Government Inefficiencies

While market failures can be corrected, in principle, only through some sort of
government action, government intervention does not guarantee a solution nor an
efficient allocation of resources. The reason is that governments are also imperfect.
Governments have their own set of inefficiencies.
A list of government inefficiencies includes:

Voter Apathy: The whole point about efficiency and addressing the
scarcity problem is to get the most satisfaction from available resources.
When people don't vote, leaders don't know what really satisfies the public.

Special Interest Groups: In a related matter, when some people don't

vote, those who do vote have a greater influence over an election. Leaders
seek to provide satisfaction for those special interest groups with the greatest
influence. And such groups do not necessarily promote what is best for the
entire economy.

Re-election Minded Politicians: Leaders who only need to please a

majority of those who vote can largely ignore the interests of others. Once
again, any resulting economic policies are not necessarily in the best interest
of the entire economy.

Complex Bureaucracies: Those who work in the large, complex

bureaucracies that tend to make up governments, might not be held
responsible for their actions, especially those actions that carry out economic
policies. Even the "best" economic policies might not be effectively carried
out by government employees.

Imperfection Information

The lack of information among buyers or sellers often means that the
demand price does not reflect all benefits of a good or the supply price does
not reflect all opportunity costs of production. That is, buyers might be willing
to pay more or less for a good because they don't know the true benefits
generated. Or sellers might be willing to accept more or less for a good than
the true opportunity cost of production.

In many cases, sellers have better information about a good that buyers.
Sellers own and control the good, they have direct contact with the good. If
there are defects or problems with the good, they are likely to know. Buyers,
in contrast, have much less familarity with a good, perhaps only knowing the
information provided by the sellers. In this case, buyers are likely to have a
different demand price than the value of the good produced, a value based
on more complete information.

I will try to give a few different examples of the benefits of monopolies, for example the unit
cost of
A Boeing 747-400 is $228-260 million (2007)
Boeing 747-8 $285.5-300 million (2007)
In 2007, there were orders for only 16 aircraft. Clearly an industry like this is going to have
huge economies of scale. To develop a Boeing 747 is very expensive. The unit cost of over
$200 million dollars means that it would not make sense to have more competition in this
market. If there was competition, then the unit costs would probably increase substantially
making it potentially unprofitable. The Boeing will have various economies of scale such as:

Specialisation
Technical economies
Bulk buying
financial economies
marketing economies

This is an example of a market where firms with monopoly power are likely to lead to lower
average costs and better deals for consumers. In developing the next generation of jumbo
jets, the firms will require huge amounts of investment. This investment is only viable for a
firm with a high market share and large profit.

Why Government Tolerates

Monopolies
1. It is difficult to break up monopolies.
2. Governments can implement regulation of Monopolies e.g. OFWAT regulates
the prices of water companies
3. Monopolies can be more efficient because of the advantages from economies
of scale. This is particularly important for firms operating in a natural
monopoly. For example, it wouldnt make sense to have many small
companies providing tap water. The large scale infrastructure makes it more
efficient to just have 1 firm
4. Firms with monopoly power are not necessarily bad. Google has monopoly
power on search engines but can we say Google is an inefficient firm who
dont seek to innovate?

Definition of Monopoly:
A pure Monopoly is defined as a single seller of a product. i.e. 100% of market

share.

In the UK a firm is said to have monopoly power if it has more than 25% of the
market share. For example, Tesco @30% market share or Google 90% of search engine
traffic.

Monopoly
Definition of Monopoly:

A pure Monopoly is defined as a single seller of a product. i.e. 100% of market

share.

In the UK a firm is said to have monopoly power if it has more than 25% of
the market share. For example, Tesco @30% market share or Google 90% of
search engine traffic.

A monopoly maximises profits where MR=MC. It sets a price of Pm and quantity Qm.
Problems of Monopoly
1. Higher Prices. Firms with monopoly power can set higher prices than in a
competitive market. (Green area is supernormal profit
2. Allocative Inefficiency. A monopoly is allocatively inefficient because in
monopoly the price is greater than MC. (P > MC). In a competitive market the
price would be lower and more consumers would benefit. A monopoly results
in dead-weight welfare loss indicated by the red triangle.
2. Productive Inefficiency A monopoly is productively inefficient because
output does not occur at the lowest point on the AC curve.
2. X Inefficiency. It is argued that a monopoly has less incentive to cut
costs because it doesnt face competition from other firms.Therefore the AC
curve is higher than it should be.
2. Supernormal Profit. A Monopolist makes Supernormal Profit Qm * (AR
AC ) leading to an unequal distribution of income.
2. Higher Prices to suppliers - A monopoly may use its market power and
pay lower prices to its suppliers. E.g. Supermarkets have been criticised for
paying low prices to farmers.
2. Diseconomies of acale - It is possible that if a monopoly gets too big it may
experience diseconomies of scale. higher average costs because it gets too
big.

2. Lack of incentives. A monopoly faces a lack of competition and therefore, it

may have less incentive to work at product innovation and develop better
products.
2. Charge higher prices to suppliers. Monopolies may use their supernormal
profits to charge higher prices to suppliers.

Advantages of Monopoly
1. Economies of scale

If there are significant economies of scale, a monopoly can benefit from lower
average costs. This can lead to lower prices for consumers.

In the above example If there were 3 firms producing 3,000 units at an

average cost of 17, average costs would be higher than a monopoly
producing 10,000 units. Therefore, for natural monopolies and industries with
significant economies of scale, monopolies can be more efficient.

2. Research & Development.

Monopolies make supernormal profit which can be invested in Research &
Development. This is important for industries like medical drugs.
3. A Firm may gain monopoly power because it is the most efficient.
Google gained monopoly power through offering innovative new products. It is hard
to argue google has x-inefficiency because of its monopoly power.

Evaluation of Monopolies

It depends on the industry in question. For example, a monopoly is needed in

a natural monopoly like tap water. However, for restaurants, there are not
significant economies of scale and it is important to have choice. Therefore
monopoly would be very inappropriate for restaurants.

Some industries need a lot of research and development (e.g. building new
aeroplanes, research drugs). Therefore, a monopoly may be needed in this
industry.

A government may be able to regulate monopolies to gain benefits of

economies of scale, without the disadvantages of higher prices.

Monopoly power
A pure monopoly is defined as a single supplier. While there only a few cases of pure
monopoly, monopoly power is much more widespread, and can exist even when there
is more than one supplier such in markets with only two firms, called a duopoly, and a
few firms, an oligopoly.
According to the 1998 Competition Act, abuse of dominant power means that a firm can
'behave independently of competitive pressures'. See Competition Act.
For the purpose of controlling mergers, the UK regulators consider that if two firms
combine to create a market share of 25% or more of a specific market, the merger may
be referred to the Competition Commission, and may be prohibited.
Formation of monopolies
Monopolies are formed under certain conditions, including:
When a firm has exclusive ownership or use of a scarce resource, such as British
Telecom who owns the telephone cabling running into the majority of UK homes and
businesses.
1.

2.

When governments grant a firm monopoly status, such as the Post Office.

When firms have patents or copyright giving them exclusive rights to sell a
product or protect their intellectual property, such as Microsofts Windows brand
name and software contents are protected from unauthorised use.
3.

4.

When firms merge to given them a dominant position in a market.

Breaking Up Existing Monopolies. Relying on the Sherman Act, the government

may sue to break up a corporation that has attained a monopoly or near monopoly
in an industry. In 1911 the government broke up Standard Oil of New Jersey (which
controlled over 90 percent of the refining and sales of petroleum products) into 30
independent corporations. In 1982 AT&T, after being sued by the government,
agreed to be broken into 23 independent local telephone companies. These
operating companies became seven regional phone companies offering local
telephone service. The long-distance service, Western Electric, and Bell Laboratories
were retained in the corporation that kept the name AT&T. Other suits by the
government have been less successful. The courts refused to break up U.S. Steel in
1920 and IBM in 1982. In 2001, the Bush administration abandoned attempts to
break up Microsoft

Unstable markets

Some primary markets can become unstable and require intervention to help them
stabilise. In particular, many food producers suffer three main economic problems:
1. Falling long term income.
2. Unstable prices.
3. Loss of bargaining power to big supermarket chains.
Falling incomes
Farm incomes have fallen in the long term because the supply of food has increased. Supply
has increased for a number of reasons, including:
1.

The greater use of new technology, and better crop yields.

2.
New entrants into the market, such as Vietnam, which entered the coffee market in
the 1980s, have also helped shift the market supply curve to the right.
3.

Loss of power to the big supermarket chains

4.
Loss of power to the big supermarket chains, which means that supermarkets can
dictate terms and prices to farmers. The buying power of supermarkets is referred to
as monopsony power. Farmers are price takers which means they have to accept the price
that the supermarkets dictate, supermarkets are the price makers.
Supply has increased due to the application of more efficient production methods and, in
some cases, new entrants into the market. Demand is relatively price inelastic, hence
revenue falls following the price reduction.
However, demand has not increased in the long run, so revenue (P x Q) falls. In fact, the
demand for some food has fallen over time.

Unstable prices
Many commodity markets exhibit short term instability. Cocoa prices are typical of
many commodity prices, with wild swings in prices.
The cobweb diagram can be used to explain the tendency for price instability of
agricultural products and commodity markets. Initially, we can assume a stable
equilibrium price, followed by a negative supply shock, such as a crop disease, bad
weather, political unrest or a war.
Cobweb diagram
Short run supply (Q1, at S1) ends up significantly less than planned (Q). Price is now
driven up to P1. Next year, planned output rises to Q2, but this drives price down to
P2.

The process continues until the price is so low that producers are driven out of the
market. There is clearly a significant information failure farmers and growers are
not fully aware of the impact of their decisions in one year on the price of products
in the following year.
A cobweb effect can also be triggered by a positive supply shock, such as an
exceptionally good harvest.
Remedies
Buffer stocks
Buffer stocks are stocks of produce which have not yet been taken to market. They
can help stabilise prices by taking surplus output and putting it into a store, or,
with a bad harvest, stock is released from storage.

A target price can be achieved through intervention buying and selling.

Unstable Commodity Markets

This is probably the last market failure you'll look at, and for the time being it's all
quite straightforward. Lets look at agricultural goods and we can start to understand
what can make these markets unstable.
If you read my post on price elasticity of supply, i would have mentioned how
planting and farming goods means supply is price inelastic. What I didn't mention
was the effects that can have on the market.
Because crops take a long time to harvest, if there is an increase in demand,
suppliers might plant more for next year, hoping that demand will stay as high.
However, there's a chance that by the time the crops are ready, the demand has
decrease again, meaning there is a large stock surplus. In order to sell the goods
and reduce the surplus, suppliers must sell at a very low price.
The problem on extreme prices can occur when demand is low. Suppliers might then
plant less, but at the time of harvesting, demand might have increased, creating
excess demand. This would mean suppliers would be able to charge ridiculous high
prices.
The problem is that the two events I've just mentioned can create a vicious spiral
causes prices to fluctuate. This naturally means the market becomes unstable and it
has therefore failed
Data response on coffee and sugar

In May 2009 it was reported that world coffee and sugar prices were expected to
rise sharply because of poor crop levels and rising demand. Rising commodity
prices have been largely unexpected because it was widely predicted that the
global recession would reduce rather than increase prices. In a recession, real
national incomes fall, and this has an effect on personal disposable income and
spending.
International coffee prices hit a 6 month high of $1.28 per pound, a rise of nearly
25% in the last 6 months. The spot price reached a 12 month high at $2.20 a pound.
It was reported that the Columbian crop was particularly affected by very heavy
rains. Rising coffee prices forced some manufacturers to raise the price of their
retail brands by around 20%. Although prices are on the rise analysts predict that
demand is unlikely to fall very much in the short term.
Sugar prices also rose, to their highest levels in around 3 years, up to $450 a tonne.
Analysts believe that the main reason for this rise was a crop failure in India and, as
the worlds biggest consumer of sugar, it increased its imports from the rest of the
world. Changes in Indias output, which is very volatile, are a main cause of
unstable sugar prices worldwide.
Unstable commodity prices are often regarded as a market failure because markets
fail to bring about a stable equilibrium. The main reasons for the instability is that
next years output is based on this years prices, which creates a time lag during
which unexpected supply shocks can dramatically alter the actual amount
produced. Others argue that unstable prices are simply a sign of the price
mechanism at work, sending out signals to consumers and producers, and providing
incentives for them. Other economists see government intervention as government
failure which leads to over-production and surpluses.

Incomplete markets
An incomplete market is one where some of the necessary conditions for market
formation exist, but not all of them. In the case of incomplete markets, some
entrepreneurs may enter the market because profits are possible. However, the
firms that do start-up will only satisfy a small proportion of potential demand. In
these incomplete markets, total supply is insufficient to meet the needs of
consumers. In such cases a market may form, but will fail to develop completely - in
other words it is an incomplete.
There are several examples of incomplete markets, including the markets for quasipublic goods and merit goods.
Quasi public goods

The market for quasi-public goods is an important example of an incomplete

market. A quasi-public good is one that resembles a pure public good, but lacks
some of its characteristics. A free market for pure public goods, like defence, is
unlikely to exist at all, but for quasi-public goods, there is a strong possibility that
free markets would satisfy a part of total demand.
Quasi public goods are:
1. Partly-diminishable, and partly-rivalrous, which means that as quasi public
good is consumed the stock available for others will diminish, but slowly.
Hence some competition between consumers may occur.
2. Partly-excludable, which means once the goods are supplied some consumers
can be excluded from consumption.
3. Rejectable, which means consumers can reject the good, and they are not
forced to consume it.
The example of bridges
Major bridges could be funded by private enterprise because it is possible to
operate a toll system, with barriers, and charge each motorist a crossing fee.
Gradually, the cost of building the bridge would be covered, and eventually a profit
could be made. However, free markets are unlikely to satisfy the need for all river
crossings, because the revenue generated would be insufficient.
Bridges are considered to be quasi public goods because some of the conditions
necessary for market formation exist, but not all.
1. Bridges exhibit some diminishability, so that when drivers go over a bridge
there are reducing the bridge-space for others.
2. Some rivalry exists between users of bridges because they often have to
queue to cross, as there is an excess of demand over supply at the point of
crossing. This indicates scarcity and provides an incentive for firms to
because it creates the possibility charging users.
3. Because the owner of a bridge could put up barriers to stop drivers crossing,
the free-rider problem is solved, and non-payers can be excluded.
4. Crossing a particular bridge to get to a destination can be rejected by drivers,
because they can take another route which avoids any toll charges, hence
bridges exhibit the characteristic of rejectability.