Textbook Notes (280,000)
US (110,000)
NYU (500)
Chapter 15

ECON-UA 2 Chapter Notes - Chapter 15: Coase Theorem, Natural Monopoly, Market Power

Course Code
Marc Lieberman

of 5
Chapter 15
1. The Legal & Regulatory Infrastructure
a. The Legal System
a.i. Economically, the law encourages people to channel their efforts into
mutually beneficial, Pareto-improving exchanges by discouraging the
chief alternative: trying to benefit at the expense of others
a.ii. The law also enables some types of Pareto improvements to take place
that would be difficult or impossible w/out the law
a.ii.1. Criminal law: prohibits actions that harm others
a.ii.1.a. Shifts behavior away from harmful activities toward
Pareto-improving activities
a.ii.2. Contract Law: establishes rules for writing & enforcing
contracts & penalties for failure to fulfill
a.ii.2.a. Enables Pareto improvements involving future
a.ii.3. Property Law: establishes rules for private ownership of
land & other assets; ensures that rewards from assets accrue to
the owners
a.ii.3.a. Enables owners to sell or rent property to those
who can use it most profitably
a.ii.4. Tort Law: allows those harmed by dangerous activities or
products to sue for damages
a.ii.4.a. Facilitates Pareto improvements that require
reasonable assumption of safety
a.ii.5. Anti-trust Law: prevents business behavior that limits
competition at the expense of consumers
a.ii.5.a. Limits market power
b. Regulation
b.i. Directs businesses to take specific actions & prohibits other actions, often
on a case-by-case basis
b.ii. Contributes to efficiency by protecting buyers, sellers, or third parties from
potential harm that market exchanges might cause
b.iii. Controversial
b.iii.1. Tighter regulations can help protect the public from harm,
but if they are too strict, they can stifle innovation
c. The Importance of Infrastructure
c.i. Strong relation b/w infrastructure & output per worker
d. Market Failures: occurs when a market-even w/the proper institutional support-is
d.i. Monopoly markets
d.ii. Externalities
d.iii. Public goods
d.iv. Information asymmetry
find more resources at oneclass.com
find more resources at oneclass.com
2. Monopoly
a. Limiting Market Power: use anti-trust law to prohibit:
a.i. Agreements among competitors
a.ii. Monopolization
a.ii.1. Prohibits certain steps to acquire or maintain monopoly
a.ii.2. Gov’t has broken up monopolies
a.iii. Mergers
a.iii.1. Prevents two firms to combine to form one new firm which
leads to a more concentrated oligopoly market which results in
higher prices
b. Coping w/Market Power
b.i. Patents & Copyrights
b.i.1. Gov’t tries to balance 2 conflicting interests:
b.i.1.a. Providing incentives to make new discoveries, and
b.i.1.b. Keeping prices low so that the efficient quantity will
be provided
b.ii. The Special Case of Natural Monopoly
b.ii.1. Due to economies of scale, one firm can produce for the
entire market at a lower cost per unit than could two or more firms
b.ii.2. Breaking up the natural monopoly does not make sense
b.ii.3. What can gov’t do?
b.ii.3.a. Public ownership & operation - ex. Post office
b.ii.3.b. Regulation - ex. Local cable industries
c. Regulation of Natural Monopoly
c.i. Marginal Cost Pricing: setting the price equal to the firm’s marginal cost of
c.i.1. Will automatically bring the market to the efficient level of
c.i.2. Problem is that MC curve lies below the LRATC meaning
that the cost per unit is greater than price
c.i.2.a. Firm suffers a loss, & in the long run would shut
c.i.2.b. Gov’t must also subsidize the natural monopoly to
cover its losses w/gov’t funds
c.i.2.b.i. Controversial bc requires taxpayers to pay for the
c.ii. Average Cost Pricing: more commonly used; price is set as low as
possible, while still covering the firm’s cost per unit
c.ii.1. Where the LRATC crosses the demand curve
c.ii.2. Fair rate of return pricing
c.ii.3. Natural monopoly makes zero economic profit, which
provides its owners w/a fair rate of return & keeps the monopoly in
find more resources at oneclass.com
find more resources at oneclass.com
c.ii.4. Does not quite make the market efficient
c.ii.5. Issue-provides little or no incentive for the natural
monopoly to control costs
c.ii.5.a. Can lead to rising costs for customers, & further
movement away from the efficient output level
3. Externalities: a by-product of consumption or production that affects someone other than
the buyer or seller; negative causes harm to others, positive creates benefits for others
a. The Private Solution
a.i. Coase theorem: when side payments can be negotiated & arranged w/out
cost-the private market will solve the externality problem on its own,
always arriving at the efficient outcome
a.i.1. The allocation of legal rights determines gains & losses
among the parties, but does not affect the action taken
a.i.2. Externalities do not always create market failures
a.i.3. Side payments that can be arranged w/out cost is satisfied
a.i.3.a. Legal rights are clearly established
a.i.3.b. The number of people involved is very small
a.i.3.b.i. Real-world situations do not satisfy these
b. Gov’t & Negative Externalities
b.i. Marginal Social Cost (MSC): The full cost of producing another unit of a
good, including the marginal cost to the producer and any harm caused to
third parties
b.ii. A market w/a negative externality will produce more than the
efficient quantity of the good, creating a deadweight loss
b.iii. Regulation
b.iii.1. Until recently, the most common method used for dealing
w/negative externalities
b.iii.2. But inefficiency in allocating production & consumption
among market participants cause economists to favor a market-
based approach
b.iii.2.a. Can achieve the efficient market quantity of a good
while ensuring that we’re exploiting all Pareto
improvements in allocating that quantity among market
b.iv. Market-Based Approach #1: Taxes
b.iv.1. A tax on each unit of a good equal to the external harm it
causes can correct a negative externality
b.iv.1.a. Brings the market to the efficient quantity of the
b.iv.1.b. Assures that the total market quantity of the good is
allocated efficiently among consumers & producers
find more resources at oneclass.com
find more resources at oneclass.com