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Chapter 7GOVERNMENT MARKETS-5080412750 Chapter in a Nutshell00 Chapter in a Nutshell1.In some cases, unregulated markets may not provide the best answers to the fundamental economic questions of society. Whenever that occurs, government intervention is needed to temper the market’s operation and make it conform to the interests of society.2.Some markets fail to allocate resources efficiently, a situation called market failure. The main sources of market failure include: (1) monopoly power, (2) spillovers or externalities, (3) public goods, (4) inadequate information and (5) economic inequality.3.Antitrust policy is the attempt to curb anti-competitive behavior and foster a market environment that will lead to increased competition. The Sherman Act of 1890 and the Clayton Act of 1914 are the foundations of federal antitrust policy.4.Besides using antitrust laws to regulate business behavior, the federal government sometimes enacts economic regulation to control the prices, wages, conditions of entry, and standards of service of an industry. Industries made subject to economic regulation have included airlines, trucking, railroads, banking, communications, and energy. By the late 1970s, however, it was generally agreed that many economic regulations were no longer suited to prevailing economic conditions. As a result, the federal government initiated steps to dismantle many economic regulations, a process known as deregulation.5.Public utilities have traditionally been subject to economic regulation on the grounds that they are natural monopolies. In return for being granted an exclusive franchise to serve a local market, the utility is subject to price regulation according to the fair-return principle. Although fair-return pricing allows a utility to realize a price that covers average total cost, it does not provide the incentive for a utility to minimize its costs.6. A spillover is a cost or benefit imposed on people other than the producers and consumers of a good or service. When the production of some good results in spillover costs, too much of it is produced and there is an over allocation of resources to its use. Conversely, underproduction and under allocation of resources arise from spillover benefits.7. Social regulation attempts to correct a variety of undesirable side effects in a market economy that relate to health, safety, and the environment—effects that markets, left to themselves, often ignore. Among the federal government agencies involved in social regulation are the Environmental Protection Agency, the Consumer Product Safety Commission, the Food and Drug Administration, and the Occupational Safety and Health Administration.8. Public goods, such as national defense, are indivisible and are not subject to the exclusion principle. As a result, the market system fails to efficiently supply public goods. 9. Without adequate information, markets may give false signals, incentives may get distorted, and sometimes markets may simply not exist. In such cases, government may decide to step in the correct the market failure.10. Because an unregulated market may fail to provide a fair distribution of income and output for society, government modifies the distribution of income through taxation and transfer payment programs.Chapter ObjectivesAfter reading this chapter, you should be able to:1.Explain why markets sometimes fail to allocate resources efficiently.2.Describe the nature and operation of antitrust policy.3.Assess the advantages and disadvantages of economic regulation versus social regulation.4.Explain why public utilities, such as electricity and cable television, have traditionally been provided an exclusive franchise to serve a local community.5.Identify the factors that contribute to the failure of the market system.-5080283845Knowledge Check00Knowledge CheckKey Concept Quizmarket failureantitrust policyfair return pricespillover effectincentive-based regulationsocial regulationprivate goodspublic goodsmanufacturer’s suggested retail price (MSRP)invoice costrebatesholdback_____ a.goods subject to the exclusion principle_____ b.goods that are indivisible_____ c.is designed to correct undesirable side effects of a market economy in areas of health, safety and the environment_____ d.when a firm can charge a price only high enough to cover average total cost_____ e.flexible methods of reducing spillover costs_____ f.an attempt to curb anti-competitive behavior _____ g.also known as the window sticker price_____ h.can take the form of either cash or low-rate financing offers_____ i.a payment made by manufacturers to dealerships to finance its inventory of cars_____ j.when markets do not allocate resources efficiently_____ k.is a cost or a benefit and is a reason for market failure_____ lwhat the dealer paid for the carMultiple Choice QuestionsAll of the following are sources of market failure exceptmonopoly powerpublic goodsspilloversproduction of output, where MR = P = ATCUnlike a competitive market, a monopoly imposes a “tax” on consumers because it charges a higher priceproduces a smaller quantityearns economic profitsall of the aboveA monopolyearns normal profitsproduces more than a competitive firmis an example of market failureproduces less than a competitive firmAntitrust policy is designed to do all of the following exceptlimit the scope of regulationprevent unfair business practicesprevent price fixing conspiraciesfoil predatory activity by firms to achieve monopoly powerThe passage of the Sherman Act of 1890 allowed the federal government toprotect consumers from firms changing unfair pricesprevent collusive agreements among firms attempting to control marketstake legal action against firms engaging in illegal monopoly behaviorall of the aboveThe Clayton Act of 1914 made explicit the intent of the Sherman Act by outlawing all of the following business practices exceptprice discrimination not justified by cost differencesmergers that lessen competitioninterlocking directoratesearning economic profitsThe antitrust laws are applicable to all of the following types of business enterprises exceptnatural monopoliesmanufacturing firmsmarketing firmstransportation companiesA paint producer dumps effluents into an adjacent stream. These effluents reduce the fish harvest of the hatchery downstream. This is an example of a (an)externalityspillover costoverallocation of resourcesall of the aboveSocial regulation is designed to correct undesirable side effects of markets in all of these areas excepthealthsafetythe environmentsocial attitudesPrivate goods aredivisiblesubject to the exclusion principlecharacterized by the principle of rival consumptionall of the abovePublic goods are indivisibleconsumed only by those who are willing to pay for themalways bought and sold in a competitive marketall of the abovePublic goods areunder produced by the competitive marketnot subject to the exclusion principlehave a high likelihood of being prey to the free-rider problemall of the aboveWhen the insurance industry follows a uniform pricing policy, it may result inpeople with more health risks buying insurancehigher insurance premiumsless coverageall of the aboveAll of the following are examples of transfer payments exceptunemployment compensationMedicarebusiness subsidiestaxes paid by pollutersThe polluter-pays principle is supposed toprovide polluters with incentives to develop more efficient pollution control techniquesincorporate the cost of pollution prevention into the prices of goods and services that cause pollutionall of the abovepunish all pollutersThe approach that the U.S. government has generally used to force companies to reduce their pollution isfair-return regulationcommand-and-control regulationincentive-based regulationantitrust regulationCritics of fair-return regulation maintain that it may result ineconomic losses incurred by the regulated firmexcessive costs incurred by the regulated firminterlocking directorates among the board of directors of competing firmstying contracts between the regulated firm and its customersWith pollution, market failure occurs because a firm does not take into account spillover costs. As a resulttoo much output will be produced at too low a pricetoo much output will be produced at too high a pricetoo little output will be produced at too low a pricetoo little output will be produced at too high a priceWhich antitrust law proclaimed that contracts and conspiracies in restraint of trade, monopolies, attempts to monopolize, and conspiracies to monopolize are illegal?Clayton ActCeller-Kefauver ActRobinson-Patman ActSherman ActIf Microsoft is a natural monopoly, antitrust policies that break it up wouldenhance its ability to compete with foreign rivalslimit the benefits that may be acquired from economies of scaleenhance the ability of the separate firms to realize economies of scalemake it harder for the firm to prevent diseconomies of scaleThe United Auto Workers (UAW) provides an example of a (an)industrial unioncraft unionexclusive unionpublic employee unionThe United Steel Workers (USW) attempts to raise wages for its members bydecreasing the demand for steel workersreducing tariffs and quotas on steel importsimposing an above-equilibrium floor on wagesreducing productivity of steel workers23. About _______ of the American labor force currently belongs to labor unions86 percent54 percent38 percent14 percent24.Empirical research has found that increases in the minimum wage causerising employment, especially among elderly workersrising unemployment, especially among teenagerssharp reductions in the productivity of workersmany large corporations to become bankrupt25. The minimum wage is essentially aprice floorprice ceilingtax on laborsubsidy to employers26. If the federal government imposes a minimum wage that is above the market equilibrium wage, we can expecta leftward shift in the supply curve of labora leftward shift in the demand curve for labora decrease in the quantity supplied of labora decrease in the quantity demanded of laborTrue-False Questions1.TFUnregulated markets may fail to provide a fair distribution of income and output.2.TFWhen externalities exist, market failures ensue.3.TFAntitrust policy is designed to curb the powers of natural monopolies.4.TFRegulation of public utilities provides incentives for cost minimization.5.TFPublic goods are subject to the exclusion principle.6.TFPrivate goods are rival in consumption.7.TFMonopolies typically produce more than competitive markets.8.TFA regulated firm can change a fair-return price and thus earn an economic profit.9.TFAn unregulated monopolist typically maximizes profits using the MC?=?MR rule.10.TFSpillovers are always costly.11.TFSpillover costs lead to overallocation of resources.12.TFThe Clayton Act outlawed tying contracts.13.TFBanking is an unregulated industry.14.TFCommand-and-control regulations do not specify the price a polluting company may charge for its product.15.TFThe most widely used method of controlling pollution in the U.S. is incentive-based regulations.16.TFSocial regulation typically controls social attitudes towards products.17.TFThe international environmental policy of the United States is founded on the polluter-pays principle.18.TFThe polluter-pays principle pays subsidies to non-polluters.19.TFPublic goods are indivisible.20.TFPrivate goods are subject to the free-rider problem.21.TFBy increasing the wages of its members, the United Auto Workers encourages auto companies to seek substitutes for union workers. 22.TFIf the demand for labor is elastic, a rise in the minimum wage will increase the total wages paid to workers.23.TFAdvocates of an increased minimum wage argue that it will encourage labor to become more efficient, thus reducing the cost of producing goods and increasing the demand for labor.24.TFAlthough international trade benefits many workers, not all workers gain from trade.25.TFSuppose that U.S. wages are three times as high as Chinese wages. If U.S. workers are more than three times as productive as Chinese workers, U.S. workers are less costly.26.TFNonunion workers at Japanese auto plants in the United States tend to validate relatively high wages paid to unionized workers at Ford and General Motors.27.TFOn average, union workers are paid lower wages than comparable nonunion workers.Application Questions1.The city council members of Fair City, Nofunland have decided that drinking is associated with spillover costs. The council decides to impose a sin tax of one dollar per quart on whiskey. The following table shows the market for whiskey in the absence of a tax.Price($/quart)Quantity DemandedQuantity Supplied$51,000,0001,000,000$10400,0002,000,000Graph the supply and demand curves. What is the equilibrium price and quantity?Illustrate the changes in the market when the tax is imposed. Shade in the amount of revenue that the government will generate from the tax.2.Assume that smoke detector alarms have significant spillover benefits. The following analysis pertains to the market for smoke detector alarms in the small, densely populated residential downtown of Paris, Texas.If the government decides to pursue a hands-off approach, will this market allocate resources efficiently?The city government decides to subsidize the sellers of smoke alarms. Illustrate the changes in the market. What happens to the equilibrium price and quantity?The city government decides to subsidize the buyers of smoke alarms. Illustrate the changes in the market. What happens to the equilibrium price and quantity?-35560194310Answers to Knowledge Check Questions00Answers to Knowledge Check QuestionsKey Concept Answers1.j4.k7.a10.l2.f5.e8.b11.h3.d6.c9.g12.iMultiple Choice Answers1.d6.d11.a16.b21.a26.d2.d7.a12.d17.b22.c3.d8.d13.d18.a23.d4.a9.d14.d19.d24.b5.c10.d15.c20.b25.aTrue-False Answers1.T6.T11.T16.F21.T26.F2.T7.F12.F17.T22.F27.F3.F8.F13.F18.F23.T4.F9.T14.T19.T24.T5.F10.F15.F20.F25.TApplication Question Answers1.a.Equilibrium price = $5.00Equilibrium quantity = 1,000,000411480245110$10400,0001,000,000$1$5Market for Whiskey2,000,000PriceQuantitySD00$10400,0001,000,000$1$5Market for Whiskey2,000,000PriceQuantitySDThe following diagram shows the supply and demand curves in the whiskey market.b.The following diagram shows the changes in the whiskey market when the sin tax is 388620579120TAX$10400,0001,000,000$1$5Changes in the Whiskey Market2,000,000S'(after tax)S(without tax)?PriceQuantityOld Equilibrium800,000D?0New Equilibrium$1$100TAX$10400,0001,000,000$1$5Changes in the Whiskey Market2,000,000S'(after tax)S(without tax)?PriceQuantityOld Equilibrium800,000D?0New Equilibrium$1$1imposed. The shaded area shows the amount of revenue the government will generate from the tax.2.a.No, the market will underproduce smoke alarms. The spillover benefits cause a market failure.b.The following diagram shows the market for smoke alarms with a subsidy to sellers.490855167640Market for Smoke Alarms with Subsidy to Sellers0$10$20$30S50100150200250QuantityPriceD??Market Equilibrium without SubsidyMarket Equilibrium with SubsidyS'00Market for Smoke Alarms with Subsidy to Sellers0$10$20$30S50100150200250QuantityPriceD??Market Equilibrium without SubsidyMarket Equilibrium with SubsidyS'c.The following diagram shows the market for smoke alarms with a subsidy to consumers.617220254635Market for Smoke Alarms with Subsidy to Consumers0$10$20$30S50100150200250QuantityPriceD′D??Market Equilibrium with SubsidyMarket Equilibrium without Subsidy00Market for Smoke Alarms with Subsidy to Consumers0$10$20$30S50100150200250QuantityPriceD′D??Market Equilibrium with SubsidyMarket Equilibrium without Subsidy ................
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