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however, because the economy is large and supphes companies to place their vending macli i nes in public ot resou ices are fbi usually-control led hr one owner. schools. In each case, a single firm has a monopoly in that particular market. Govcrn,ne,,(—created monopolies. Government- Licenses. A license isa legal permit to operate a created monopolies are formed when the govern business or enter a market. In some cases, licenses ment grants a single tirm or individual the exclusive can create monopolies. For example, a state might right to provide a good or service. The government grant a license to one company to conduct all vehicle does this when it considers such monopolies to be in emissions tests in a particular town. Or a city might the public interest. Government-created monopolies license a parking lot company to provide all the pub may be formed in three wars. lie parking in the city. licenses ensure that certain Patents and copi’ri,glits. Ihese legal grants are goods and services are provided in an efficient and designed to protect and promote intellectual capital. regulated way. lhev give inventors or creators the right to control the production, sale, and distribution of their work, Natural monopolies. The third type of monopoly is thus creating a temporary monopoly over that work. a natural monopoly. This kind of monopoly arises For example, a patent issued to a pharmaceutical when a single firm can supply a good or service more company gives that company the sole right to pro efficiently and at a lower cost than two or more com duce and sell a particular drug for a period of peting firms can. For example, most utility industries 20 years. Such patents encourage investment in are natural monopolies. They provide gas, water, and research and development. In the same way, a electricity, as well as cable TV services, to businesses copyright grants exclusive rights to an artist, writer, and households. Because natural monopolies are ef or composer to control a creative work, such a•sa ficient, governments tend to view them as beneficial. painting, a novel, or a song. for a period of time. A natural monopoly occurs when a producer can Public /*anchises. A public franchise is a contract take advantage of economies of scale to dominate issued by a government entity that gives a firm the the market. The term economies of scale refers to sole right to provide a good or service in a certain the greater efficiency and cost savings that result area. For example, the National Park Service issues from increased production. A firm that achieves public franchises to companies to provide food, economies of scale lowers its average cost per unit of lodging, and other services in national parks. School production by increasing its output and spreading districts may issue public franchises to snack food fixed costs over a larger quantity of goods.
Grand Canyon Lodges inthe Grand Canyon National Park is a public franchise. Its contract with the government gives it a monopolyon lodging,dining,trans portation, and other amenities inthe park.
(Thupler 7 Market Structures and Market Failures 125
126
potential
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up
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127
it
128
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Markets?
a
products.
clothing
Producers,
similar
like
their
Competition,
restaurant,
most
oligopoly
and
on
company
competitive
falls
act
nuniber
Differentiated
OPEC
shoe
of
of
display,
market
monopoly.
Many
often
much
end
oligopolies
Examples
monopolis hut
between
store,
corn-
store,
work
producers
under
com
of
varied.
of
buy in
has
end
like
made
power
products
you
include
of
a
the
spectrum.
the
engage
Differentiated
ness.
Many
kets
many
characteristics.
it
and
in
can
In
company
the
customers
are
is
would
industry
number of
cause
in
Each
marked
l’herefore,
also
shoe,
that
service
effect,
perfect
Monopolistic style,
Monopolistic
‘tou
favored
distinct
supermarkets.
charge
have
The
restaurants
producers.
has
exists
of
in
It
the
book, be
might
is
color,
these
of
its
product
same the
is
many
industries,
over
called
worked
a
goods
competition.
may
more
market
shoe
neither
the
company
shoes
enough
and
in
company
products.
differences,
material,
all
well
many
is
restaurant shoe
develop
producers
monopolistic.
producers
compete
competition for
offered
Monopolist
true
with
with
others.
differentiation,
to
But
a
wonder
to
such
it.
make
industry
monopoly
manufacturing
some
many
for
as
appear
“monopolizes”
its
or
brand
Firms
At
by
industries.
our
Such
gas
as
own
with
shoes
quality
producers
its
or
degree
indicates
why
the
the
banks,
ica
shoe
stations
line
sellers.
is
does
unique.
customer
in
The brand,
loyalty,
one
same
competing
share
Ily nor
especially
a
are
this
of
market
of
example
which
of
competitive
another
auto
main
not
an
not
construction.
shoes
that
industries.
market
In
competitive time,
Less
and
type
four
As
its or
oligopoly.
favoring
fit
commodities.
repair
a
loyalty
means
trade
brand reason
a the
like
big
hotels.
the
common
of
distinctive
basic
indicates,
brands
the
result,
for
power.
market
Shoe
city,
this
model
shops,
busi
name.
sheer
mar
they and
gives
one
Be
p. I seek
fairly those a A the Few low
allows the profit. entrepreneur be enough
Some their
prices are However, brand.
price
To Increasing Nonprice listically consideration. pizza to ?etition,
customer
able
other,
attract custom
in
compete to close
barriers
close ot
brands,
leadership control
monopolist
distinguish
many For
stand
rise
to
other In
shirts
but substitutes,
competitive
open
because using
addition,
example, substitutes
customers. Competition
too
T-shirt may
Market
firms to and
with either
they
with
firms, over
to
much,
entry.
a But
product
have
or make
a shop
icallv
also
prices.
rival their products
a
to taco
business.
will they collusion
there
Share it even
good
a this enter
Start-up customers for
does
By markets
have or
taste
a
firms, stand provide competitive goods
differentiation
also
profit.
create one convincing
when
are Because market
set
Through
the
not
some
from for
That
engage
of to too
another.
both
and
producers costs
have market
cost
one those
T-shirt be a a
may
many control
Web power different suitable
means
producers
feasible. services
offer
type
much
to are
markets.
in
consumers
shift products
For
take site and
and
nonprice
designs
producers
relatively
is fast
of
over
that
in
lunch.
to
limited. example,
and to
producers
advertising earn food
from
price
monopo
foods. get
control
another
This
prices. an
are
sell
may
a over into
that corn
into
for
If
their
to of
factors. Physical
of products
petitors a
may materials. of
Service.
example, others both
offer also services, department sistants
are enhanced Location.
based other
basic
pair
total increase
their
price.
Nonprice
brand
willing
not
offers
offer
their
of
product
businesses
and sales
on
unique
because
characteristics. Chapter Some running consider to
that
such
a
A location.
their is
food,
Gas services table customers
help fast can
to
in
consumer
competition better
stores
consumers
pay producers
as a
or
physical
stations, food therefore
7
customers
firm’s
of
service, market. but
Market food
shoes
buying
service, may
for
the than
provide
Although may
the
chain
them. free
compete delivery shoe’s market
who
may
characteristics. Sinictures
others,
more dry There
appeal
Upscale
will
charge offer any
typically
a
food
and
make
firm
personal
likes
cleaners,
stand
In nonpnce petitive attract supermarket
apart ganic by
an
unique
pay other
they
expensive
better monopohsticaby
are share,
a these selling
and eco-friendly
to with samples
higher
may
and sit-down
grocery that
selections.
more from
foods
consumers
out many
offer focuses
customers,
pair, markets,
catering.
Market
compettion
design, producers
one
shopping service
natural
win
motels, or particular
the
from
and
for
prices.
For
sets
the
restaurant
or regardless proportion
kinds
another
competition
stores
customers
restaurant image.
on projecting because
Failures
firms
special
example, and
same itselt its
Such
color, than
This
com
Some
and
who tour
For
com of as
10
hope or
may use
shoe
or
131
132
imperfect
market
As
II
market in
ers
established
might
though
may
similar
may
example,
“natural,”
One
on
Status
or
because
• others
Externalities,
Positive Unit
ads,
our
7.6
Externalities
from
Factory
often
These
Immunizations
some
the
willingly
have
brand 2
survey be
Market
structures
their
negative.
share.
and
basis
illness.
I- low
bag
a
provide
competition. it
other
had
similar
perceived
and
a
greater
or
is
through
handbag
may
image.
Markets from
main
of
or
located
of
for
more
Negative
pay
convenient
spillover their
Failures:
provide
market
be
product
much
inlormation
is
a
fall
status
goal
and
more
a
discount
Sometimes
Work
regarded
lashionable
status
advertising.
negative
perceived
near
from
into
Because
is
a
effects
Externalities less
Public
structures
in
positive
frr
to
without
the
a
differences
What spot.
a
an
money.
increase
highway.
externality.
designer
customer’s
store.
as
broad
of
about
expensive
companies
status
these
more
externality.
production than
Goods?
Although
Are
the
Another
shows,
category
their
their
structures
a
another.
exclusive,
or
jeans,
designer
are
It
shopping
imposes
eyes
trendiness.
boutique
products
usually
sales
or
most
They
compete
advertis
customer
consumption,
even
than
of
For
protect
a
label
and
more
cost
mall,
a
on
the
people
come
run
spillover
whether
fact,
keeps
same
results
community—not
if
people
a
forms.
suiting
nalities
the
sumption
An
Externalities:
goods
economic
ficient
do
But
river
a
Now
by
Externalities
neighbor
other
producer
in
not
externality
it
imperlect
neighbor
you
many
is
a
and
please
who
When
are
from
way,
as
allocate
consider
firm you
than
effects. an
up
spillover
that
also
inefficiency.
forms—some
the
externality
live
like
the
economists
the
at
plants
that
you,
or
a
just
has
holds Costs
polluted
competition
evidence
night, factory
producer
downstream,
is
Suppose
goods
consumer.
actions
it
occur
a
we
the
a
that
or
consequences
more
effects,
a
side
a
and
will
not.
recipients— new
that
party
and
is
if
dumps
in
positive,
and
water
Externalities
of
effect
call
complicated
of
you
also
that
Benefits
call
many
flower
is
companies
either
consumer.
services
market
You
is
with
an
them
hear
that
an
a
Acme
affects
not
chemical
of
corn
externality,
ways might
for
externality.
costs
garden
production
loud
the
is
the
That
market
failure.
people in
an
Corn
syrup
the
and
and
or
example
only
music
or
the
think
music
externality.
Spill
waste
individuals,
and
health
benefits,
public
take
failures.
Syrup most
other form
factory,
too.
at
If
of
Over
the
that
or
into
mans’
of
that
all,
exter
of ef
In
con—
ol
than re- Company, produces an unpleasant odor. Every’day that odor drifts into a nearby neighborhood. The odor is an externality by itself, but it has other side ciled s as ‘ell. Because of the smell, Some people in the area decide to sell their homes, The odor is SC) bad, however, that no one wants to buy the houses. As a result, housing prices fall. An economist would consider the decline in prop erty values around the factory to be a cost of corn syrup production, but it is not a cost paid by Acme Corn Srup Company. Rather, this cost is external to the company and is borne by homeowners in the comnumnity. ‘l’hatexternal cost is an externality. ‘l’here are two types of externalities: negative a positive. A negative externality is a cost that falls on someone other than the producer or consumer. This cost may’be monetary, but it may also simply be an undesired effect. Most of the examples discussed above are negative externalities. “4 A positive externality, on the other hand, is a A college education is a good example of a positive externality. Each individual’sconsumption of a good—inthis case, higher benefit that falls on someone other than the producer education—will create a benefit for society inthe form of a or consumer. If you enjoy hearing the music from more productive workforce. a neighborhood party, that spillover sound is a posi tive externality’. Other examples include the broader benefits of getting an education or developing a less- consumers into the model of supply and demand. polluting car. Students who get a college education To understand what this means, consider the benefit directly’ by getting higher-paving jobs. But if case of negative externalities generated by our imag their success also results in greater economic pros inary corn syrup company. When Acme produces perity’ for their communities, that is a positive exter corn syrup, it incurs a private cost. This private cost, nality. In the same way, if a car company designs a however, does not take into account the external cost new car that emits fewer pollutants, the company paid by others as a result of Acme’s pollution. may benefit from increased sales. But society ben If Acme were to factor in this external cost, its efits, too, as a result of reduced air pollution. total cost of production would increase. To make up Another type of positive externality is known as for this extra cost, Acme would have to increase the a technology spillover. The benefit from a technol price of corn syrup. In response to a price increase, ogy spillover results when technical knowledge the quantity of corn syrup demanded would most spreads from one company or individual to another, likely decrease. Acme would then have to lower its thereby promoting further innovations. For exam output to match the shrinking demand. ple, other car companies might expand on the less- The fact that these changes in price and quantity polluting car design to make additional improvements demanded do not occur under ideal market condi in pollution control. Those improvements are a tions is a sign that the market is not working effi technology spillover. ciently. The result is that goods that generate nega tive externalities tend to be overproduced, because How Externalities Reflect Inefficiency their full cost is not reflected in the market price. Although positive and negative externalities have The reverse is true of goods and services that very different results, they are both examples of inef generate positive externalities. They tend to be ficiency and market failure. That is because they fail underproduced relative to their benefits. Consider a to factor all costs of production and all benefits to beekeeper who sells honey for a living. The money
Chapter 7 _WarketStructures and Market Failures 133 Private and Public Goods Private goods, which are provided by the market system, differ intwo keyways from public goods, which are generally provided by governments.
Private Goods Public Goods Availableonly Availableto to purchasers everyone
(excludable) nonexcIudable)
Consumption Consumptionby byone person one person does prevents another not prevent another fromconsuming fromconsuming (rival in consumption) (nonrival in consumption) I
she makes from her business is her private benefit. Examples of public goods include fire and police The beekeepefs neighbors, however, receive an ex services, national defense, and public parks. Public ternal benefit when her bees pollinate their flowers goods are the opposite of private goods, or goods and fruit trees at no cost. Ihev may wish that she and services that are sold in markets. would double her number of hives. But unless the Economists make two key distinctions between beekeeper can reap a private benefit from doinp so, public and private goods. First, private goodsaie she is unlikely to expand her business no matter how excludable. This means that anyone who does not much it might benefit her neighbors. pay for the good can be excluded from using it. A grocery store, for example, will sell apples only to cus The Problem of Public Goods tomers willing to pay for them. Public goods, on the Another example of market failure involves public other hand, are nonexciudable. Think of streetlights. goods—goods and services that are not provided How could you prevent some people from using the by the market system because of the difficulty of light from streetlights? You could not. This makes getting people who use them to pay for their use. them nonexcludable.
A Fourth of July fireworks show put on by a cityis an example of a public good. The city could make the show a private good by setting up a fence and selling tickets, but it could not prevent “free riders” from watching the show from outside the gates.
134 Unit 2 How ,‘vtarketsO,ork Second, private goods are said to be rival in this situation the free-rider problem. If streetlights consumption, which means that a good cannot be were a private good, for example. the company that consumed by more than one person at the same time. provided them would want to charge the people Thus, for exanple. if you buy an apple and eat it, that who use them. But street lighting is not excludable. apple is no longer available for anyone else to eat. In Anyone who passes under a streetlight can take a contrast, public goods are nonrival in consumption. “free ride” by using the light and not paying for it. One person’suse of a streetlight’sglow does not dimin Because of these free riders, no private business will ish another’s ability to use its light as well. provide street lighting. ‘l’heresult, from the point ol Based on these two characteristics, you can see view of economists, is a market failure. why parks and sidewalks are considered public goods. Externalities and public goods remind us that No one can be excluded from using them, and anyone markets do not always work perfectly. As a matter of can enjoy their benefits without depriving anyone else. fact, they do not work perfectly much of the time. Private firms do not provide us with these public However, this does not mean that the market system goods for a simple reason; they have no way to is fatally flawed. Despite its weaknesses, the market make the people who benefit from nonrival and system is still the most effective, efficient, and flexible nonexcludable goods pay for them. Economists call way br all of us to get the things we want and need.
There arc four basic market structures, each with different charactei istics. Because only one of these structures is perfectly competitive, economists classify the other three as examples of imperfect competition and, therefore, as market failures. What is perfect competition, and why do economists like it so much? Perfect competition is the most efficient and competitive market structure. it consists of many producers who provide identical goods. usually referred to as commodities. Prices are established by the interaction of supply and demand.
What is a monopoly,and why are some monopolies legal? A monopoh is the opposite of perfect competition. In a monopoly, a single producer provides a unique product and therefore has significant control over prices. Ihe government permits certain kinds of monopolies to exist because they are believed to serve the public interest. What is an oligopoly,and how does it limit competition? An oligopoly is a market domi nated b} a small number of producers who provide similar, but not identical, goods. Firms in an oligopoly often set prices based on other firms’ pricing decisions. Because oligopolies can dominate markets, their effect may be much like that of a monopoly. What is monopolistic competition, and how does it affect markets? Monopolistic com petition is a market in which many producers provide a variety of similar goods. Such markets are characterized by the use of nonprice competition to differentiate products and
build brand loyalty. b the extent that firms “monopolize” their own brands, they may ha.e some control over prices, but such markets remain relatively competitive. Marketfailures: What are externalities and public goods? Externalities are side effects
of produc consumption. They i positive or negative. c goods are goods C that are r r all people to coi- - ether or not those r - the goods. Exterr c goods “‘‘ f market f&
Chapter 7 Market Structures aud Market Failures 135 ThePowerto Choose
GlobalWarming:A Real Solution
by Robert F.KennedyJr., and skylights that cut utility Rolling Stone, June 18,2007 bills by up to 570,000 pci store.
Global warming may be the In early May 200, ], 100 ol’the 11w company, which oper ultimate negative externality. hit i( ins 0 p bu siness leaders ates the nat ion’s Second - Iarest
Most scientists agree that fos iat hered loi a sum init at a pi i— corpoi ate truck fleet, also saved sil fuel emissions are heating vale resort nest led on 2.() aeres s22 million last year just by up the planet to a dangerous in ( aliloriiia’s Napa Valley. 11w installing auxiliary powei units degree. Experts are divided, attendees, iat hered at the invi that allmv drivers to opeiite however, on what to do about tat ion of SiIicon \ a11evventuie electric systems without idling it. As you read this article, ask capitalists, in luded ( ,k( )s and their vehicles. In a move with yourself which of the solutions other top executives l’rom such even more far-reaching poten posed might be most effective. lortu ne 500 corporations as tial, \Val—\‘lart has ordered its Can government incentives \Val Mart, Proctor & ( ;aiithle truck suppliers to double the really get the market to clean and BP.1 hey had been invited gas mileage of the company’s up its act? to discuss ways to end America’s entire fleet by 2015. When those tossil—lueladdiction and save trucks become available to other the voi Id 1mm global warming. businesses, America will cut its But in reality’they’had come to demand ftr oil by six percent. make money ft,r theit compa- The executives gathered nies -and that may turn out to at the retreat weren’t waiting be the thing that saves us. around for federal subsidies or [‘or tli ree days, the execu new regulations to tilt the mar tives listened as their colleagues ket in their direction. Business and business risals described logic, not government interven how they are using new tech— tion, was driving them to cut nologies to wean themselves energy costs and in’est in new from oil and boost their profits fuel sources in the process. l)uPont has cut As the discussions at the its climate-warming pollution summit demonstrated by seventy-two percent since America doesn’t need to sait 1990, slashing 53 billion from for futuristic, pie-in-the-sky its energy hills while increasing technologies to cut its reckless its global production by nearly consumption of oil and coal. a third. Our last, best hope to stop cli Wal-Mart has installed new, mate change is the free market energy-efficient light bulbs in itself. There is gold in going refrigeration units that save the green, and the same drive to company .512million a year, make a buck that created global
136 Unit2 How Markets Work p I..
T
1
Wind farms generate electricity using a renewable resource. Many states offer economic incentives to encourage the market for renewable energy.
warming in the first place can Hummers and other low- nologies that use less energy and now be harnessed to slow the efficiency automobiles—and emit far less carbon. In addition, carbon based pollution that is then rebating that money to companies that figure out how to overheating the planet drivers who choose to purchase cut their emissions to below their So why, if we can profitably more efficient cars like hybrids. limit will earn credits that can slash planet-warming pollution, This cross between a fee and a be sold to those companies that does the world face a climate rebate motivates manufacturers can’t meet their quota, creating crisis? The answer is simple: to develop less-polluting vehicles a powerful incentive to actually
market failure. and is a perfect example of how beat the pollution limits . The global climate crisis is to give consumers an incentive the result not of an orderly free to conform their self-interest to Clean Incentives Revenues from market but of a distorted market the public interest, turning every the sale of carbon credits under run amok. A truly free market driver into a guerrilla warrior in the cap-and-trade system should is the planet’s best friend. Free the battle against global warming. be used to create market-based markets promote efficiency. financial incentives to speed the “Efficiency,”after all, means Cap and Trade One of the most development and adoption of the elimination of waste—and effective tools for harnessing promising new technologies... pollution is waste. markets to save civilization is All across Europe, citizens are Here are six modest, tried- a mandatory cap on planet- scrambling to cover their roofs and-true mechanisms we can warming pollution—one that and homes with solar collectors implement to quickly foster begins by cutting emissions now and transform their residences
free-market solutions to global and then reduces them eighty into mini power plants. . . Con warming: percent by 2050. Establishing necticut already offers a rebate mandatory limits in all industrial of up to $46,500 for homeown Feebates California is consider sectors would create a huge ers who go solar, and Congress ing imposing a $2,500 fee on market for products and tech- could boost the rapid expansion
Chapter 7 Market Structures and Market Failures 137 ot e’ 1stirig teclllu)h)gIes b pro per capita energy consumption says K ng. “We tan not onE vidi ng similar mtenti es or for the rest of the nation has replace gasoline and d rainat solar v atei heaters, residential soared by lift v percent ,“ says callv reduce cat boo em issiolls, wind turbines, geothermal sys lom King, (.ThOof Pacific Gas but we’ll also have a grid that is tems, modern electronic lighting and Electric. “And we haven’t more decentralized and hen.,e
and impro ed insulation . . . even made a dent in the poten- more resilient.” tial that’s out there—we can go Decoupling Utilities currently beyond anything anybody’s Performance Standards The make money only by producing ever projected. quickest way to improve the and selling us more electricity — energy efficiency of appliant es, giving power companies little Net Metering California also cars, trucks and buildings is to incentive to promote energy took an early lead in this area, establish minimum standards
i of cfl’iciency.Califin nia, ho e er. allowing homeownet s who based on the cu rent state has decoupled prof’its trom install solai lne1s 01 wind technology. Rather than pre energy sales, creating a new turbines to sell their excess sci ibmg specific solutions, per- kind of market that rewards effi- electricity back to the utility. formanee standards harness the ciency. Utilities make money not The electi ic meter actually spins market by establishing targets by selling power but by helping backward when the home is and rewarding companies that consumers use it more produc- generating more electricity than create the best emissions-cutting tively in their homes. The tesult: it consumes, and customers are technology. The government Californians use almost half as billed only for the net amount of has successfully done this for many kilowatts as other Amen- energy they consume from the energy -intensive appliances like cans. “We’ve been able to keep utility’s grit!. “Our objective is refrigerators, which now con-
energy demand flat fot thirty to give every homeowner the in - sume seventy-five percent less years with a rapidly growing centive to turn their house into energy than they did twenty—five population. while the average a clean—energypower station,” years ago
The challenge facing US today ‘vr i1-iEpIC \ is.. . to create a rational mar- I ,IIclcED1bET ‘ ketplace—one that serves the broader interests of our nation ( by unleashing the innovative , pos.er of American entrepre / neurs to transform our energy economy. Done right, this trans formation will not only curb global warming, it will create an engine of sustainable economic growth for generations.
Robert F Kennedy Jr is an envi ronmental lawyer and a professor at Pace University School ojLais’.
138 Ur,it2 HowMarkts Work