Performanceiof 04

Market Performance
• Four objectives a society must meet if it wishes to

maximize the welfare of its citizens.
1. Efficiency (The scarce resources of society should
be employed to yield the highest possible real
income)
2. Growth (Society should seek to increase the
quantity and quality of the factors of production
so that economic growth can occur)
3. Full Employment
4. Equity
– In evaluating the market performance of an
industry we seek to understand how the industry
contributes to the above list of objectives. We
need to remember we are comparing actual
performance to potential.
Efficiency: Basic Math
• Given: MPK = 40 PK = $10
MPL = 18 PL = $6
What can the firm do to increase efficiency?
• Given: MPK to produce oranges = 40
MPK to produce apples = 60
PK = $10
What can the firm do to increase efficiency?
Efficiency: Additional Explanations
Reasons for inefficiency

1. Firms do not take advantage of economies of scale.
Economies of Scale – Increases in production
that reduce minimum average cost.
2. Excess Capacity
3. X-inefficiency – inefficiency that results from the
lack of competitive pressure.
4. Advertising
Measuring the Inefficiency of
Monopoly Power
• Dansby-Willig Performance Index - Ranks
industries according to how much social
welfare would improve if the output in an
industry were increased by a small amount.
• If DW = 0 , Social welfare would not be
improved if industry output was expanded.
• If DW > 0 , Social welfare would be improved if
industry output was expanded.
Dansby-Willig performance
indices for Selected U.S industry
Industry Dansby-Willig Index
Textiles .38
Apparel .47
Rubber .49
Food .51
Printing and Publishing .56
Leather .60
Paper .63
Petroleum .63
Chemicals .67
Efficiency and Profit Rates
• What should be the long-run level of profit in an
industry? Normal profits
• Normal profits – the real rate of return to long-term
investments in the economy.
• Why would profits diverge from the normal rate of
return?
– Windfalls and risk can explain short term
fluctuations, but not necessarily long-run
differences.
– This leaves us monopoly power
Why Above Normal Profits?
• Higher concentrated industries tend to earn
higher profits.
• Firms with higher barriers to entry also tend to
earn higher profits.
• In contrast, buyer concentration tends to
reduce the level of profits.
Efficient Scale of Production
• Review Economies and Diseconomies of Scale
• Research suggests that some firms are too small to fully exploit
economies of scale.
• Why? Product differentiation and geographic isolation
• Who is likely to be most efficient?
– Perfect competition: No, the firms cannot afford the best
technology.
– Oligopoly: No, the industry lacks competition.
– Efficiency seems to be maximized somewhere between these
two extremes.
Efficiency of Advertising
• Advertising can
– provide information, which is good.
– waste societies resources, which is not
good.
– be utilized to erect barriers to entry
(not good).
Efficiency of Product Variation
• Changing the product is an effective
method of non-price competition in
addition to advertising.
– Durability
– Range of styles
– Frequency of model changes
• All of these vary depending upon the
level of competition.
Economic Growth:
Progress, Research, and Innovation
• Economic Growth: The Basics
– Q = f(quantity of the factors of production, quality
of the factors of production)
– Changes in quantity will not lead to persistent
economic growth across time.
– Persistent economic growth comes about from
changes in quality, or technological change
• What market structure is necessary to produce
technological change?
Economic Growth: Competing Views
• The traditional view is that competition spurs technological
change.
• An opposing vision is offered by Joseph Schumpeter.
– Schumpeter argued that common competition (price, quantity)
did not create economic growth.
– Technological change comes about when firms create new
modes of production. Who is capable of such innovations?
Firms that are large enough to survive if the innovation fails.
Hence, monopoly power is necessary for economic growth.
• The evidence suggests that a mix of firms produces the greatest
level of innovation.
Full Employment and Price Stability
• Who would have more stable prices?

Oligopoly vs. Competition
• If prices are stable, what happens to
employment?
Equity
• Can we have a perfectly equitable distribution
of income and still expect economic growth?
• How much inequity is necessary?
• Other social issues:
– Racial Discrimination and the work of Gary
Becker.
– The alienation of workers.

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Market Performance

• Four objectives a society must meet if it wishes to

Reasons for inefficiency

• Who would have more stable prices?

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