Government+in+the+Marketplace

Government in the Marketplace

 * by Nathan Reese**

A marketplace is a place where firms and consumers come together to trade goods and services with no outside interference from the goverment. Sometimes, rules and regulations are passed by the government that must be followed by firms.

__**Market Failure**__

Often, free markets won't provide the socially optimal ouput so goverments must get involved. One reason for this is market power, when a firm sells output at a price that is greater than its marginal cost of production. If the value to society is greater than the cost of resources to produce another level of output, the government may step in to increase social welfare. As illustrated in the graph below, you can see what will happen in a monopoly if a firm doesn't produce at the optimal output or equilibrium, there will be a deadweight loss if the government doesn't step in. The goverment can then force the firm to produce more or set the price.

Government policies designed to keep firms from monoplizing their markets are //antitrust policies//. The main purpose of antitrust policies are to keep firms from colluding with each other to create a monopoly. It may prohibit agreements or practices that restrict free trading and competition between business entities. This includes in particular the repression of cartels. It may ban abusive behavior by a firm dominating a market, or anti-competitive practices that tend to lead to such a dominant position. Practices controlled in this way may include predatory pricing, tying, price gouging, refusal to deal and many others. It may supervise the mergers and aquisitions of large corporations, including some joint ventures. Transactions that are considered to threaten the competitive process can be prohibited altogether, or approved subject to "remedies" such as an obligation to divest part of the merged business or to offer licences or access to facilities to enable other businesses to continue competing.
 * __Antitrust Policy__**

Another reason the government may get involved is because of //negative externalities//. These are external costs, such as pollution. Governments often create regulations about the amount of pollution or toxins that a firm can produce because of the harm these things can do to other people or the environment. The profit maximizing level of production for a firm, may be where pollution is high so companies have an incentive to produce at that level. This is where the government steps in and makes the firm produce at the level of output that is best for society.
 * __Externalities__**

Not all externalities are negative though, there are such thing as positive externalities. One example of positive externalities is public transportation. Bus fare doesn't usually cover the cost of operating the bus system, but the positive externalities provided to the public make it worth keeping the bus system. Because of the benefit to society, it wouldn't make sense to raise fares to cover costs or shut down because they are operating at a loss.

//Rent Seeking// is when someone, usually a lobbyist makes an effort to motivate another party's decision because of selfish reasons. When they are successful, there ends up being a large amount of surplus to the party that the lobyist supports. If the lobbyist convinces the government to lower prices, then there will be a large amount of surplus for the consumers.
 * __Rent Seeking__**

An example of rent seeking is the Davis-Bacon Act. The Davis-Bacon Act requires federal contractors to pay "prevailing wages" as defined by the Department of Labor. Davis-Bacon does not allow contractors to compete on the basis of price. The act burdens new entrepreneurs who bid for federal contractors. They can't provide their service at a lower price, making it difficult to compete. However, unions find the law beneficial and lobby vigorously to preserve it. Economic theory predicts that the sum total of funds spent to acquire political privilege exceeds the value of those privileges. If a firm hires a lobbyist for $900 so they can get $1,000, they are getting a $100 reward for hiring a lobbyist. But there is also another firm that will have spent $900 on a lobbyist that lost. So the total spent is $800 more than the benefit as a whole.

Below, you can see why a company would engage in rent seeking. If a company has a monopoly, they they can set the price at Pm, but if there is no monopoly, the price will go down to Pc. At the monopoly price, the firm earns profits in the area A, and consumer surplus is C. If there is no monopoly, the price goes down to Pc and the firm loses all profits, and consumer surplus is the total of A, B and C. The firm will spend up to the amount in A to lobby their side and avoid regulation. In theory, the consumers are willing to spend the total in A and B to lower the price, but individually they have less to gain so they won't lobby.


 * __Government Policy and International Markets__**

Governments will also set policies such as quotas and tariffs that are designed to benefit specific firms, but will hurt others. A quota is a limit on the number of units of a product a foreign company can import into the country. The United States government sets quotas on items such as textiles and automobiles to keep the US markets from having too many foreign products that can put US companies out of business.

Tariffs are also designed to limit foreign competition in domestic markets by rasing the cost of shipping products to the United States. Lump sum tariffs are when companies must pay a fee to sell a certain product, no matter the amount the sell. A per-unit tariff requires the foreign company to pay a tariff for each item that is imported. A lump sum tariff is basically adding a fixed cost, so marginal cost stays the same for the company. As long as they can still sell their products above the price where marginal cost meets average cost, then they will continue to import those goods, but at a greater quantity. Per-unit tariffs benefit domestic companies more because the marginal cost goes up for the foreign companies along with average cost, so it forces their prices up which raises the demand for the domestic competitors.

Tariffs will actually hurt the country that imposes them because the costs outweigh the benefits. The tariffs help domestic companies, but reduce competition and raise prices to the consumer. Tariffs are extra revenue for the government which can help benefit the economy, but not enough to make up for the extra costs to consumers. There is also the fact that countries may retaliate and impose their own tariffs against the country that imposed tariffs originally. Below is a graph showing the loss to consumers when a tariff is imposed. You can see when tariffs are imposed, the supply moves to the left and increases the equilibrium price. The shaded yellow area is the loss to consumers.

Questions
1. Government policies designed to keep companies from colluding with each other and creating a monopoply are called what? a. Non-monopoly laws b. Anti-trust policy c. Tariffs d. Rent-seeking

2. If 2 companies are involved in rent-seeking, each one spends $500 on lobbyist, and company A is successful in lobbying the government and therefore earns $800 more in profit, who is worse off?

a. Company A b. Company B c. The consumers d. B and C

3. True or False: Lump-sum tariffs will increase marginal costs of foreign companies.

a. True b. False

4. How much is a monopolistic company willing to spend in order to lobby in their favor of no regulation

a. total consumer surplus b. it isn't worth spending money to lobby c. total costs d. total profit

5. What are negative external costs that hurt the environment called?

a. Negative Externalities b. Pollution Costs c. Hazardous Costs d. Tariffs

Answers
1. b, Anti-trust policy is designed to stop companies from colluding to create a monopoloy

2. d, Company B is worse off because they spent $500 and got nothing in return, and the consumers are worse off because overall, the market lost $300 trying to lobby the government

3. b, False because lump-sum tariffs are fixed and will only raise average costs

4. d, total profits because that is what they will lose if the government regulates the market and they lose the monopoly

5. a, Negative Externalities are external costs that hurt the environment or something outside of the firm

Baye, M. (2006), Managerial economics and business strategy. McGraw-Hill, Irwin.

http://www.renewamerica.us/readings/market.htm

http://www.mhhe.com/economics/baye/stud/chap13out.htm

http://en.wikipedia.org/wiki/Antitrust

http://www.house.gov/jec/growth/rentseek.htm

http://economics.about.com/cs/taxpolicy/a/tariffs_2.htm