1chapter

• Objective of the economy is to allocate resources in the most efficient ways to meet people’s needs

• There are a lot of objects of economy differentiated by their scale and opportunities: the world economy, national economies of different countries, economy of regions, economy of enterprises, economy of industries, economy of households.

• All these objects are interconnected and interdependent.

• The term government refers to the particular group of people, the administrative bureaucracy, who control a state at a given time, and the manner in which their governing organizations are structured.

• That is, governments are the means through which state power is employed.

• Government regulation is the study about the development, evaluation, and implementation of how government spends tax money.

• State is a set of institutions that possess the authority to make the rules that govern the people in society, having internal and external sovereignty over a definite territory.

• Sovereignty is the exclusive right to exercise supreme political (legislative, judicial, and executive) authority over a geographic region, group of people, or oneself.

• Government regulates the national economy.

• Any national economy consists of the government, enterprises, and households.

• Each of these actors of the national economy has their own economic policy and management

• However, they operate in the framework of economic policy and institutions formed at the government level.

• Globalization is another force which influences economic entities and their integration.

Two Main Sectors

• Private

• Public

Adam Smith: The Duty of the government is

• Protecting every member of the society from the injustice or oppression of every other member of it

• Protecting the society from violence and invasion of other independent societies.

• Free Market is a market where price is determined by the unregulated interchange of supply and demand.

• Free market is the best economic arrangement for producing goods and services in abundance.

• But society needs more then just output. It needs efficiency and equity.

• Efficiency - producing largest possible amount of goods with the least possible costs.

• Equity - equal opportunities, equal access, equal rights.

Markets

• are not always efficient (not producing the highest amount of goods and services at the lowest possible costs)

• or if efficient markets may not always provide the equitable distribution of these goods and services

Market Failures

• public goods

• externalities

• transaction costs

• asymmetric information

• imperfect competition

• Public Goods are nonrival (consumption of the good by one individual does not reduce availability of the good for consumption by others) and non-excludable.

• It is difficult to exclude people (free-riders) who do not pay for the goods from enjoying the benefits they provide.

• Example: public health programs, police protection, army, education.

• Government Intervention: taxation and distribution of public goods.

• Negative Externalities is an action of a product on consumers that imposes a negative side effect on a third party; its "social cost". Many negative externalities are related to the environmental consequences of production and use

• Example : air pollution, anthropogenic climate change, overfishing

• Transaction Costs are incidental costs to buyers and sellers of making a transaction.

• They include the costs of gathering information about markets, making decisions, negotiating a deal, writing contracts, etc.

• When these costs are significant the free market yields inefficient outcomes.

• Example: Anti-pollution agreement

• Government Intervention: Government regulations and rules economizing transaction costs.

• Asymmetric Information exists in the situation when buyers or sellers are better informed about product characteristics then those with whom they trade.

• Imperfect Competition or the situation in any market where the conditions necessary for perfect competition are not satisfied may result in monopoly.

• Natural monopoly is an industry in which total costs are kept to a minimum when just one producer serves the whole market.

• Price incentives – impose a tax on various kinds of activities in order to decrease their attractiveness.

• Try to control behavior directly, in the field of antitrust when the government takes explicit action to block mergers that might threaten the competitive character of a market.

- In the area of utility regulation – prevents public utilities from charging excessive rates for their electricity.

- Much health, safety, and environmental regulation similarly specifies the technological requirements that must be met or the pollution standards that cannot be exceeded

• Economic regulation is aimed to control product price.

• In case of natural monopolies, not to allow them to charge excessive prices.

• The objective is not to minimize the rate to consumers, inasmuch very low rates may affect the wish to stay in business and worsen the quality of the product being provided.

• A series of complex issues affects the role of the dynamics of the investment process in technological improvements.

• Innovations è cheaper products in the future. Firms should have incentive to undertake innovation

• The newest form of regulation, often referred as being social-regulation policies.

• Through the efforts of government agencies that society has funded research into implications of various kinds of hazards so that we can form an assessment of their consequences and determine the degree to which they should be regulated.

• Health, safety, and environmental regulation deals with risks in the environment, in the workplace and from the products consumed.

2Chapter

• Industries that are not subject to governmental controls on product standards, prices, profits, or entry and exit.

• Industries in which competition is the primary mechanism that society relies on to produce good economic results.

• Collusion is an agreement between two or more persons, sometimes illegal and therefore secretive, to limit open competition by misleading, or defrauding others of their legal rights, or to obtain an objective forbidden by law typically by defrauding or gaining an unfair advantage

• In the study of economics and market competition, collusion takes place within an industry when rival companies cooperate for their mutual benefit.

• Collusion most often takes place within the market structure of oligopoly, where the decision of a few firms to collude can significantly impact the market as a whole.

• Tacit collusion – achievement of mutual understanding without open communication

The field of economics, which is aimed to understand

• the structure and behavior of the industries (goods and services producers)

• The size structure of firms (one or many, “concentrated” or not)

• The causes (above all the economies of scale) of this size structure

• The effects of concentration on competition

• The effects of competition upon prices

• Investment

• Innovation

Economies of scale Situation in which output can be doubled for less than a doubling of cost.

• As output increases, the firm’s average cost of producing that output is likely to decline, at least to a point.

This can happen for the following reasons:

• If the firm operates on a larger scale, workers can specialize in the activities at which they are most productive.

• Scale can provide flexibility. By varying the combination of inputs utilized to produce the firm’s output, managers can organize the production process more effectively.

• The firm may be able to acquire some production inputs at lower cost because it is buying them in large quantities and can therefore negotiate better prices. The mix of inputs might change with the scale of the firm’s operation if managers take advantage of lower-cost inputs.

• Economic analysis of the market is based on 3 key concepts:

  • 1) Structure (concentration, product differentiation, entry barriers)

  • 2) Conduct (Pricing, Advertising, Research and development)

  • 3) Performance (Efficiency, Technical progress)

Linkage: the structure of a market (number of sellers, ease of entry) explains the conduct of participants, while the performance of the market is an evaluation of the results of the conduct.

• Concentration – number of firms in the market and how sales are distributed among them

• A simple index is to rank firms by their market shares and to add the market shares of the top 4 sellers – the four-firm concentration ratio.

• Entry barriers – describe the ease with which a new firm can enter an industry - makes entry more costly or more difficult

• Entry barriers may permit existing firms to charge prices above the competitive level without attracting entry (patent on a product that has no close substitutes è charge monopoly price)

• Product differentiation – a strategy in which one firm product is distinguished from competing products by means of its design, services, quality, location, etc.

• In markets of homogeneous products (wheat, steel, oil, etc.), price may be the primary basis for competition.

• Differentiated products (breakfast cereals, autos, medicines) are less likely to be sold on a price basis è product differentiation can be important in the creation of barriers to entry.

• Efficiency – allocation of resources within given state of technology

• Technical progress – a dynamic efficiency with which an industry develop new and better production methods and products

• Conduct refers to decisions made by firms in regard of price, quantity, advertising, research and development, etc.

• Conduct can sometimes “feedback” to change structure

• Antitrust and regulation can influence the structure and conduct of an industry in order to improve the industry’s economic performance

• An antitrust decision è dissolution of a monopoly into a number of independent sellers è the concentration/industry structure

• Antitrust Policy – laws and government actions to promote competition and prevent monopoly

• Competition should be primary mechanism to produce good economic results

• Historical Background

- Trusts – dominant firms during the 1870-80s formed several industries controlled by a single decision group (Monopoly)

• Monopoly Pricing seeks to maximize revenue by producing less output at higher prices

• Regulatory Agencies created to control:

  • Natural Monopolies

Sherman Act of 1890 – political reaction to the growth of trusts formed in 1880s.

• Section 1 - Restraint of Trade illegal – prohibit contracts, combinations, and conspiracies in restraint trade (imprisonment or a fine), price-fixing arrangements

• Section 2 – Monopolization is a Felony market dominance

• Clayton Act of 1914 – designed to define anticompetitive acts more clearly

• It outlawed price discrimination, tying clauses and exclusive dealing agreements, interlocking directorates and mergers between competitors, in case if these practices “substantially lessen competition or tend to create a monopoly.”

• Interlocking Directorates - situations where a director of one firms is also a board member if a competing firm – in large corporations where the effect would be a reduction of competition

• Federal Trade Commission Act of 1914

• The objective – to create a special agency FTC that could perform both investigatory and adjudicative functions