A manager’s guide to Government in the marketplace Rules and regulations passed and enforced by...

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


0

PricePrice


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


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


Lump-Sum Tariff on a Foreign Firm In Action

14-34


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


Price


A

Market supply curve before lump-sum tariff

Market supply curve after lump-sum tariff

Quota In Action

14-36


Price

Demand

E

H

A

B

C


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…


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.


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


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.


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.


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


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.


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


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.


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.


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.


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.


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


The Economics of Discrimination

Discrimination: the offering of different opportunities to similar individuals who differ only by race, ethnicity, gender, or other personal characteristics


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.



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.



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.


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.


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


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.


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.


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.

A manager’s guide to Government in the marketplace Rules and regulations passed and enforced by...

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