Chapter 14: A Manager’s Guide to Government in the
Marketplace
Market Failure
Market may fail to produce the socially optimal level due to following reasons:
1. Market Power - the ability of a firm to set its price above marginal cost
Monopoly usually has market power and thus the government creates regulation to ensure that
the monopoly does not charge high price to the consumer. Charging at monopoly price is not the
socially optimal price. Hence government takes action to correct this, to increase social welfare.
Regulation: anti-trust Policy - government policies designed to keep firms from monopolizing
their market. The government attempts to eliminate deadweight loss of monopoly by making it
illegal for firms to engage in activities that foster monopoly power. Such activities include:
collusion, price discrimination, merger and acquisition.
Price regulation
Sometimes due to the benefits of Economies of scale, it is better for one firm to serve the entire
market. In this case, the government can regulate the price that the monopoly can charge.
Problem arises when the ATC is higher than the price. The monopoly would not want to produce
the product since it is making a loss. The government needs to subsidize the monopoly which
then can lead to complacency that hinders the monopoly to reduce costs.
2. Externalities
Negative externalities - Costs borne by parties who are not involved in the production or
consumption of a good. For example, pollution.
In the existence of externalities, the free market equilibrium is not the socially efficient output.
Third party can be affected by the transaction made by the producer and consumer. Hence, in
order to mitigate this problem, government attempts to govern the waste disposal and pollution
matter.
The Clean Air Act (in the United States of America)
It is passed on to make sure that companies need to consider the effect of their activities to the
environment. Companies can trade the permit to pollute with one another after they obtain the
permit from the government. This way, each company has the incentives to develop a less-
polluting production method to be able to sell the permit and recover some money from it.
3. Public good - a good that is non-rival and non-exclusionary in consumption.
Marketplace
Market Failure
Market may fail to produce the socially optimal level due to following reasons:
1. Market Power - the ability of a firm to set its price above marginal cost
Monopoly usually has market power and thus the government creates regulation to ensure that
the monopoly does not charge high price to the consumer. Charging at monopoly price is not the
socially optimal price. Hence government takes action to correct this, to increase social welfare.
Regulation: anti-trust Policy - government policies designed to keep firms from monopolizing
their market. The government attempts to eliminate deadweight loss of monopoly by making it
illegal for firms to engage in activities that foster monopoly power. Such activities include:
collusion, price discrimination, merger and acquisition.
Price regulation
Sometimes due to the benefits of Economies of scale, it is better for one firm to serve the entire
market. In this case, the government can regulate the price that the monopoly can charge.
Problem arises when the ATC is higher than the price. The monopoly would not want to produce
the product since it is making a loss. The government needs to subsidize the monopoly which
then can lead to complacency that hinders the monopoly to reduce costs.
2. Externalities
Negative externalities - Costs borne by parties who are not involved in the production or
consumption of a good. For example, pollution.
In the existence of externalities, the free market equilibrium is not the socially efficient output.
Third party can be affected by the transaction made by the producer and consumer. Hence, in
order to mitigate this problem, government attempts to govern the waste disposal and pollution
matter.
The Clean Air Act (in the United States of America)
It is passed on to make sure that companies need to consider the effect of their activities to the
environment. Companies can trade the permit to pollute with one another after they obtain the
permit from the government. This way, each company has the incentives to develop a less-
polluting production method to be able to sell the permit and recover some money from it.
3. Public good - a good that is non-rival and non-exclusionary in consumption.
