And I have now decided to shut this down more or less permanently. The same sort of discussions will continue here every Friday, though, so feel free to keep reading over there if you wish.
Hope you all had a good time with the stuff here.
Friday, September 28, 2012
Thursday, May 17, 2012
Post Elsewhere
So, I am not moving away from this blog, but I am posting some more technology-related economics things on my company blog. The first of such posts can be found here, if you wish to read it: http://www.clevercloudcomputing.com/wordpress/?p=63.
Enjoy! I'll be back to updating this regularly fairly soon. Not sure how fairly soon, but fairly soon.
Enjoy! I'll be back to updating this regularly fairly soon. Not sure how fairly soon, but fairly soon.
Wednesday, April 11, 2012
Public Goods and Common Property Resources
In this post, I will cover two additional types of problems that the traditional free market structure faces: public good and common property resources. In both cases, the lack of ability to structure ownership in the form or private property prevents efficient allocation of resources.
First, a normal, market good is defined as something that is rival and exclusive; that is, only one person may use it, and the use of one prevents it from being used by others. These goods fall under the sphere of private property for efficient management, as what is essentially described is a good for which the requisites for private property are met: exclusivity, transferability, and enforceability.
A public good is the exact opposite of a normal good - it is non-rival AND non-exclusive. That is, one person using the good does not prevent someone else from using it, and that use does not prevent another person from using the good in the future.
The quintessential example of a public good is the lighthouse. The light from the lighthouse is provided to all and the provision cannot be withheld; moreover, any individual seeing the light does not prevent another individual from seeing the light, as well.
Public goods have a problem that is well understood - free ridership. Since you cannot prevent anyone from gaining access to the benefits of the good, no one is willing to pay for it. This means that the amount of resources allocated to providing a public good will be inefficiently low in a market situation.
To rectify the problem, an outside agency must provide the good and force individuals to pay for it, assuming that they can provide the good without it costing more than the benefits. This outside agency is, invariably, the government, as in many cases. This is why the government provides and maintains things such as lighthouses.
In between public goods and normal goods are common property resources. These goods are rival and non-exclusive. That is, they can be used by anyone, and the use will, eventually, prevent others from using the resource.
The problem commonly associated with common property resources is 'tragedy of the commons,' a phrase coined by Hardin in his paper of the same name. In the paper, he describes a system of common grazing grounds in which each individual herder comes to the rational decision to overgraze, eventually ruining the pasture for everyone.
This decision is reached because the individual herder gains the full benefit of grazing, but shares the cost of grazing with everyone. As such, from the herder's perspective, it is always efficient to graze more.
In essence, this problem causes individuals to utilize a resource to an inefficiently high degree. Put theoretically, individuals aim to use the resource until Net Revenue = Net Cost, rather than Marginal Revenue = Marginal Cost as normal. NR = NC is the point at which zero actual profit is gained, and this is, obviously, an incredibly inefficient allocation of resources.
Fixing the problems associated with common property resources is much more difficult than it is with public goods. There are two broad approaches - regulation from an outside source, and privatization.
Privatization involves changing the common property resource into a normal good. This is done by associating some cost to use the good, thereby changing it from non-exclusive to exclusive. As normal goods co-exist with capitalism in a much more beneficial way than common property goods, this is often the method by which the problem is fixed.
Regulation involves an outside source, again almost invariably the government or a government agency, that comes in and prevents individuals from overusing the resource. This approach is commonly used in the management of fisheries, where the regulatory agency simply prevents individuals from fishing above a certain amount by making it illegal to fish without a permit and strictly regulating the number of available permits.
This approach is largely used when privatization fails to be a realistic option, as the cost of privatizing a common property resource is often unimaginably high.
Two random asides before I wander off to do other things...
First of all, there exists a third sort of good - exclusive, non-rival goods. These are called club goods, and things such as television fall into this category. That is, you can prevent people from watching television, but one person watching television has no impact on the ability of another person to watch television.
Secondly, for those of you more environmentally inclined, the evolution from public good to common property resource is a well documented phenomenon in that area. This evolution occurs as population density increases. That is, as the density of population increases, what was once a public good with non-rival traits becomes a common property resource, with rival traits.
For example, imagine a river. If one person lives on the river and goes to the bathroom in it fairly regularly, there is little impact on the river itself and no other individuals to get upset. This situation occurs even when there are two, or three people living on the river, although perhaps not if they live right next to one another. This is an example of a public good.
However, when you have 10,000 people living on the river, if they all go to the bathroom it suddenly becomes a river of waste that no one wishes to live next to. As a result of the non-exclusive nature of using the river as a waste-removal method, it has been ruined for everyone. This is an example of a common property resource, with the only variable changed being that of population density.
And now I am done. Hopefully this was interesting. I will be moving, fairly soon, the actual finishing article of this series. I believe I have two more topics I want to cover first, and then we will be able to examine when it is that the government should be involved in the economy, what I believe to be a particularly important question.
Comments, suggestions, questions, and insults may all be put down below. In the comments section, not some other definition of down below...
First, a normal, market good is defined as something that is rival and exclusive; that is, only one person may use it, and the use of one prevents it from being used by others. These goods fall under the sphere of private property for efficient management, as what is essentially described is a good for which the requisites for private property are met: exclusivity, transferability, and enforceability.
A public good is the exact opposite of a normal good - it is non-rival AND non-exclusive. That is, one person using the good does not prevent someone else from using it, and that use does not prevent another person from using the good in the future.
The quintessential example of a public good is the lighthouse. The light from the lighthouse is provided to all and the provision cannot be withheld; moreover, any individual seeing the light does not prevent another individual from seeing the light, as well.
Public goods have a problem that is well understood - free ridership. Since you cannot prevent anyone from gaining access to the benefits of the good, no one is willing to pay for it. This means that the amount of resources allocated to providing a public good will be inefficiently low in a market situation.
To rectify the problem, an outside agency must provide the good and force individuals to pay for it, assuming that they can provide the good without it costing more than the benefits. This outside agency is, invariably, the government, as in many cases. This is why the government provides and maintains things such as lighthouses.
In between public goods and normal goods are common property resources. These goods are rival and non-exclusive. That is, they can be used by anyone, and the use will, eventually, prevent others from using the resource.
The problem commonly associated with common property resources is 'tragedy of the commons,' a phrase coined by Hardin in his paper of the same name. In the paper, he describes a system of common grazing grounds in which each individual herder comes to the rational decision to overgraze, eventually ruining the pasture for everyone.
This decision is reached because the individual herder gains the full benefit of grazing, but shares the cost of grazing with everyone. As such, from the herder's perspective, it is always efficient to graze more.
In essence, this problem causes individuals to utilize a resource to an inefficiently high degree. Put theoretically, individuals aim to use the resource until Net Revenue = Net Cost, rather than Marginal Revenue = Marginal Cost as normal. NR = NC is the point at which zero actual profit is gained, and this is, obviously, an incredibly inefficient allocation of resources.
Fixing the problems associated with common property resources is much more difficult than it is with public goods. There are two broad approaches - regulation from an outside source, and privatization.
Privatization involves changing the common property resource into a normal good. This is done by associating some cost to use the good, thereby changing it from non-exclusive to exclusive. As normal goods co-exist with capitalism in a much more beneficial way than common property goods, this is often the method by which the problem is fixed.
Regulation involves an outside source, again almost invariably the government or a government agency, that comes in and prevents individuals from overusing the resource. This approach is commonly used in the management of fisheries, where the regulatory agency simply prevents individuals from fishing above a certain amount by making it illegal to fish without a permit and strictly regulating the number of available permits.
This approach is largely used when privatization fails to be a realistic option, as the cost of privatizing a common property resource is often unimaginably high.
Two random asides before I wander off to do other things...
First of all, there exists a third sort of good - exclusive, non-rival goods. These are called club goods, and things such as television fall into this category. That is, you can prevent people from watching television, but one person watching television has no impact on the ability of another person to watch television.
Secondly, for those of you more environmentally inclined, the evolution from public good to common property resource is a well documented phenomenon in that area. This evolution occurs as population density increases. That is, as the density of population increases, what was once a public good with non-rival traits becomes a common property resource, with rival traits.
For example, imagine a river. If one person lives on the river and goes to the bathroom in it fairly regularly, there is little impact on the river itself and no other individuals to get upset. This situation occurs even when there are two, or three people living on the river, although perhaps not if they live right next to one another. This is an example of a public good.
However, when you have 10,000 people living on the river, if they all go to the bathroom it suddenly becomes a river of waste that no one wishes to live next to. As a result of the non-exclusive nature of using the river as a waste-removal method, it has been ruined for everyone. This is an example of a common property resource, with the only variable changed being that of population density.
And now I am done. Hopefully this was interesting. I will be moving, fairly soon, the actual finishing article of this series. I believe I have two more topics I want to cover first, and then we will be able to examine when it is that the government should be involved in the economy, what I believe to be a particularly important question.
Comments, suggestions, questions, and insults may all be put down below. In the comments section, not some other definition of down below...
Monday, April 2, 2012
Odd Things
So, the service through which I normally get email was transferred to Google recently and, as such, I now have two separate accounts set up to post here. Kind of weird, but it should work out fairly well.
This post is largely to clear up confusion and let anyone who actually checks this regularly that I'll have another post up by Thursday at the latest.
This post is largely to clear up confusion and let anyone who actually checks this regularly that I'll have another post up by Thursday at the latest.
Wednesday, March 28, 2012
Market Equilibrium and Externalities
So, it's been a while since my last post here, for which I apologize. I've been caught up in running my business and getting through to the end of my last semester at college.
Anyways. In my last post I examined the relation between competitiveness in markets and socially optimal market structure. Now I shall be doing the same sort of thing with markets that contain externalities, tossing in market equilibrium and a few other ideas.
First of all, let's get a clear idea of what market equilibrium is. I'm sure most of you know that you can construct supply and demand curves for any market. The demand curve shows how much people are willing to purchase at a particular price, and it decreases as price increases; similarly, the supply curve shows how much the producers in the market are willing to provide at a certain price, and it increases as price increases.
The graph of these curves, which most of you probably already know in a vague sort of sense, looks something like this...
That point where the two lines cross is called market equilibrium. This is the point at which the amount supplied and the amount demanded is equivalent; that is, there is no shortage and no surplus, as are indicated by the B and A quadrants.
More importantly than this, it is generally the case that utility is maximized at equilibrium. This occurs because consumer and producer surplus are maximized. Consumer surplus is the triangle above the blue line and below the green line on the above graph; it represents the utility gained by consumers who would be willing to pay a higher price, but instead only have to pay the equilibrium price. Similarly, producer surplus is the utility gained by producers when they can sell a unit of a good that they would provide at a lower price at a higher price, and is the area above the red line but below the blue one in the above graph.
The total area of consumer and producer surplus is maximized at equilibrium, which you can simply take my word on, work out by moving things around on the graph, or figure out mathematically with integrals or somesuch. For the moment, we will simply move over this point and continue on, with one exception: the loss of surplus as a result of moving away from equilibrium is called dead-weight loss, and will be referred to later.
When a market contains an externality of some type, what is really occurring is a divergence between social and private demand or supply. That is, the fact that the transaction in question has some impact on others is not factored into the demand and supply of individuals, but it is factored into the demand and supply preferred by society.
As an example, the social supply curve for a good whose production involves pollution is lower than the private supply curve, as the cost of the pollution is spread over everyone affected, not only those involved in the transaction. In an unfettered market, the equilibrium reached would then be one of personal utility maximization, as opposed to social utility maximization.
On the graph, this boils down to have two supply curves, rather than one - one social, one private. We can treat the social supply curve as the 'true' demand curve, while the private one is considered to be maladjusted. It can then be said that the equilibrium point created by the private supply curve creates dead-weight loss from the point of view of society, whose supply curve is different. This results in a net loss of utility for society as a whole.
This problem cannot be fixed within the confines of the market.
Let me say that again: the problem cannot be fixed simply by changing the market in some way. The only way to cause a convergence of the social and private supply curves is for some external agency to make it happen, usually through taxation or direct regulation. Regardless, the entity that performs this service in the vast majority of cases is the government.
Externalities then represent one instance in which the market will reach a socially non-optimal equilibrium without some attempt by an outside agency to bring private demand and supply in line with social demand and supply.
And that was significantly easier to write than my last post. Hopefully it was easier to understand, as well, but we shall see. Even more hopefully, I'll probably be back to updating once or twice a week over the next few weeks!
Comments, questions, suggestions, and other nonsense should be left below. I appreciate any feedback you have for me, as this is written for the rest of you just as much as it is for me.
Anyways. In my last post I examined the relation between competitiveness in markets and socially optimal market structure. Now I shall be doing the same sort of thing with markets that contain externalities, tossing in market equilibrium and a few other ideas.
First of all, let's get a clear idea of what market equilibrium is. I'm sure most of you know that you can construct supply and demand curves for any market. The demand curve shows how much people are willing to purchase at a particular price, and it decreases as price increases; similarly, the supply curve shows how much the producers in the market are willing to provide at a certain price, and it increases as price increases.
The graph of these curves, which most of you probably already know in a vague sort of sense, looks something like this...
That point where the two lines cross is called market equilibrium. This is the point at which the amount supplied and the amount demanded is equivalent; that is, there is no shortage and no surplus, as are indicated by the B and A quadrants.
More importantly than this, it is generally the case that utility is maximized at equilibrium. This occurs because consumer and producer surplus are maximized. Consumer surplus is the triangle above the blue line and below the green line on the above graph; it represents the utility gained by consumers who would be willing to pay a higher price, but instead only have to pay the equilibrium price. Similarly, producer surplus is the utility gained by producers when they can sell a unit of a good that they would provide at a lower price at a higher price, and is the area above the red line but below the blue one in the above graph.
The total area of consumer and producer surplus is maximized at equilibrium, which you can simply take my word on, work out by moving things around on the graph, or figure out mathematically with integrals or somesuch. For the moment, we will simply move over this point and continue on, with one exception: the loss of surplus as a result of moving away from equilibrium is called dead-weight loss, and will be referred to later.
When a market contains an externality of some type, what is really occurring is a divergence between social and private demand or supply. That is, the fact that the transaction in question has some impact on others is not factored into the demand and supply of individuals, but it is factored into the demand and supply preferred by society.
As an example, the social supply curve for a good whose production involves pollution is lower than the private supply curve, as the cost of the pollution is spread over everyone affected, not only those involved in the transaction. In an unfettered market, the equilibrium reached would then be one of personal utility maximization, as opposed to social utility maximization.
On the graph, this boils down to have two supply curves, rather than one - one social, one private. We can treat the social supply curve as the 'true' demand curve, while the private one is considered to be maladjusted. It can then be said that the equilibrium point created by the private supply curve creates dead-weight loss from the point of view of society, whose supply curve is different. This results in a net loss of utility for society as a whole.
This problem cannot be fixed within the confines of the market.
Let me say that again: the problem cannot be fixed simply by changing the market in some way. The only way to cause a convergence of the social and private supply curves is for some external agency to make it happen, usually through taxation or direct regulation. Regardless, the entity that performs this service in the vast majority of cases is the government.
Externalities then represent one instance in which the market will reach a socially non-optimal equilibrium without some attempt by an outside agency to bring private demand and supply in line with social demand and supply.
And that was significantly easier to write than my last post. Hopefully it was easier to understand, as well, but we shall see. Even more hopefully, I'll probably be back to updating once or twice a week over the next few weeks!
Comments, questions, suggestions, and other nonsense should be left below. I appreciate any feedback you have for me, as this is written for the rest of you just as much as it is for me.
Thursday, February 23, 2012
Competitiveness in Markets
My last post ended with no real conclusion and only one interesting result, as has been pointed out by multiple people. This post is going to rectify that, as I will begin a discussion as to when competitive markets are desired and when alternatives are actually more useful.
I'm sure some of you are already thinking something involving the idea that a market is always in the best possible condition when it is competitive. However, there are a number of reasons why competitive markets do not always maximize social utility.
The theory of capitalism is ultimately based around a simple principle - voluntary exchange. A voluntary exchange is one in which both parties agree to the exchange. This agreement is made only if both parties believe they benefit from the exchange. As all exchanges in a truly free market are voluntary, every exchange within a truly free market should, ideally, increase the utility of both parties involved.
This, of course, glosses over a trio of important points. First of all, the fact that both parties may not have equivalent knowledge about the exchange. In an instance where knowledge is not distributed equally, it is possible for a voluntary exchange to be one that is not beneficial to both parties.
Secondly, there exist a class of market failure called externalities, as described back towards my first few posts. An externality is a cost or benefit of an exchange that falls upon individuals not directly involved in the exchange.
Pollution is the class example of a negative externality, as the cost of pollution is shared by many individuals not involved in the process of creating pollution or buying the goods manufactured by said process. For positive externalities, higher education is generally used as an example, as many people benefit positively from a more educated populace but have nothing to do with the education process or the positions that are filled because of it.
Third, common property goods and public goods are not allocated properly in a free market. Public goods are non-exclusive and non-rival; that is, someone else's use of a public good does not reduce the amount of it available nor prevent someone else from using it. Common property goods are only non-rival; that is, you cannot prevent someone from using them but the use of the good reduces the amount of it that is available. Lighthouses are an excellent example of public goods, while publicly available. grazing land is the class example of a common property good.
We'll come back to some of these problems later, as my final point in this series of posts will be to determine when markets are performing optimally and how to get them to that point.
For now, let us assume that we are examining a market in which everyone has access to all information and there are no externalities. Moreover, this market is in no way related to a common property or public good.This market obviously does not exist, but these assumptions allow us to ignore some general problems and focus specifically on the competitiveness of the market.
As such, in this market any voluntary exchange will always result in a net benefit for the parties involved. This means that, generally speaking, a market holding to these conditions would provide the greatest benefit to society when the most transactions occur.
In addition, a truly competitive market would offer indistinguishable goods at the same price to all buyers, with the number of firms and buyers being to the point that no single transaction causes a change in price, no matter how large. The more competitive the market, the closer it resembles this model.
Our third and final consideration is that of economies of scale. In a market that possesses economies of scale, it is cheaper to produce goods when you produce a large number then when you produce a small number.
Now, let us examine a market for good N. Let us say that efficient production of N for a single firm falls between A and B. Let us say that there exist M different significant differentiations of good N, and that the demand for each is N1, N2, N3, ... , NM. Finally, let the total demand for N be D.
A voluntary transaction will occur if and only if both parties believe they benefit from the transaction; simply breaking even is not enough, as there is then no motivation to perform the transaction.
Let us say that there exist no significant differentiations for good N. N1 then equals D. If D < A, then either no N is produced or there is significant scarcity rent that drives up the prices for N. If A<D<B, the socially optimal number of firms producing N is one, and will be X if X*A<D<X*B.
In simple terms, the optimal number of firms in this market is the number that produce as close to the total demand for good N while staying mostly within the bounds of efficient production.
This can be extended to markets with differentiation simply by treating each differentiation of N as its own market.This is justified because each significant differentiation of N is more or less attractive to a subset of the individuals who have a desire for N and, as such, the existence of each distinct differentiation increases the possibility for voluntary exchanges.
Treating each as its own market leads us to the same conclusion as when we have no differentiation for each one, so we can simply treat a market with differentiation as a composite of markets without differentiation, with one difference - all goods within a differentiable(This analysis leaves out the idea of rent-seeking behavior, which we will examine at a later point. This behavior sets in through the use of monopoly power to create barriers to entry and other such cases, and significantly changes the solutions given here.)e market provide the same service, and therefore we can substitute between them.
This means that slack from one company can be taken up by another to reduce scarcity rents and still providing opportunities for voluntary exchange.
Still, the same overall conclusion holds, even if the exact numbers are not the same. We will not go through the math here, as it is very long and does not add anything useful in addition to the short mathematical section above.
From here, we can then say that the optimal number of firms and production of firms in the market for N is almost never the same as in the model for a competitive market.
We then conclude that competitive market structures are not always socially optimal.
This is contrary to the beliefs of many people, I'm sure, but I welcome the discussion, controversy or what-have-you.
(This analysis leaves out the idea of rent-seeking behavior, which we will examine at a later point. This behavior sets in through the use of monopoly power to create barriers to entry and other such cases, and significantly changes the solutions given here.)
As I move on from here, I'll be taking time to examine other peculiarities of markets, i.e. several of the things that are assumed to not be present in this examination of competitiveness. I will, hopefully, reach a conclusion as to what can be done to move a market closer to its socially optimal form by the end of the next few posts.
Anyways. Questions, comments, suggestions, complaints, and whatnot are all welcome. Especially suggestions, so I don't run out of things to talk about. Should be able to dump them below fairly easily.
I'm sure some of you are already thinking something involving the idea that a market is always in the best possible condition when it is competitive. However, there are a number of reasons why competitive markets do not always maximize social utility.
The theory of capitalism is ultimately based around a simple principle - voluntary exchange. A voluntary exchange is one in which both parties agree to the exchange. This agreement is made only if both parties believe they benefit from the exchange. As all exchanges in a truly free market are voluntary, every exchange within a truly free market should, ideally, increase the utility of both parties involved.
This, of course, glosses over a trio of important points. First of all, the fact that both parties may not have equivalent knowledge about the exchange. In an instance where knowledge is not distributed equally, it is possible for a voluntary exchange to be one that is not beneficial to both parties.
Secondly, there exist a class of market failure called externalities, as described back towards my first few posts. An externality is a cost or benefit of an exchange that falls upon individuals not directly involved in the exchange.
Pollution is the class example of a negative externality, as the cost of pollution is shared by many individuals not involved in the process of creating pollution or buying the goods manufactured by said process. For positive externalities, higher education is generally used as an example, as many people benefit positively from a more educated populace but have nothing to do with the education process or the positions that are filled because of it.
Third, common property goods and public goods are not allocated properly in a free market. Public goods are non-exclusive and non-rival; that is, someone else's use of a public good does not reduce the amount of it available nor prevent someone else from using it. Common property goods are only non-rival; that is, you cannot prevent someone from using them but the use of the good reduces the amount of it that is available. Lighthouses are an excellent example of public goods, while publicly available. grazing land is the class example of a common property good.
We'll come back to some of these problems later, as my final point in this series of posts will be to determine when markets are performing optimally and how to get them to that point.
For now, let us assume that we are examining a market in which everyone has access to all information and there are no externalities. Moreover, this market is in no way related to a common property or public good.This market obviously does not exist, but these assumptions allow us to ignore some general problems and focus specifically on the competitiveness of the market.
As such, in this market any voluntary exchange will always result in a net benefit for the parties involved. This means that, generally speaking, a market holding to these conditions would provide the greatest benefit to society when the most transactions occur.
In addition, a truly competitive market would offer indistinguishable goods at the same price to all buyers, with the number of firms and buyers being to the point that no single transaction causes a change in price, no matter how large. The more competitive the market, the closer it resembles this model.
Our third and final consideration is that of economies of scale. In a market that possesses economies of scale, it is cheaper to produce goods when you produce a large number then when you produce a small number.
Now, let us examine a market for good N. Let us say that efficient production of N for a single firm falls between A and B. Let us say that there exist M different significant differentiations of good N, and that the demand for each is N1, N2, N3, ... , NM. Finally, let the total demand for N be D.
A voluntary transaction will occur if and only if both parties believe they benefit from the transaction; simply breaking even is not enough, as there is then no motivation to perform the transaction.
Let us say that there exist no significant differentiations for good N. N1 then equals D. If D < A, then either no N is produced or there is significant scarcity rent that drives up the prices for N. If A<D<B, the socially optimal number of firms producing N is one, and will be X if X*A<D<X*B.
In simple terms, the optimal number of firms in this market is the number that produce as close to the total demand for good N while staying mostly within the bounds of efficient production.
This can be extended to markets with differentiation simply by treating each differentiation of N as its own market.This is justified because each significant differentiation of N is more or less attractive to a subset of the individuals who have a desire for N and, as such, the existence of each distinct differentiation increases the possibility for voluntary exchanges.
Treating each as its own market leads us to the same conclusion as when we have no differentiation for each one, so we can simply treat a market with differentiation as a composite of markets without differentiation, with one difference - all goods within a differentiable(This analysis leaves out the idea of rent-seeking behavior, which we will examine at a later point. This behavior sets in through the use of monopoly power to create barriers to entry and other such cases, and significantly changes the solutions given here.)e market provide the same service, and therefore we can substitute between them.
This means that slack from one company can be taken up by another to reduce scarcity rents and still providing opportunities for voluntary exchange.
Still, the same overall conclusion holds, even if the exact numbers are not the same. We will not go through the math here, as it is very long and does not add anything useful in addition to the short mathematical section above.
From here, we can then say that the optimal number of firms and production of firms in the market for N is almost never the same as in the model for a competitive market.
We then conclude that competitive market structures are not always socially optimal.
This is contrary to the beliefs of many people, I'm sure, but I welcome the discussion, controversy or what-have-you.
(This analysis leaves out the idea of rent-seeking behavior, which we will examine at a later point. This behavior sets in through the use of monopoly power to create barriers to entry and other such cases, and significantly changes the solutions given here.)
As I move on from here, I'll be taking time to examine other peculiarities of markets, i.e. several of the things that are assumed to not be present in this examination of competitiveness. I will, hopefully, reach a conclusion as to what can be done to move a market closer to its socially optimal form by the end of the next few posts.
Anyways. Questions, comments, suggestions, complaints, and whatnot are all welcome. Especially suggestions, so I don't run out of things to talk about. Should be able to dump them below fairly easily.
Saturday, February 18, 2012
Non-Competitive Markets
This post is inspired by one of my friends, who asked me why it is that banks require you to pay fees and all sorts of other things, while credit unions generally do not.
Now, I'm not an expert when it comes to banks and other financial institutions. That's not what I'm interested in. However, I know the signs of a market that is not competitive when I see them. Or, at least, assuming that the above statement is correct and the services provided by a bank and a credit union are substitutes, the overall market is not competitive one.
Hence, this post is going to talk about what causes a market to become not competitive. Fairly soon I'll also have a post up talking about whether or not a non-competitive market is necessarily a bad thing, but for the moment we will leave issues of social surplus and equity in our other pants.
A market in perfect competition is the economic version of a perfect gas. That is, it doesn't exist, but it has a lot of nice properties that are theoretically important. Perfectly competitive markets have a large number of buyers and sellers, and all goods in the market are perfect substitutes for one another. No business makes a profit, and social surplus is maximized. There are a number of other minor and major theoretical details that aren't particularly important here.
What is important is to understand the criteria that define a competitive market. First, goods should be perfect substitutes. The further from perfect substitutes goods in the same market are, the less competitive the market is as a whole. The most important case in which goods are not substitutes is when product differentiation occurs, usually in the case of certain goods being better or worse. Brands and brand loyalty are also a good example of this.
The second condition is that there must be a large number of buyers and sellers. The obvious opposite case is a monopoly, a market with only one seller. There are also monopsonies, markets with only one buyer. Both show how important this particular condition is for determining if a market is competitive.
Non-competitive markets come into existence because businesses want to make a profit. In a truly competitive market, no profits are made. Again, many theoretical reasons that we will skip here, but the main important one is that, as a result of the large number of buyers and sellers and lack of product differentiation, no business can sell a good at anything more than cost without having zero customers.
Transitions from competitive to non-competitive occur, then, because businesses want to make money which, I think, is a fact we can all agree on. They go about doing this in many different ways, but they are all aimed at either positive differentiation of their own product or reducing the number of other businesses in the market.
Regardless, it can then be said that the inexorable profit seeking activity of business people is what causes a market to become less competitive, something I think some of you will find quite surprising.
Anyways. Some further examination of competition will be in order later this week. Questions, comments, suggestions, and your least favorite word in the English language can all be left in the comments section if you so wish.
Now, I'm not an expert when it comes to banks and other financial institutions. That's not what I'm interested in. However, I know the signs of a market that is not competitive when I see them. Or, at least, assuming that the above statement is correct and the services provided by a bank and a credit union are substitutes, the overall market is not competitive one.
Hence, this post is going to talk about what causes a market to become not competitive. Fairly soon I'll also have a post up talking about whether or not a non-competitive market is necessarily a bad thing, but for the moment we will leave issues of social surplus and equity in our other pants.
A market in perfect competition is the economic version of a perfect gas. That is, it doesn't exist, but it has a lot of nice properties that are theoretically important. Perfectly competitive markets have a large number of buyers and sellers, and all goods in the market are perfect substitutes for one another. No business makes a profit, and social surplus is maximized. There are a number of other minor and major theoretical details that aren't particularly important here.
What is important is to understand the criteria that define a competitive market. First, goods should be perfect substitutes. The further from perfect substitutes goods in the same market are, the less competitive the market is as a whole. The most important case in which goods are not substitutes is when product differentiation occurs, usually in the case of certain goods being better or worse. Brands and brand loyalty are also a good example of this.
The second condition is that there must be a large number of buyers and sellers. The obvious opposite case is a monopoly, a market with only one seller. There are also monopsonies, markets with only one buyer. Both show how important this particular condition is for determining if a market is competitive.
Non-competitive markets come into existence because businesses want to make a profit. In a truly competitive market, no profits are made. Again, many theoretical reasons that we will skip here, but the main important one is that, as a result of the large number of buyers and sellers and lack of product differentiation, no business can sell a good at anything more than cost without having zero customers.
Transitions from competitive to non-competitive occur, then, because businesses want to make money which, I think, is a fact we can all agree on. They go about doing this in many different ways, but they are all aimed at either positive differentiation of their own product or reducing the number of other businesses in the market.
Regardless, it can then be said that the inexorable profit seeking activity of business people is what causes a market to become less competitive, something I think some of you will find quite surprising.
Anyways. Some further examination of competition will be in order later this week. Questions, comments, suggestions, and your least favorite word in the English language can all be left in the comments section if you so wish.
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