a manager’s guide to government in the marketplace rules and regulations passed and enforced by...
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A manager’s guide to Government in the
marketplace
Rules and regulations passed and enforced by government enter into every decision firms and consumers make.
As manager, it is important to understand
1.regulations passed by government
2.Why such regulations have been passed
3.How they affect optimal managerial decisions
Reasons for government involvement in market
economy1. Provide legal, monetary and social framework
for markets to operate
2. Insure that markets operate in a competitive manner
3. Redistribute income and wealth in a more desirable (equitable) fashion
4. Guarantee a more efficient allocation of resources in the face of externalities
5. Stabilize the overall level of economic activity
MARKET FAILURE
Market Failure
Market economy may produce too much or too little of certain products
Failure to make efficient use of society’s limited resources
4 reasons why free markets may fail to provide socially efficient outcomes (need for government intervention)
1.Market power
2.Externalities
3.Public goods
4.Incomplete information
Market FailuresMarket Power:- Firms with market power tend to
restrict output to force prices up.
Price > MC there may be a net gain to society if additional output is produced
Government may intervene in the market to regulate actions of firms in an attempt to increase social welfare
Monopolies = deadweight loss
Government uses antitrust policy to enact and enforce laws that restrict the formation of monopolies
Outlaws price-fixing agreements and other collusive practices
Competition Act 1889 (Canada) – outlaws price fixing, bid-rigging conspiracies, mergers that inhibit competition etc.
Bureau of Competition- enforcer
Sherman Antitrust Act 1890 (USA)
Exceptions may be made if mergers will result in increase in technology or efficiency
Externalities When production/consumption processes create
benefits or costs for people who are not part of the production or consumption process of that good.
Failure of markets to take into account all the costs and benefits associated with production or consumption of a good or service
Business consider only private or internal costs – cost borne by the firm– in production decisions
Consumers tend to consider only private or internal benefits in consumption decisions
Both groups ignore external costs borne by others or benefits that may be received by others.
Ignoring external costs or benefits – Externalities– results in an inefficient use of our scarce resources
Produce too much some items because full costs are not considered or produce too little because full benefits are not considered
External costs Having a quiet dinner at your favorite restaurant
only to have a shrieking baby at the next table
Watching a movie at the theatre with a kid using the back of your seat as a bongo drum.
Negative= costs, positive = benefits
Negative: pollution, smoking etc.
Positive: anchor store in a mall, day care, education etc
Scenario: Textile firm emits pollutants, a by-product of the production process, into a river. cost to society of dirtier water marginal cost to society increases.
If firms are allowed to dump pollutants in the water for free then marginal price paid by society for textiles is greater than price paid to firms.
Social costs is the full cost to society of producing the textiles– private costs + external costs.
Correcting for external costs:- how do we force business and individuals to consider all the costs of their actions?
Forcing them to internalize the costs.
Cost of pollution is not internalized by those who buy and sell textiles.
Basic reason for this market failure is the lack of well defined property rights
Possibilities:
1.Government can assign property rights to un-owned resources like lakes and rivers so individuals may charge for their use.---Basic reason for this market failure is the lack of well defined property rights
2.Legislations to limit (forbid) activities that create external costs
Government may force firms to internalize the cost by enacting policies that shift the cost of production to where it actually equals the social cost of production.
e.g. Clean Air Act : Get a permit to pollute. Pay a fee for each unit of pollutants emitted. internalize the cost of emission
Permits can be sold by one firm to another within and across industries
This provides an incentive for firms to develop and innovate new technologies that produce less pollution
Coase Theorem: government intervention to eliminate the effect of externalities is not necessary
If property rights are well defined (by the courts) bargaining between the parties involved would result in an optimal solution.
This works if transactions costs – costs of striking the bargain-- are relatively low and in which the number of people involved is relatively small
Market Failure and the provision of public goods
Markets may fail because some goods are not simply well suited to be provided by private firms.
These products must be provided by government or they won’t be provided at all.
3 categories of goods & services
1. Pure private goods – convey their benefits only to the consumer. eg. Hamburger for lunch, jacket you are wearing etc.
2. Private goods that yield external benefits: - education, flu shots, driver’s training etc.
3. Public goods – benefits are enjoyed equally by paying and non-paying members of society.
Problem, everyone enjoys so who wants to pay for the good???
PUBLIC GOODSGoods that benefit persons other than those who
buy the goods
Public goods are non-rival and non-exclusionary
Non-rival If one person’s increase in consumption does not reduce the quantity available to others
e.g. fireworks, radio signals, lighthouse etc.
Rival goods when you consume the good another person is unable to consume it as well
Non-exclusionary once the good is made available, everyone gets it; no one can be excluded from enjoying the good.
Most goods are exclusionary: e.g. chocolate bar
FREE RIDER PROBLEMSince everyone gets to enjoy a public good once it
is available, individuals have little incentive to purchase the good.
Rather, they prefer to let other people pay for it and then they can ‘free-ride” on the efforts of others
If everyone thinks this way, the good will not be available
Markets will not provide public goods efficiently.
Imagine, a private firm providing street lights and charging for it? Nobody will pay for it. If one person pays for it, everyone else will enjoy it (free ride).
National defense, snow warning systems, etc. cannot be offered so as to restrict their benefits to payers alone
Government solves the public-goods problem by forcing everyone to pay taxes and then uses to fund public projects
Not all publicly provided goods are public goods. eg. Education, public swimming pools
Government may not provide the socially efficient quantity of a public good. It may over provide
Firms may provide public goods to increase their profits. e.g. clean local parks, give money to PBS creates goodwill and may create brand loyalty or increase the demand for the firm’s product
Demand for Public a Good In Action
14-24
Market Failure
Quantity of streetlights
Price
0
Individual demand for streetlights
Individual consumer surplus = $72
Total demand for streetlights
Demand for Public a Good In Action
14-25
Market Failure
Quantity of streetlights
0
PricePrice
Quantity of streetlights
Total demand by B and C
B’s and C’s individual demand
A’s demand for streetlights
A’s consumer surplus from free-riding
= $85.50
30
30
INCOMPLETE INFORMATION When participants in a market have incomplete
information about things such as prices, quality, risks, etc. it may result in inefficiency in input usage and in firm’s output
Classic example: The call for restaurants to indicate the caloric input of each meal on their menu.
If individuals are not told that cigarettes are harzardous, some people would smoke out of ignorance
Government requires labels/warnings on products
Regulates work environment (hard hats, dangers of chemicals etc.)
Laws against insider trading
Certification
Truth in advertising
Rent SeekingGovernment policies generally benefit some parties
at the expense of others.
Some people (lobbyists???) spend considerable sums in attempts to influence government policies : rent seeking
Monopolist can spend money on campaign contributions, wining and dining politicians or even bribes to avoid regulation that will eat into its profits.
Resource Allocation and Rent Seeking
Government policies can improve the allocation of resources to alleviate market failures.
These policies, however, generally benefit some parties at the expense of others. Implications: lobbyists spend considerable sums
in attempt to influence government policy; a process known as rent seeking.
14-29
Rent Seeking
Incentives to Engage in Rent-Seeking Activities In Action
14-30
Rent Seeking
Price
Quantity
DemandMR
MC = AC
C
A B
Quotas A quota is a government restriction that limits the
quantity of imported goods that can legally enter the country. Implications:
Reduces competition in domestic marketHigher domestic pricesHigher profits for domestic firms Lower consumer surplus for domestic consumers
Conclusion: Domestic producers benefit at the expense of domestic consumers and foreign producers
14-31
Government Policy and International Markets
Quota In Action
14-32
Government Policy and International Markets
Price
DemandG
E
KA
B
M
Quantity in the domestic market
Tariffs A tariff is designed to limit foreign competition in
the domestic market to benefit domestic producers, which accrue at the expense of domestic consumers and foreign producers. Lump-sum tariff: fixed fee that foreign firms must
pay the domestic government to be able to sell in the domestic market.
Excise (per-unit) tariff: the fee an importing firm must pay to the domestic government on each unit it brings into the country.
14-33
Government Policy and International Markets
Lump-Sum Tariff on a Foreign Firm In Action
14-34
Government Policy and International Markets
Price
Quantity of individual foreign firm’s output
MC AC2
AC1
Average cost before lump-sum tariff
Average cost After lump-sum tariff
Impact of a Lump-Sum Tariff on Market Supply In Action
14-35
Government Policy and International Markets
Price
Quantity in the domestic market
A
Market supply curve before lump-sum tariff
Market supply curve after lump-sum tariff
Quota In Action
14-36
Government Policy and International Markets
Price
Demand
E
H
A
B
C
Quantity in the domestic market
Supply before excise tax
Supply afterexcise tax
In this section we’d look for the In this section we’d look for the answers to these questions:answers to these questions:
How do wages compensate for differences in job characteristics?
Why do people with more education earn higher wages?
Why are wages sometimes above their equilibrium values?
Why is it difficult to measure discrimination?
When might the market solve the problem of discrimination? When might it not?
37
U.S. Median Weekly Earnings, Selected Occupations, 2006
OccupationBoth
sexesMen Women
Gender gap
Chief executives $1,875 $1,907 $1,422 34.1%
Aircraft pilots 1,407 1,419 n.e.d.
Educ. administrators 1,125 1,275 1017 25.4%
Fire fighters 912 918 n.e.d.
Registered nurses 978 1,074 971 10.6%
Social workers 732 749 728 2.9%
Secretaries 583 559 584 – 4.3%
Telemarketers 395 n.e.d. n.e.d
Waiters/waitresses 363 401 348 15.2%
Maids/housekeeping 355 404 348 16.1%n.e.d. = not enough data for BLS disclosure requirements 38
EARNINGS AND DISCRIMINATION 39
Introduction In competitive markets, the wages workers earn
equal the value of their marginal products.
There are many factors that affect productivity and wages…
EARNINGS AND DISCRIMINATION 40
Compensating Differentials Compensating differential: a difference in wages
that arises to offset the nonmonetary characteristics of different jobs
These characteristics include unpleasantness, difficulty, safety. Examples: Coal miners and fire fighters are paid more
than other workers with similar education to compensate them for the extra risks.
Night shift workers paid more than day shift to compensate for the lifestyle disruption of working at night.
EARNINGS AND DISCRIMINATION 41
Ability, Effort, and Chance Greater ability or effort often command higher
pay. These traits increase workers’ marginal products, make them more valuable to the firm.
Wages also affected by chance E.g., new discoveries no one could have
predicted make some occupations obsolete, increase demand in others
EARNINGS AND DISCRIMINATION 42
Ability, Effort, and Chance Ability, effort, and chance are difficult to measure,
so it is hard to quantify their effects on wages.
They are probably important, though, since easily measurable characteristics (education, age, etc.) account for less than half of the variation in wages in our economy.
EARNINGS AND DISCRIMINATION 43
Case Study: The Benefits of Beauty
Research by Hamermesh and Biddle:
People deemed more attractive than average earn 5% more than people of average looks.
Average-looking people earn 5-10% more than below-average looking people.
EARNINGS AND DISCRIMINATION 44
Case Study: The Benefits of Beauty
Hypotheses:
1. Good looks matter for productivity In jobs where appearance is important,
attractive workers are more valuable to the firm, command higher pay.
2. Good looks indirectly related to ability People who make an effort to project
attractive appearance may be smarter or more competent in other ways.
3. Discrimination
EARNINGS AND DISCRIMINATION 45
The Superstar Phenomenon Superstars like Will Smith, Bono earn many
times more than average in their fields.
The best plumbers or carpenters do not.
Superstars arise in markets that have two characteristics: Every customer in the market wants to enjoy the
good supplied by the best producer. The good is produced with a technology that
allows the best producer to supply every customer at a low cost.
EARNINGS AND DISCRIMINATION 46
Human Capital Human capital: the accumulation of
investments in people, such as education and on-the-job training
Human capital affects productivity, and thus labor demand and wages.
Weekly Earnings of Full-Time Employed Persons Age 25+ by
Education, 2007:Q4
Educational attainment
Median weekly earnings
Less than H.S. $ 424
H.S. diploma 610
Some college or Associate degree
697
Bachelor’s degree 994
Advanced degree 1,259
47
EARNINGS AND DISCRIMINATION 48
The Increasing Value of Skills
Women
Men
72%
87%
2005
35%
44%
1980
Percentage difference in annual earnings for college graduates
vs. high school diploma
The earnings gap between college-educated and non-college-educated workers has widened in recent decades.
EARNINGS AND DISCRIMINATION 49
The Increasing Value of SkillsTwo hypotheses:
1. International tradeRising exports of goods made with skilled labor, rising imports of goods made with unskilled labor.
2. Skill-biased technological changeNew technologies have increased demand for skilled workers, reduced demand for unskilled workers.
Difficult to determine which hypothesis better explains the widening earnings gap; probably both are important.
EARNINGS AND DISCRIMINATION 50
The Signaling Theory of Education
An alternative view of education:
Firms use education level to sort between high-ability and low-ability workers.
The difficulty of earning a college degree demonstrates to prospective employers that college graduates are highly capable.
Yet, the education itself has no impact on productivity or skills.
Policy implication: Increasing general educational attainment would not affect wages.
EARNINGS AND DISCRIMINATION 51
Reasons for Above-Equilibrium Wages
1. Minimum wage laws
The minimum wage may exceed the eq’m wage of the least-skilled and experienced workers
2. Unions
Union: a worker association that bargains with employers over wages and working conditions
Unions use their market power to obtain higher wages; most union workers earn 10-20% more than similar nonunion workers.
EARNINGS AND DISCRIMINATION 52
Reasons for Above-Equilibrium Wages
3. Efficiency wages
Efficiency wages: above-equilibrium wages paid by firms to increase worker productivity
Firms may pay higher wages to reduce turnover, increase worker effort, or attract higher-quality job applicants.
In each case, identify which worker would earn more and explain why.
A. The best physical therapist on the planet or the best writer on the planet
B. A trucker that hauls produce or a trucker that hauls hazardous waste from nuclear power plants
C. A graduate of an Ivy League college or an equally intelligent & capable graduate of a state university
D. Someone who graduated from a state university with a 3.7 GPA, or someone who graduated from the same university with a 2.4 GPA
A C T I V E L E A R N I N G A C T I V E L E A R N I N G 22
Explaining wage differentialsExplaining wage differentials
53
EARNINGS AND DISCRIMINATION 54
The Economics of Discrimination
Discrimination: the offering of different opportunities to similar individuals who differ only by race, ethnicity, gender, or other personal characteristics
EARNINGS AND DISCRIMINATION 55
Measuring Labor-Market Discrimination
Median earnings of full-time U.S. workers, 2007: White males earn 21% more than white females. White males earn 24% more than black males.
Taken at face value, these differences look like evidence that employers discriminate.
But there are many possible explanations for wage differences besides discrimination; the data above do not control for differences in other factors that affect wages.
EARNINGS AND DISCRIMINATION 56
Measuring Labor-Market Discrimination
Differences in human capital among groups: White males 75% more likely to have college
degree than black males White males 11% more likely to have graduate
degree than white females Women have less on-the-job experience than men Public schools in many predominantly black areas
are of lower quality (e.g., funding, class sizes)
There may well be discrimination in access to education, but this problem occurs long before workers enter the labor force.
EARNINGS AND DISCRIMINATION 57
Measuring Labor-Market Discrimination
Recent study by Bertrand and Mullainathan finds evidence of labor-market discrimination:
5000 fake résumés sent in response to “help wanted” ads.
Half had names more common among blacks, like Lakisha Washington or Jamal Jones.The other half had names common among whites, like Emily Walsh or Greg Baker.
Otherwise, the résumés were the same.
The white names received 50% more calls from interested employers than the black names.
EARNINGS AND DISCRIMINATION 58
Discrimination by Employers Competitive markets provide a natural remedy
for employer discrimination:
The profit motive…
The non-discriminating firms can hire females for a lower wage, giving them a cost advantage and economic profits, which attract entry of other non-discriminating firms.
Suppose some firms discriminate against female workers. They will hire fewer females, more males.
Result: A wage differential.
EARNINGS AND DISCRIMINATION 59
DMDF
The discriminating firms will begin to lose money and be driven out of the market. Result: Demand for female workers increases, demand for male workers falls until wages are equalized
Discrimination by Employers
WM
LM
DM
SM
WM
Male workersWF
LF
DF
SF
WF
Female workers
DF
DMWF
WM
EARNINGS AND DISCRIMINATION 60
Discrimination by Consumers Discrimination by consumers may result in
discriminatory wage differentials.
Suppose firms care only about maximizing profits, but customers prefer being served by whites.
Then firms have an incentive to hire white workers, even if non-whites are willing to work for lower wages.
EARNINGS AND DISCRIMINATION 61
Discrimination by Governments
Some government policies mandate discriminatory practices. apartheid in South Africa before 1994
early 20th century U.S. laws requiring segregation in buses and streetcars
Such policies prevent the market from correcting discriminatory wage differentials.
EARNINGS AND DISCRIMINATION 62
CONCLUSION In competitive markets, workers are paid a wage
that equals the value of their marginal products.
Many factors affect the value of marginal products and equilibrium wages.
The profit motive can correct discrimination by employers, but not discrimination by customers or discriminatory policies of governments.
Even without discrimination, the distribution of income may not be equitable or desirable – a topic we explore in the following chapter.