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Market Failure and Government Intervention

Table 17-2 summarizes the different studies that we have just briefly introduced.  Each of these studies implicitly involves different objectives (column 1) and choices (column 2) which will be studied more carefully in various chapters (column 3) of this book.  Each of the studies is likely to be the province of a different department (column 4).  Not surprisingly, the departments in many business schools have the same names as their business counterparts; in other words, the staff members of a firm are trained to solve problems with different objectives, constraints and choices.  

Managers must choose the right people to make the choices that will maximize an organization's goals.  These organizational goals must be continually evaluated in light of the changing market which means that the manager must have an understanding of the changing market equilibrium defined by supply and demand for a firm's production.  Increasingly, this understanding must be global.

SECTION 3.  THE ECONOMIC BASIS FOR GOVERNMENT INTERVENTION: Market Failure

One important role that faces executives is to defend a company in the face of government intervention.  To avoid making shallow arguments on the basis simply of self interest, it is wise to learn the economic language and logical basis for deciding whether a government should intervene in the market place or not.  Essentially the argument is made on the basis of the desirability of leaving a market alone (“laissze faire”) unless it clearly fails to perform its functions.  The economic arguments for government intervention are typically justified on the basis of market failures.  Private markets have characteristics which can cause them to fail to achieve a desired social optimum.   Market power, lack of information, externalities, indivisibility of a product, inequities, and dynamic forces can all push a market away from such a social optimum.  

A.  Market Power

Market power causes the price to move above the social optimum price and quantity to fall below the social optimal quantity.  As a result both producers and consumers experience welfare loss.  The deadweight welfare loss can be measured in terms of the loss in consumer and producer surplus due to the lower quantity and higher prices resulting from market power.

Market power is easy to identify in the media.  It occurs whenever there is evidence that firms have the ability to influence market prices.  For example, read the following article about Oracle purchasing PeopleSoft, and the debate it has with the Antitrust agencies in order to prove that it won’t have the ability to influence prices anticompetitively:

The U.S. Department of Justice said in a post-trial filing that Oracle Corp.'s proposed takeover of PeopleSoft Inc. "would likely result in substantial anticompetitive effects, and is accordingly unlawful."

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