Man this semester is flying by! Yesterday we discussed different ways in which prices "fail" and we talked about why prices fail.
Recall that prices coordinate information. Specifically prices, when working properly, will accurately reflect without any work on our part the relative scarcity of different items so that we can accurately weigh the costs/benefits and tradeoffs of different decisions. In cases like monopoly it's not the high prices that are really the problem...the problem is that the high prices reflect a scarcity that does not truly exist thus creating an inefficiency (we have too few transactions). This is the same reason that price controls are so bad...they also create an artificial surplus, at least in the case of price ceilings that we have talked about.
All of these cases are failures from an economists point of view because scarce resources with alternative uses are being kept from being used or produced how they ought to be.
On lesson 11 we talked about asymetric information as one example and yesterday we talked about monopolies. Other market failures similarly result in prices that don't acurately reflect the information they ought to and like the used-car case there are often various potential solutions. We need to be aware of how different solutions will actually get at the root problem. So we could set a price ceiling to keep a monopolist from "overcharging" but what effect might a price ceiling have on a business' production?
As for monopolies, it is hard to have a monopoly if:
Two cadets conspire and cheat on a test and their teacher brings them up for an honor hit. Each cadet knows that if they both don't talk they'll will fail the class but get no honor probation. However, if one of them talks, the one who talks will have to redo the assignment while the other will be disenrolled. If both talk they'll each redo the assignment but receive honor probation. What is the best outcome for the cadets? What do you think will happen?
Recall that prices coordinate information. Specifically prices, when working properly, will accurately reflect without any work on our part the relative scarcity of different items so that we can accurately weigh the costs/benefits and tradeoffs of different decisions. In cases like monopoly it's not the high prices that are really the problem...the problem is that the high prices reflect a scarcity that does not truly exist thus creating an inefficiency (we have too few transactions). This is the same reason that price controls are so bad...they also create an artificial surplus, at least in the case of price ceilings that we have talked about.
All of these cases are failures from an economists point of view because scarce resources with alternative uses are being kept from being used or produced how they ought to be.
On lesson 11 we talked about asymetric information as one example and yesterday we talked about monopolies. Other market failures similarly result in prices that don't acurately reflect the information they ought to and like the used-car case there are often various potential solutions. We need to be aware of how different solutions will actually get at the root problem. So we could set a price ceiling to keep a monopolist from "overcharging" but what effect might a price ceiling have on a business' production?
As for monopolies, it is hard to have a monopoly if:
- consumers can turn to other products if you prices are too high (there are close substitutes)
- for example it would be really hard to have a monopoly on apples because even if you owned all the apple farms in the world you still have to compete with oranges
- another way of saying this is that the product has to be unique in quality (think water)
- consumers can turn to other firms that is you can't have a monopoly if there is more than one company
- a prospector could start up a new firm in your industry relatively cheaply and easily
- the easier it is for someone to enter the business the harder it will be to raise prices so that you can raise profits.
- so if you are a corn "monopolist" and raise prices so that you have large profits what will happen? probably, wheat farmers will start planting corn since it's cheap to switch so that quantity supplied will again increase and prices will decrease thus leaving the monopolist right back where he/she started.
- on the other hand if you are a monopolist of electricity and you raise prices there is a large cost for someone else to come into the market. Just to get started a new company would have to lay miles of utility lines. This is an expensive endeavor! You'd have to believe that your profit margin would be extremely large and large for a long time to even attempt to challenge the current provider of electricity.
Two cadets conspire and cheat on a test and their teacher brings them up for an honor hit. Each cadet knows that if they both don't talk they'll will fail the class but get no honor probation. However, if one of them talks, the one who talks will have to redo the assignment while the other will be disenrolled. If both talk they'll each redo the assignment but receive honor probation. What is the best outcome for the cadets? What do you think will happen?
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