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Lecture 19

ECON 208 Lecture 19: ECON 208 - 004 Lecture 19

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McGill University
Economics (Arts)
ECON 208
Paul Dickinson

If NOT at PC output: • Q1 , Pd > MC • Q2, Pd < MC • Pd > MC • Not allocatively efficient • What if you monopolize an industry, you can get economies of scales? o Can be better for consumers, producers and economy… Increased Surplus Graph: MyCourses (not yet posted) • Results in more surplus • Society is better off --> more economic surplus Allocative Efficiency and Market Failure • Market failure occurs when market economies fail to produce efficient outcomes/fail to generate allocative efficiency o Several causes - discussed in Chapter 16 • Market transactions may impose costs or confer benefits on economic agents who are not involved in the transaction. • Cases like these are called externalities because they involve economic costs or benefits for parties that are external to the transaction. • Sometimes regulation can "correct" market failure --> sometimes it makes it worse 12.2 Economic Regulation to Promote Efficiency 1. Monopoly and Price Control • Effective max P on monopolist can: o Increase output o Improve allocative efficiency by o Reducing deadweight loss, which o Moves output closer to P = MC • Problem: Controlling monopolies cuts economic profits o Affects R&D, innovation and economic growth? • Government implements maximum price • Demand curve facing monopolists is the orange line (horizontal line) • MR curve match where the D curve goes from horizontal to downward sloping (where price drops) o Because MR drops as soon as you lower price to sell more (bc you lower price on each product sold) 2. Regulation of natural monopolies • A natural monopoly is an industry characterized by economies of scale sufficiently large that one firm can most efficiently supply the entire market demand. • ATC falls over whole range of market output • With a natural monopoly, economies of scale are so dominant that there is room for at most one firm to operate at the minimum efficient scale. a. One response to natural monopoly is for the government to assume ownership of the firm (public ownership) a. In Canada, such government-owned firms are called Crown corporations. b. Another response to the problem of natural monopoly is to allow private ownership but to regulate the monopolist’s behaviour. c. Another response is regulation******* o Three general types of pricing policies exist for regulated natural monopolies: marginal-cost pricing, two-part tariffs, and average-cost pricing. Focus on 2 policy options: public ownership or regulation 3 ways to regulate natural monopolies: 1. Marginal-cost pricing (set p = MC) 2. Average-cost pricing (set p=ATC) 3. A 2-part tariff 1. Marginal-cost pricing • Allocatively efficient, by economic losses • Can't continue without subsidy o economic losses would lead to firm closing down o Government can cover losses • Purple area: would come from government 3. Average-cost pricing • Closer to allocative efficient point than if the firm was uncontrolled, but there is still deadweight loss • *Remember output where p=MC is where allocative efficiency is 2. A two-part tariff • Objective: allocative efficiency without economic losses or subsidy Part 1: P1 = MC at Q1 - Allocatively efficient • • Part 2: Lump=sum 'access fee' = blue shaded area • Ex golfing: pay money per round and membership fee • Purple area is the membership fee Problem areas of regulation include: • Profit incentive for R&D and innovation? o Why spend money on research for a smaller return on that spending? • Incentive for minimize costs? o 'unnecessary' costs (gold-plated water cooler effect) o If the government is going to cover costs, there is no incentive to minimize costs • Administration: calculating zero economic profit? o 'normal' rate of return on capital investments • Administration: monitoring uses resources (opportunity cost) o Need someone to enforce regulations • Consumers pay for it, not tax-payers Regulation of Oligopolies: • There is growing skepticism about regulators' ability to improve the behaviour of oligopolistic industries. • Advanced industrial countries pushed toward deregulation and privatization when it was realized that: o Regulation often reduced competition o Public ownership was not clearly more efficient o Globalization led to more international competition 1. How much control without harming long-tern R&D? o Economic profit made from drug companies --> prices differ per country.. Should they be allowed to control this? 2. Will regulatory authorities: o Protect consumers by competition? o Protect firms from competition? Note: air fares fell when airlines deregulated o Who is the board protecting? Start by protecting consumers but may end up protecting firms Last decades seen moves from regulation to privatization: • Regulation often reduced competition • Public ownership was not clearly more efficient o Not always - ex Hydro (government was the only body able to afford to build a dam on St James) • Globalization gave more international competition o Reduced need for regulation? o Monopolies at home aren't protected bc of reduced tariffs --> can go abroad • Short-term may be hurt… but long-term? 12.3 Canadian Competition Policy *Not eligible for examination The Evolution of Canadian Policy • Competition policy is policy designed to prohibit the acquisition and exercise of monopoly power by business firms • Canadian competition policy began in the late 1890s. • By the 1950s, the following activities were illegal: a. price-fixing agreements that unduly lessen competition b. mergers or monopolies that operate to the detriment of the public interest c. “unfair” trade practices Recent reform • In 2009, the Competition Act was amended to a. increase the penalties for deceptive marketing and empower the courts to award restitution to victims of false advertising b. create a more effective mechanism for the criminal prosecution of significant cartel agreements c. introduce a two-stage merger review process
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