SCHOOLS BRIEF State and market People are quick to assume that “market tein by th government Ths final buctin our sees on como tlaes arcs fra sang prsumnpon {they never do) but because the altemative is usually worse” COORDING to the central only ther, the benefit from con- deduction ofeconomicthe- suming one more unit exact fom, under certain conditions matches te cost of producing it markets allocate resources eff- IF output were less, the benefit ciently. “Effciency"hasa special from consuming more would ex- ‘meaningin this contest The the- ceed the cost of producing it. 1F ‘ory says that markets will pro- output were higher, the cost of ‘duce an outcome such that, producing the extra units would given the economy's scarce re- exceed the extra benefits. So the ‘Ouest is impossible to make point where supply equals de- anybody beter-ofF without mak: mandis “efficient ing somebody else worse-off “The shaded area in chart 2 Economic theory, in other shows the “surplus” created by words, offers a proof of Adam — the market The upper partis the Smith's big idea. In @ market consumers supplus: the benefit ‘economy, if certain conditions from consumption (ie, the total, aremetaninvsiblehand guides area under the demand curve) ‘countless apparently -unco- less what consumers have to pay ‘ordinated individuals toa result forit In the same way, the lower thatisinoneplausiblesense,the part measure the producers sur- best that can bedone. pilus: revenues received, less the Inrich countries, markets are _ cost of production (the area un to fama aac ateon. der thesuppy cue Yet a certain awe is appropriate. is gain in welfare is at its ‘When Soviet planners visited a greatesifconsumption and pro- vegetable marketin Londondur- duction happen where the lines ing the early days of perestrodea, cross. If, for some reason, con- they were impressed to find no sumption and production are ‘queues shortages, or mountains Jess. than that, the surplus is ‘ofspoiled and unwanted vegeta- smaller and the economy suffers bes. They took their hosts aside and said: “We understand, you Ihave tosay itsall doneby supply ‘anddemand.Butean'tyautellus ‘whats really oingon? Whereare your planners, and what are their methods?* ‘The essence of the market mechanism is indeed captured by the supplyyand-demand di ‘fram shown in charts. The sup- ply curve measures the cost t Sellers, at any level of output, of selling one more unit of their ood. As output grows, the aw of diminishing returns forces this extra (or marginal) costhigher, so thesupply curveslopes upwards. In the same way, the demand curve measures the benefit 10 consumers of ‘consuming one ‘more unit. As consumption ‘rows the benefit from extra consumption falls, so the de- ‘mand curve slopes downwards “Atthe place where the curves ES oe «ros, a price is set such that de- oat ‘mand equals supply. There, and ‘what economists call a dead- \Weight loss, as shown in chart 3. If produetion and consunip- tion are more than the eficient amount, thesameistrue-Produc- es’ surplus is smaller because the extra ouput has cost more ro smake than it rings in revenuc consumer’ surplus is reduced because the extra consumption has cost buyers more than the benefits it brings. Again, as shown in chart 4, the economy Suffers a deadweight oss. Fine on paper However, the conditions for market efciency are extremely ddemanding—far oo demanding ever to be met in the real world. ‘The theory. requires "perfect competition’: there “must be ‘many buyers and sellers; goods from competing suppliers must beindistinguishable;buyersand sellers must be fully informed; and markets must be complete thatis, there must be markets not just for bread here and now, but for bread in any state of the world. (What is the price today fora loafto be delivered in Tire bbuktu on the second Tuesday in December 2014 ifitrains?) In other words, market fail ure is pervasive. Itcomes in four ‘main varieties: ‘* Monopoly. By reducing his sales, monopolist can drive up the price of his good. His sales will fall bu his profits wil ise. Consumption and_ production are less than the efficient amount, causing a deadweight Joss in welfare + Public goods Some goodscan- hot be supplied by markets If you refuse fo pay for anew coat, the seler will refuse to supply you. IFyou refuse to pay for na tional defence, the "good" can- snot easily be withheld, You Imight be tempted to let others pay. The same reasoning applies {other non-excudable" goods such as aw and order, clean ait, land so on. Since private sellers ‘annotepecttorecoverthe costs of producing such goods, they ‘will tosupply them. ‘Extemalties. Making some foods causes pollution: the cost 'Sbommeby peoplewith nosayin deciding how much to produce. Consuming some goods educ- tion, antilock brakes) spreads bendfis beyond the "buyer, ‘again this wil be ignored when ‘the marker decideshow much to produce: tn the exse of “food” ‘Externalities markets ll to ils in the tase of bod too much, ‘Information In some ways a Special kind of extemal, this eserves to be mentioned sepa. ely because of the emphasis placed upon it in recent exo omic theory. To see why it formation matter, consider the market for used cars A buyer, Tacking reliable information, may ste the price as providing clas shout ers condion, is putssellesina quandary they cut prices, they may only convince people that thet cars ‘re rubbish ‘The labour market, many economists belive, is another such “markt for lemons” This my help spin wy 0 ifficul forthe unemployed t9 price themselves inte works How harmful? ‘When mates fai.herisacase for intervention. But two ques tions need to be answered fi. How much does market flare ‘mate in practice” And can gov emnments put the failure right? “The rest of this article deals with the fst question. Fora bref re Sponse to the second, see thebox nthe next page Markets often coret their own failures. In other cases, an spparent failure. dors nobody Snyharm.n general market ail tire matters fess in practice than isofen supposed. ‘Monopoly, for instance, may seem to presiude an efficent ‘market This is wrong. The mere {et ofmonopoly does not extab-sis that any economic harm is + beingdone ifs monopolyispro- tcced from would compet tor by high bariers to entry, can sas its prices and earn &x ‘ssi profi If that happens, the monopoly. is undeniably harm But ifbariers to entry are low, lack of actual (as Op- posed 16 potential) competitors does not prove hat the monop- oly is damaging: the threat OF ‘competition may be enough to take behaveas Gough were ‘competitive fm. “That is why economists are no longer so intersted in con: centration ras the ouput of fan industry’ biggest frm oF firms asa proportion ofthe ine dlsar/s total output). Judging Whether markets are “contest. able™thatis whetherbariesto ney are igheis Cough to be ‘more important. ‘Many economists would ae cept that Microsoft. for instance, iS" nearmonopolst in some Barts ofthe personal-computer Software businesyet would a gue that the fm Is doing no farm to consumers because its markets remain highly contest able, Because of that persistent threat of competion, the com- pany prices i products keenly. Ith apd in thee wa i be hhavesas though were smaller firm na competitive market ‘Suppose on the other hand, shard natural monoplya rm nox subject 10 the lw diminishing. reums, whose ests fall indefinitely as i ine creases its output is succesfully collecting excessive profits Then woulkbe “competitor: would Spare no efoto make the mat Fetcontesable though innova: tion orby other means. “Telecommunications was once considered a natural mo: nopoly. Today, thanks 9 new technology and deregulation, t isan intensely competitive bust ness—and_ in ‘many. couateies ‘would be more 50 if not foe re maining. goverment restric: tions. Economists used to see natural monopolies wherever theylooked. Now, thanks mainly te Innvaion sped chiey bythe private pursuit of profit these beasts ae sighted much less often eonomists have also changed their thinking on pub: lic goods Almost all economists secept that thereat such things: "nal defence and law andor ‘nain the most traightor- "amples. Bu i was once oy — taken for granted that many wardly excludabe: satelite oh proc ao quay Fronds collect» see not bybeing pure public goods, tion, and in return provide a ilaiiyhenngsonee ier cal ht narambi te i vant characterise) This sonal. With cable and paypet fongerso. View, excludaility works wth “the clasical example of a even finer discrimination. And public god isa lighthouse these-marketstengthening ferviesarebothnonetcludable — novations werenot necesay ind"nomivalrousin consump privately provided television to tion’, meaning that extra ships cceed despite is publicyood fan consume ts output without appearance’ Nowexchdable sheeting wershaingtocan- Weston was and financed Simeless Thisimpliesthatight- through’ advertising. (another howard: Kidtinnveton only the tate can provide them, Such a nest example ced by Fable ofthe bees conomists fom John Stuart The same Ronald Coase wh a MilltoPasl Samuelson-yetitis tacked the lighthouse myth ts todas withthe facts ‘beter known fand won « Nobel "As Ronald Coase pointed out _ prize for his work on externa in a celebrated paper, fom the Iesthe third species of market ii ey many of rin faye cuneate He ighhouses were privately built at, 20 long 28. prope and run. Payment to cover costs Tights are clearly established, iand provide a prof) was ex. extealites willnoteausean i tracted rough fees collected in efficient allocation of resources local pots. ‘The governments In fact few economists would role was confined fo authorising agre: in many cases avo this collection, exacty asa mod- ably high costs wl prevent the fem government might provide netsary transactions from tlc fora private road bude tocol ing pace EvensoyMrCoasr'in. leevaoll. Sigh was rita. Markets find (On the face of it television ways to take account of eternal broadening is another pure itier—ways to. “intemalse™ ie good-again, both non: them, av economists sty-more Exttableandgoraplrauin oterhan you dik consumption. Now, thanks to Bees ae to etemaliies as technology, it ie straight: lighthouses ae © public goods. Imperfect government "HE case for intervention in response to market failure re- | “Tosinetnotontytharte tet amano tha gor ‘emments can do something about it Just as the dangers of mar- ket failure are often exaggerated, $0 too are the skills of yment-Intervention must overcome three formidable dit } ficulties: the tendency of regulated firms to “capture” their regu- | lators, weak incentives for efficiency within the public sector, | and missing information (where markets lack it, governments are likely to lackit as well) ‘The regulation of monopolies isa tellingexample ofcapture. ‘Most monopolies or nearmonopolies are supported father than curbed by regulation. For instance, the licensed profes sions—doctors, lawyers and so on~are among the world’s best. ‘defendecl monopolies Ratherthan merely certifying theskillsof| plein such occupations most governments make it legal unlicensed sellers to practise. Te resulting monopoly styp- cally run by the licence holders themselves. In industry, to, regulation that begins asan attempt to con- rola monopoly often ends up defending it America's Intersta ‘Commerce Commission began as an agency to regulate ra ‘ways which anguably had monopoly power. In due course it ex- tended it each to tucking—parly to help the ralways survive. Inmuch of Europe, regulation oftelecommunications has lately ‘changed in the same way: from controlling to protecting. ‘The record of intervention is poor. Sometimes there is no ‘choice, but history suggests that the burden of proof should Hie | with those who would extend the government’ role. SCHOOLS BRIEF tmpentenatate entrants sonoma ziemsisee oe mapereas ibis aes Sone mare erate le eee ara creak neers ‘keepers. The supposed market owcmear sl ae OE Tommy Pooeees ane tact Hgkeranaee sehen eae Socccat en ocean rae aceite meecitiaenes ee] yore iets ee TS een ome ccna at sone oa, Eedeemecme Rieu eral lack of i: eae Sito rare eee iat ot of markets ‘economic theory says 80, but be- ‘cause experience seems to agree ‘A tesa of al the ais in hie Sees srabiefom Macha | apr of Usha Messe ad en 1a, VAC GST in Canad Pree sed oes wih prepayment [peta or money oder ‘TheEeomomit eerpape Grouping, | Rapin Deye ut Wt rh St Now Yok, N09 Te bakes Fae Gaara. Amencan apes scape