a party/firm, you actively lobby to change things
(strives in political decisions)