BEV Midterm 2, Midterm 1: BEV

Factor Markets

"Factors of Production" are bought and sold in order to be transformed into other goods - Labor market: workers offer their services and employers hire them - Capital markets: financial capital like stocks and bonds are traded - Land markets: land is bought, sold, or leased for use in production - Commodity markets: raw materials like oil, gold, and agricultural products are traded Some factor markets are likely to be more efficient than others. - Capital markets are often expected to be efficient → information is often widely-available and can flow freely - Commodities markets also efficient because products are homogenous within product class and information about those products is typically available without many restrictions - Labor markets are less effective because of employment conditions -> Skills take a long time to acquire, Moving is costly and sometimes limited by national boundaries

What are some strategies economists recommend for addressing market power? (focusing on competition and protecting consumer welfare)

- Antitrust enforcement - Encouraging entry and reducing barriers to entry - Public ownership or provision - Compulsory licensing of technologies, Compulsory divestiture of assets, Wholesale Breakup of existing companies or forced divesture of company assets less severe competition policy tool: managing the extent of intellectual property

What are benefits of efficient markets?

- Efficient Markets yield an efficient allocation of resources - markets encourage competition - Supports product variety - Markets encourage innovation -Markets promote investment, risk-taking, and capital formation - Markets enable international trade, the diffusion of technology and economic development - Markets support economic freedoms and political freedoms note: markets do not always yield efficient outcomes

What are key features of platform markets?

- facilitate interactions or transactions between parties - reduce transaction costs (e.g. costs and challenges associated with engaging in exchange - characterized by network effects (when the value of participating in the market depends on the number of other parties associated with the market (often in digital markets) e.g. value of using apps like TikTok and Instagram depends on their inherent quality and on the number of other users of those apps Note: not all platform markets are matching markets (e.g. Amazon) These markets only focus on facilitating transactions or interactions between different groups

Beyond high prices, reduced product quality, or limited choices, Government Intervention is also warranted when

- innovation is stifled by dominant firms using market power to suppress competition - Natural monopolies or industries with network effects - high fixed costs prevent fair competition

Government involvement is necessary in industries (market power)

- with public goods or externalities (e.g. healthcare or pollution-heavy sectors) - when private firms under-provide services or cause societal harm

Five reasons why inclusive economic institutions support markets, businesses, and economic and social outcomes

1. Foster innovation: allowing people to pursue entrepreneurial ideas and take risks, leading to technological advancements, productivity increases and overall economic growth 2. Reduce Poverty: by giving people access to opportunities, education, and fair markets. They provide foundation for upward social mobility, enabling people to improve their living conditions through their own efforts 3. Believe Market Fairness: when people believe markets are fair and that they have a chance to succeed, social unrest and conflict are less likely 4. Social Stability: creates broad-based prosperity → more accountable and representative government that makes policies in the interests of the people and that promotes sustainable and equitable business policies and economic developments 5. More resilient to economic development: such as financial downturns or pandemic because they are more flexible, innovative, and better able to mobilize resources and respond effectively to new change

Downsides of Efficient Markets

1. Income inequality and wealth disparities 2. Short-term focus 3. Ethical Concerns 4. Instability and Crises Recognizing these limitations allow policymakers and economists to strike a balance between fostering efficient markets and ensuring they work for the broader good of society

What are the imperfections and frictions of an efficient market + examples?

1. Not all market participants have access to the same information -> some parties can make better-informed decisions than others e.g. in financial markets, insider information can give certain investors an unfair advantage 2. Real-world markets are subject to various frictions, including transaction costs, taxes, and regulatory constraints → prevents prices from adjusting smoothly to new information, leading to inefficiencies e.g. in labor markets, minimum wage laws or union agreements prevent wages from adjusting to reflect changes in labor demand or productivity 3. Human behavior does not always conform to rational decision-making models -> psychological biases, herd behavior, and emotional reactions can lead to mispricing and suboptimal resource allocation (e.g. in market bubbles and crashes) 4. Markets fail to account for externalities - costs or benefits that affect third parties who are not directly involved in a transaction e.g. pollution from a factory imposes costs on society that are not reflected in the price of the factory's product

Market failures have 2 important implications

1. They create opportunities for firm - firms can take advantage of market failures to capture value and achieve superior profits - firms can create and capture value by devising approaches to minimize or eliminate market failures 2. They create inefficiencies that reduce social welfare relative to the amount that would be achieved in markets were efficient - reduction in social welfare, esp. consumer surplus, can lead to regulatory or legislative intervention - government intervention can limit negative implications of market failure - government intervention may not provide a useful remedy for the market failures and can be harmful

Three important ways in which institutions and government support markets.. what are the important functions of government?

1. guaranteeing property rights 2. enforcement of contracts 3. providing investments in public goods and national and regional infrastructure One of the most important functions of governments and related institutions in supporting market efficiency arises from their ability to establish trust by ensuring transparency, accountability, stable and sensible regulation, and adherence to the rule of law

What is a market?

A market is a system or environment in which buyers and sellers engage in the exchange of goods, services, or resources Markets facilitate transactions by providing a structured setting where prices can be determined through forces of supply and demand allocates resources efficiently operate on the principle of voluntary exchange, where participants willingly trade goods or services in exchange for money

When does arbitrage not work as effectively?

Arbitrage does not work as effectively in labor or product markets due to various frictions and barriers. Wage differences for similar jobs across regions or industries may persist because workers face significant costs and constraints in moving from one location to another or switching jobs - inhibits the kind of arbitrage that would bring wages into alignment across different labor markets - price differences for identical goods across regions or stores can persist due to factors like transportation costs, tariffs, or differences in consumer preferences

Friedrich Hayek, Road to Serfdom

Argues that decentralized decision-making is superior to central planning, harnesses dispersed knowledge that no central authority could harness "knowledge problem" → crucial information about local conditions, preferences, and technologies is spread among individuals and cannot be centralized Price mechanism aggregates and conveys this knowledge, guiding economic decisions by reflecting the relative scarcity of goods and services views markets as a form of spontaneous order that naturally emerges from voluntary interactions → leads to more efficient and adaptable outcomes acknowledges the efficiency of markets in allocating resources and argue that this is the result of their effectively coordinating all information relevant for production and sale

Markets arising from technological advances

As technology evolves, it can open up entirely new sectors by reducing costs or enabling activities that were previously impossible - e.g. the invention of the printing press reduced the cost of book production by 80-90%, enabling thousands of book copies to be made relatively quickly and cheaply - e.g. the invention of textile machinery, transistor, commercial internet, autonomous vehicle market

Income inequality and wealth disparities of efficient markets

Businesses thrive when they achieve substantial scale. This scale can concentrate wealth in the hands of those who own the businesses that successfully achieve scale - highly efficient labor markets in sectors like information technology often reward skilled workers with high incomes and stock options, while less-skilled workers may experience stagnating wages or precarious employment Income inequality induces both social and economic and businesses challenges - Social costs of inequality and wealth disparities → limiting wellbeing and inducing human suffering → social unrest, reduced social mobility, and concentration of political power - Weakens business dynamism, productivity and innovation - Entrenched elite: monopolize opportunities and power, preventing new entrants into business and innovation ecosystems

Product Markets

Buying and selling of finished goods and services. Involves the sale of the goods and services to consumers, businesses, and government entities

What is the role of business in markets

By leveraging the information available in costs, prices, and an understanding of the marketplace, businesses enable the potential benefits of markets to be realized Businesses take advantage of the opportunities available in markets to provide goods and services, to improve goods and services, and to develop new goods and services - In doing this, they are supported by their investors (debt and equity investors) and by various stakeholders who participate (e.g. workers) and are affected by those businesses (e.g. consumers and society) The abilities of markets to achieve effective resource allocation and productive efficiency depends on business, identifying, and achieving market opportunities and engaging in active competition They respond to scientific and technical opportunities, opportunities to develop new markets and improve existing products, to identify and serve existing and new customer needs, to the incentives of their managers and investors, and to the pressure imposed on them by their stakeholders

Addressing Market Power: Encouraging entry and reducing barriers to entry

By lowering regulatory, financial, or technological barriers that prevent new firms from entering a market, governments can foster a more competitive environment - includes: reducing licensing requirements, easing restrictions on foreign competition, or providing incentives for startups - By increasing competition on incumbent (current) firms to lower prices, improve product quality, and innovate - e.g. direct support for small businesses (e.g. via innovation subsidies) or startups can challenge monopolistic or oligopolistic firms, promoting consumer welfare

Karl Marx, Das Kapital

Capitalist markets lead to the exploitation of labor and the concentration of wealth → social and economic inequalities

What are central planning economies?

Central planning and command allocation systems are economic models where a central authority, typically the government, make all decisions about the production, distribution and consumption of goods and services involves setting production targets, controlling prices, and allocating based on a planned economy's goals

Milton Friedman, Capitalism and Freedom

Championed economic freedom and minimal government intervention → markets are the most efficient way to allocate resources and generate wealth

Why markets may fail to emerge or work properly?

Complex matching problems: some markets (e.g. organ donation) require matching based on specific criteria (such as blood type) rather than just price Market friction: barriers like search costs, i.e., finding the right partner, or transaction costs, i.e., making the trade, can prevent markets from functioning Repugnance: some markets fail to emerge because certain types of transactions are considered morally unacceptable e.g. it is illegal to sell human organs because society considers the sale of human body parts to be morally abhorrent Lack of trust or coordination: markets can fail when participants do not trust the system or cannot coordinate effectively

Addressing Market Power: The most drastic tools in antitrust toolkit

Compulsory licensing of technologies, Compulsory divestiture of assets, Wholesale Breakup of existing companies or forced divesture of company assets this is done by agreements between governments and companies, e.g. via "consent decrees" - e.g. 1956 US Department of Justice entered into a famous Consent Decree which required the firm to limit its operations strictly to providing regulated telecommunication services and mandated that it license all of its existing patents to other companies at reasonable fees Compulsory Divestiture: the outcome of attempted mergers - e.g. before 2004 merger of US-based office supply firms, FTC required Staples to sell 63 stores to prevent the combined firm of monopolizing the office supply market The most powerful antitrust tool involves breaking up firms deemed to be monopolies into a set of smaller companies, with the aim of enabling them to compete against each other - e.g. forced breakup of John D. Rockefeller's Standard Oil Monopoly in 1911 and AT&T's long-distance telephone monopoly in the US in 1982 Governments are usually reluctant to undertake such drastic steps and only resort to such approaches when a firm's monopolistic dominance has been demonstrated to cause significant harm to consumers and restricts competition

Effective Markets: Congestion

Congestion making it hard to process all the information or participants. The college application process often faces this problem (information overload)

Positive way firms achieve market power

Creating products so unique, innovative, or valuable to customers that firms are able to achieve sufficiently high market shares that the industry becomes an oligopoly (or monopoly) e.g. Eastman Kodak Company achieved a near monopoly in selling film in the US over the 20th century due to the positive feedback loop between high quality and low cost and the firm's excellent strategy and operations management - obtained product quality and R&D and then took advantage of economies of scale in manufacturing, R&D, distribution, and advertising to achieve simultaneous cost advantages in production and WTP

How did early markets emerge?

Early markets emerged as a solution to the inefficiencies of barter and self-sufficiency in subsistence market Centralized locations introduce a broader pool of participants and make it easier to find trading partners The development of currency as a medium of exchange further simplified transactions by providing a standardized measure of value Markets improved flow of information as traders could learn about prices, demand, and the availability of goods through direct interaction with others Made trade more efficient and became cultural and social centers → led to development of more sophisticated economic systems and extensive trade networks in the ancient world

What are the different types of markets?

Factor Markets Product Markets Matching Markets Platform Markets

How do firms obtain market power?

Firms can achieve market power because of inherent microeconomic features of the industry environment, actions that firms undertake, or as a result of government action can be done via: - economies of scale - start up costs - legal barriers - network effects

How do firms exploit market power?

Firms with market power leverage this power by a) charging prices that are substantially above marginal cost b) achieving a lower quantity of goods and services sold than would be in a market that were more competitive c) investing to a lesser degree in quality and innovation that would be achieved in a more competitive market examples include: - Sugar Trust of 19th century acquiring all sugar refineries and setting prices without fear of competition - American Tobacco Company exploiting market power through predatory practices (built political power to avoid regulations that harmed profitability)

Alvin E. Roth's work examination on why some markets emerge naturally, why others do not, and how careful market design can solve complex problems

For matching markets to work effectively, both sides of the transaction need to find the right fit. Roth's work focuses on these kinds of matching markets, where designing a system that helps participants find the right partner is crucial for the market to function effectively. Markets typically emerge when there is clear demand and few barriers to exchange. If people want to buy and sell something, and it is easy to trade, the market forms naturally (e.g. farmers bringing apples to market to sell to consumers is a simple market that requires little extra design) However, markets that involve matching are more complex because both sides need to find a good fit, and this process can be disorganized without structured system

When should governments attempt to address market power?

Government intervention is generally advised when consumer welfare is harmed by high prices, reduced product quality, or limited choices due to monopolistic or oligopolistic market structures. Government needs to carefully weigh the costs and benefits of intervention, focusing on situations where market failures harm the public and avoid over-regulation where market forces can achieve favorable outcomes.

Governments can support markets by investing in public good and providing infrastructure that complement private investment

Government invest in and maintain this infrastructure to support market activities, reduce transaction costs, and facilitate the flow of goods, services, and information Efficient markets require infrastructure like transportation networks, communicative systems, and utilities → expensive and requires significant fixed costs since investments benefit many firms and many individuals, no single firm or single individual has the incentives to invest in them sufficiently Solution: society as a whole make those investments Public goods: goods and services, like national defense, public health and a national highway system, whose benefits are so diffuse and subject to free-rider problems → private markets would not invest in them

Governments promote financial stability

Government, through central banks and treasury departments, manage monetary and fiscal policies that can stabilize the economy and help avoid economic depressions, currency deflations, and other economic disasters creates a stable environments (without excessive volatility, crises, and systemic failures) in which markets can function smoothly government establish regulations to address market failures, such as monopolies, negative externalities (e.g. pollution), and information asymmetry government oversight needs to ideally be designed to enable markets to support economic exchange while promoting positive social outcomes → regulatory certainty

Markets arising as solutions to coordination problems

Many markets have arisen to solve coordination problems, where the main challenge was connecting buyers and sellers, producers and consumers, or other economic actors in a more efficient manner - e.g. Amsterdam Stock Exchange, est. in 1602, was created to centralize the buying and selling of shares in companies like the Dutch East India Company - e.g. Chicago Board of Trade in 1848 allowed for the trading of futures contracts, where buyers and sellers could agree on the future delivery of crops at a set price → provided price transparency and reduced uncertainty for both producers and traders - Airbnb created a platform that solved this coordination problem by connecting homeowners (hosts) and travelers

What is an efficient market?

Market efficiency is a central concept in economies that refers to how effectively markets allocate resources and process information. An efficient market is one where prices or wages accurately reflect all available information, ensuring that goods, services, and labor are distributed in the most effective way to meet the needs of society → plays a crucial role in guiding economic decisions, influencing investment strategies, and shaping public policy It effectively integrate and process all available information leading to prices, wages, or rents that accurately reflect value of goods, services, or labor in a world of frictionless trade

John Maynard Keynes, General Theory of Employment, Interest, and Money

Markets are always self-correcting, point out that insufficient aggregate demand can lead to prolonged periods of high unemployment and economic instability

Spontaneous Markets -> how can markets arise?

Markets can arise from the opportunity for individuals with resources to exchange them with other individuals who possess other resources Barter systems emerged simply because people had different goods or skills, and trading allowed them to meet their diverse needs Trading relationships were facilitated by specialization, either because certain locations had natural endowments of resources or because individuals, communities, or regions developed specialized skills - Silk Road: vast network of trade routes connecting East Asia, the Middle East, and Europe - Markets along the Silk Road emerged spontaneously because merchants had access to rare goods that were in high demand in distant regions, allowing for free exchanges along trade routes - Hudson's Bay Company (HBC) began building trading posts near what is currently Hudson Bay in the late 1600s, the Cree and some of their traditional allies, including the Assiniboine and Ojibwe, began offering beaver pelts, as well as fox mink, otter, and muskrat, in exchange for metal tools, wool blankets and textiles, tobacco, alcohol, and firearms even in places that one might not imagine markets to emerge, they sometimes do - WWII prisoners of war established markets for food, clothing, and other goods within weeks of being captured Modern economies are also characterized by markets that emerge because individuals both seek and can offer particular items example: informal street markets - (e.g. market in Mumbai, India, each of which is an informal marketplace in which residences and traders sell goods, including spices and jewelry or leather belts, wallets, and jackets

Markets that arise to meet unmet consumer needs and preferences

Markets may arise is to satisfy unmet consumer needs and preference - enterprising individuals or businesses must first recognize that such needs exist or are latent and they must also develop the products or services that consumers value - e.g. the need for financial protection against the many hazards of such journeys led to the emergence of early insurance markets - Lloyd's of London emerged in Edward Lloyd's coffee house. Lloyd's became a hub where merchants, shipowners, and insurers gathered to exchange shipping news and conduct business

Effective Markets: Safety

Markets need to be safe for participants. This means people should feel confident that they won't be manipulated or misled. in some market designs, participants benefit by being honest about their preferences, which leads to better overall outcomes.

Failure to align with ethical concerns in efficient markets

Markets provide incentives to ignore worker safety, degrade the environment, betray their customers' trust, or engage in other unethical practices that lower costs and increase profits - markets can lead to ethical breaches that do not involve specific malfeasance on the part of the business

Institutions support markets

Markets typically require institutional and government support to achieve efficiency - requires a framework of rules, norms, and infrastructure in order to function effectively note: markets do not operate in a vacuum. They require robust institutional framework and active government support to correct market failures, provide public goods, ensure fair competition, and maintain stability without these, markets are prone to inefficiencies, crises, and inequities, which can undermine their effectiveness and sustainability

Monopoly and Oligopoly

Monopoly: where one firm achieves dominant market share in an industry Oligopoly: small number of firms achieve dominant market share in an industry - rule of thumb: if the combined market share of an industry's four largest firms exceed 60%, the industry is likely an oligopoly

Platform Markets

Platform markets involve intermediaries "platforms" that connect multiple parties for the purpose of exchange, including buyers and sellers, drivers and riders, or users and advertisers think of them as a conduit (note: because Amazon stores the products <part of their inventory>, it is a product market) Have to attract various sets of participants (e.g. buyers and sellers) and maintain a structure and set of rules that facilitate market exchange network effects play a role!! ^^ e.g. Apple AppStore, only market places (Amazon and eBay), ride-sharing app Uber

Addressing Market Power: Antitrust Enforcement

Primary tool where governments use competition laws to break up monopolies, prevent anti-competitive mergers, and prosecute firms engaging in price-fixing, collusion, or predatory pricing goal of this is to enable competition which place downward pressure on price and create incentives for increases in product quality + innovation

Prone to instability an market crisis in efficient markets

Prone to speculative bubbles and volatility, which can have a ripple effect on businesses in related and even distant markets - overrate to short-term trends or herd behaviors - require thoughtful inventions and regulations to mitigate their negative effects

Addressing Market Power: Public ownership or provision

Public ownership or provision in sectors where competition is infeasible like essential goods and services like defense, public transportation, or basic healthcare - when private firms fail to provide these critical services efficiently or equitably, market failures occur - public provision ensures that these services remain accessible and affordable for all - state-run enterprises or public funding of essential services, e.g. healthcare systems and public transportation networks, are ways government can step in to guarantee widespread access when the private market falls short

Short Term focus of efficient markets

Publicly-traded firms are regularly scrutinized by analysts and investors who seek increases in market value in the short term → firms make investments that are consistent with short term gains rather than long term gains - stifles long-term innovation, investment in human capital, and sustainability initiatives - leads to instability as more firms become vulnerable to shocks when they sacrifice resilience for short-term gains Firms with greater equity financing may be more subject to short-term pressures to increase market values than those that are financed to a greater extent by debt investors (equity investors have a shorter time horizon over which they would like to maximize firm value)

Less severe competition policy tools: managing the extent of intellectual property

Reforming IP laws, such as shortening patent durations or limiting extensions, help balance innovation incentives with competition, reducing excessive pricing power Three key intellectual property rights are → - Patent: applies to technological innovations - Copyright: creative expressions - Trademarks: branding investments These tools provide temporary monopoly rights over those pieces of intellectual property IP laws create significant market power in some industries, e.g. pharmaceuticals and technologies Intellectual property encourage innovation by granting temporary monopolies - Managing the length of time and the scope of these rights help balance competition and innovation

Characteristics of Inclusive Economic Institutions

Secure property rights: - individuals and businesses can own, transfer, and use property (physical, financial, intellectual) securely without fear of arbitrary seizure Rule of law: - a legal system that applies equally to all individuals, ensuring contracts are enforceable and disputes can be adjudicated fairly Broad access to education and opportunities: - inclusive institutions ensure access to education, healthcare, and infrastructure, enabling individuals to develop productive skills Fair, open, and competitive markets: - barriers to entry for new businesses are low, allowing anyone with ideas and resources to start a business and supporting competition Transparent, informed policy-making and equal treatment by the government: - governments characterized by inclusive economic institutions engage in transparent policy-making processes, based on input from informed experts, and they apply policies equally to all groups without favoritism or corruption

Governments leverage anti-trust policy ("competition policy") to mitigate potential impact of the negative consequences with market power

Sherman Antitrust Act of 1890: prohibits monopolistic practices and restraints on trade Clayton Antitrust Act of 1914: addresses specific practices like price discrimination and mergers that reduce competition

Markets arising from infrastructure investments or public policies

The creation of new physical or digital infrastructure or public policies can also lead to the emergence of new markets by reducing transaction costs and enabling new types of trade or economic activity - e.g. Erie Canal, construction of railroads But while investments create substantial business, economic, and social benefits, they are not without downsides - Erie Canal and network of railroad imposes substantial social and economic costs on North American population Public infrastructure projects continue to lead to the development of modern markets - e.g. China's high-speed rail network has spurred the development of real estate markets, labor markets, and product markets throughout the country - South Korea's investments in national internet structure in the 1990s and early 2000s, including broadband and fiber-optic cables, have contributed to the rapid development of the country's information technology, electronics, and online gaming industries

How to design effective markets

Three key principles that can make markets function more effectively: (1) market thickness (2) market congestion (3) market safety

Matching Markets

Transactions depend not only on prices but also on preferences (a need for each other), compatibility, or other non-price factors, lead both buyers and sellers to be meticulous about matching with each other - e.g. labor markets for specialized skills → employment markets require potential employers to make offers and potential employees to want to accept offers from a particular potential employers - Some matching markets (e.g. employment markets) can be organized by a price mechanism but others are not (e.g. college admissions, physician/medical residencies, and organ transfers)

Examples of Inclusive vs Extractive Institutions Systems

US, northern and western European countries, and Japan have relatively inclusive economic institutions → high levels of innovation, growth, and social well-being Nations with extractive institutions, e.g. North Korea or Venezuela, have less business dynamism and suffer from economic stagnation because wealth and political power are concentrated

What is price?

acts as a signal that conveys information about relative scarcity and value of goods and services coordinates the actions of buyers an sellers, guides their decisions on what to produce, how much to produce, and what to consume price fluctuates based on supply and demand dynamics

The Efficient Market Hypothesis (EMH)

asset prices reflect all available information at all time. Categorized into three forms: - Weak Form Efficiency - Semi-Strong Efficiency - Strong Form Efficiency In an efficient financial market, no investor can consistently outperform the market without additional risk, because all relevant information is fully embedded in asset prices

How do policymakers and economists strive to improve market efficiency?

by addressing the underlying causes of inefficiency → by enhancing transparency, reducing transaction costs, or implementing regulations that mitigate the impact of externalities

Markets encourage competition

consumers can choose freely across many producers, affording them the opportunity to choose among those producers who can offer the best possible products at the best possible prices

Efficient Markets yield an efficient allocation of resources

consumers obtain the goods they want at the prices they are willing to pay for them

Bounded Rationality

criticized the assumption of perfect rationality in market participants, arguing, respectively, that cognitive limitations and innate biases lead to suboptimal decision-making and suboptimal market inefficiencies

Markets support economic freedoms and political freedom

economic freedoms are greater in a market-based system, since a model that utilizes the information inherent in a system of prices and costs is more likely to deliver the goods and services that consumers value than one in which decisions are made by a not-fully-informed group of decision makers however markets promoting economic freedom is more controversial free-market economies allow individuals to make their own choices and pursue their own interests, promoting individual liberty and autonomy free market protect individual liberty and prevent the concentration of economic and political power regulatory capture: businesses are able to control the policy-making mechanism and, thereby, lead governments to make decisions that favor businesses, even at the expense of social welfare

Economies of Scale

exist in industries where the average cost of production declines with as the quantity produces rises (cost advantages that businesses achieve due to increased production. As volume of production grows, the cost per unit decreases ) market powers likely to arise in industries with high barriers to entry economies of scale is a powerful barrier to entry e.g. Consumer products firms: Unilever and Procter & Gamble invest heavily to achieve global economies of scale in marketing and branding, experience economies... firms like Coke and Pepsi invest heavily to achieve global economies of scale in distribution e.g. A car manufacturer producing 1,000 cars a month can buy materials in bulk at a discount and use machinery more efficiently, lowering the cost per car impact: achieving economies of scale can lead to long-term reductions in average cost, making a business more competitive as it grows.

Karl Polanyu, Great Transformation

expansion of market mechanisms can disrupt social structures and degrade the environment → social dislocation and ecological harm introduced double movement: society pushes back against the negative impacts of market expansion through protective regulations and social policies

How can businesses achieve oligopoly outcomes as a result of their own actions? (Negative Ways)

firms can achieve market power via mergers and acquisitions - e.g. John D. Rockefeller employed this to create the Standard Oil Monopoly - e.g. US airline industries were less profitable during period of deregulation in the 1970s and early 2000s but a series of mergers led the US to have an oligopoly of four major airlines (American, Delta, United, and Southwest) "Endogenous sunk costs": investments that help create economies of scale, and hence, barriers to entry - Actions include investments like large factories and substantial infrastructure investments Collusion: firms coordinate or agree, either explicitly or implicitly, to set prices, control output, or divide markets instead of competing against each other - can occur through cartels (formal agreements) or through informal understandings where firms follow each other's pricing or production decisions without direct communication - Wealth of Nations "People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices" achieving control of essential resources - e.g. DeBeers obtained contracts to be the near sole wholesaler for the diamond market for a considerable fraction of the 20th century obtaining favorable regulatory or government support - e.g. British East India Company had a monopoly on trading rights between the UK and the Indian subcontinent for more than 200 years Predatory pricing: setting average prices below average costs in order to drive rivals out of the industry Leveraging network effects that lock in users and lock out potential entrants

Start up Costs

fixed costs associated with entry into the industry or beginning production if this cost is a substantial fraction of the total market size, there may only be room in an industry for a small number of large firms → leads to natural oligopoly e.g. early 1900s, the costs of creating infrastructure to deliver long-term telephone service was so great relative to market size that only a single firm could provide these services at a lower average costs → AT&T and its bell System

Negative consequences of market power include:

higher price lower product quality less quantity sold less innovation outsized political and market influence

Government must enforce contracts

if individuals and businesses do not have confidence that a business contract will be honored or that their enforcement can be guaranteed by a neutral party → they will be unlikely to enter into such agreements → difficult to engage in trade e.g. Grand Inga Dam Project → because of political instability, contractual uncertainty, and questions over land and property, many international partners have wavered in their commitment to the project (esp due to concerns of lack of transparency and enforceability of contracts)

Network Effect

if the value of a product increases with the number of users, potential new entrants will find it difficult to attract customers is a natural barrier to entry

Supports product variety

in competitive markets, differences in consumer preferences allow different types of producers to emerge and flourish supports consumer choice and consumer satisfaction enables flexibility and responsiveness in changes in consumer preferences - markets respond quickly to changes in consumer preferences, technology, and external conditions → prevents shortages and surpluses

Barter Systems

individuals exchanged goods and services directly but inefficient due to "double coincidence of wants"

Markets encourage innovation

leads to innovation even in circumstances in which the identify of leading firms does not turnover struggle to continuously obtain profits in market competition drive firms toward finding ever more efficient means of products → firms that fall behind the frontier in efficient markets are unable to compete profitably markets incentives firms to improve productivity to reduce costs and improve product quality in order to maintain or increase profits leads to regular improvements in production methods, offering better quality products at lower prices, and in introducing new products, new generations of products, and even new industries, all of which leads to greater efficiency, higher productivity growth, and increases in social welfare

Government provide social safety nets

like unemployment benefits, social security, and healthcare, protecting individuals from extreme poverty or market fluctuations stabilize demand and support efficiency by maintaining consumption levels, esp. during business downturns

Pricing System/Standardization/Medium of exchange

makes it easier to assess the value of goods and services or to know where and when to trade → helps match supply and demand

Joseph Stiglitz, Globalization and its discontents

market imperfections can lead to unequal outcomes and exacerbate social inequities, esp. in developing countries

Government should avoid intervention when (market power)

market power is temporary and self-correcting - e.g. in dynamic industries like tech where initial monopolies from innovation are quickly challenged competition is already functioning well market power encourages investment and innovation that benefits consumers if regulatory costs exceed potential benefits

Perfectly Efficient Markets

markets if they achieve Pareto optimally, the condition where no one can be made happier (i.e. achieve higher utility) through market exchanges without someone becoming less happy (i.e. achieving lower utility). - characterized by perfect competition and "zero" profits (profits equal the cost of capital in society) But this is rarely the case due to market failures

Ludwig Von Mises, Human Action

markets provide necessary price signals for efficient resource allocation, which is impossible in socialist system

Where might price not convey value accurately?

markets with less competition or where firms have pricing power like monopolies or differentiated products, prices can be set above the average WTP factors like brand perception and consumer preferences can shape WTP

What are strengths of central planning economies

mobilize resources quickly and direct them toward specific national objectives, such as industrialization, infrastructure development, or military production reduces economic inequality by controlling wages and prices

In an efficient market the price of a good or service or the wage for labor is based on all known factors and..

on world in which all parties could trade with each other without any costs or difficulties - prices quickly and accurately adjust to new information e.g. new info abt a company's financial health, technological advance, or a change in consumer preferences becomes available is immediately reflected in the price of the related assets, goods or services rapid incorporation of info ensures that price serves as an accurate signal to both producers and consumers -> producers make informed decision about where to allocate resources based on prices of inputs + expected returns ; consumers use price signals to make purchasing decisions that align with their preferences and budget constraints

Legal Barriers

patents, copyrights, and government regulations that inhibit new firms from entering the market. Regulations like zoning laws and licensing restrictions control entry into an industry e.g. towns like Concord MA have strict regulations that prevent chain stores from opening restaurants in the town (without long, uncertain, and extremely expensive approval process) thus limiting competition and creating market power for existing restaurants

Extractive Institutions Systems

political and economic power are concentrated in the hands number of elites, often at the expense of broader society subject to the changing whims of those in power and often make decisions not based on economic rationale or the rule of law but based on personal preferences or short-term expediency

Long term success or failure of nation is largely determined by...

presence or absence of inclusive economic and political institutions

Governments ensure that markets are competitive and not dominated by monopolies or cartels

prevent firms from engaging in anti-competitive practices like price-fixing, collusion, and monopolistic behavior, distorting market efficiency and harm consumers

When do prices reflect cost of production? When do they not?

prices generally reflect cost of production but this relationship depends on market conditions In competitive markets, prices tend to be close to the marginal cost of production, as firms compete to offer the lowest price But markets where firms have significant market power like monopolies or oligopolies, prices exceed production costs, allow for higher profit margins Short-term factors like supply chain disruptions or demand spikes can cause temporary deviations from production costs Over the long term, price gravitates towards covering both fixed and variable costs and can be influenced by external factors like taxes, tariffs, and subsidies

EMH: Strong Form Efficiency

prices reflect all information, both public and private. Supposes that even firm insiders, those who have inside information about a firm, cannot consistently achieve excessive returns

EMH: Weak Form Efficiency

prices reflect all past market data, such as stock prices and trading volumes

EMH: Semi-Strong Form Efficiency

prices reflect all publicly available information, including news and financial statements

Markets promote investment, risk-taking, and capital formation

provide a mechanism for individuals and firms to invest in businesses and capital products enables economic growth by funding new ventures, technological advancements, and infrastructure development

Inclusive Economic Institutions

systems and structures within an economy that promote broad participation, opportunity, and protection of individual economic rights for a wide range of people enables markets to function as effectively as possible and to enable countries that possess such institutions to achieve market-led economic growth, social stability, and social welfare

What is market power?

the ability of a firm or a group of firms to influence or control the price, supply, or terms of exchange in a particular market Market power arises when there is a lack of competition allowing one or more firm to behave like "price makers" rather than "price takers" Allows firms to: raise prices above competitive levels reduce the quantity or quality of goods and services without losing substantial customers to competitors

Effective Markets: Market Thickness

the number of buyers and sellers participating in a market. The more buyers and sellers there are, the better the chances of finding a good match

Market Failures

various frictions, such as market power, externalities, and information problems, often prevent markets from being perfectly competitive Market Failure could be in a way that is not especially significant - firms could have limited market power without harming consumers or innovation in substantial ways But... market failures could have significant departures from efficiency with substantial negative implications for consumers and society - e.g. combination of market power and negative externalities in US tobacco industry have resulted in substantial costs to human health and social welfare

Markets enable international trade, the diffusion of technology and economic development

when differences in productivity result in exchange rates, countries that can produce goods at lower cost can effectively trade with countries that produce at higher costs David Ricardo's Principles of Political Economy and Taxation: - countries can trade in ways that benefit both nations if each specializes in its area of comparative advantage, even if one country has absolute advantage in the production of all good

Search Costs

when finding a suitable trading partner requires significant time and effort, making exchange cumbersome and limited

Governments establish and enforce laws that protect property rights, incentivizes investment, innovation, and trade

without clear property rights, risk of theft, expropriation, or fraud would discourage economic activities individuals and businesses are unlikely to make risky investments of capital in ventures that, even if initially successful, have a high chance of being taken away

What are inefficiencies of central planning economies?

without price signals provided by markets, central planners struggle to match supply with demand accurately → leads to shortage of goods and surpluses of others lack of competition and profit motives → low productivity and innovation centralized nature of decision-making → bureaucratic inefficiencies, where decisions are slow and disconnected from the realities of production and consumer needs → misallocation of resources

Gary Becker

work extended economic analysis to various human behaviors, competition influences societal outcomes

Arbitrage

works by exploiting price discrepancies for the same asset across different markets or forms - buy the asset where its price is lower and simultaneously sell it where its price is higher, taking the difference as profit - arbitrage promote market efficiency by making prices reflect the underlying value of the asset - help equalize prices, ensuring the assets are consistently priced according to their intrinsic value