Micro CHAPTER 6.4:

CHAPTER SUMMARY

Governments intervene (get involved in) markets for a lot of reasons, usually with the general goal of maximizing social net benefit.

One thing that governments do to encourage competition is to enact anti-trust laws, which aim to ensure that markets have competition. These laws are designed to break up monopolies, encouraging firms to compete with one another, which benefits consumers.

In more competitive markets, there are other things that governments might do to try to increase or decrease the quantity produced and sold. They can implement taxes in two ways:

• Per-unit production taxes: These are taxes that go up the more you produce, which shifts the MC, AVC, and ATC upward for each firm, decreasing the profit-maximizing quantity for firms, and shifting the supply curve upward, decreasing the equilibrium quantity.

• Lump-sum taxes: These are taxes that simply charge businesses a flat amount of money (e.g. $100), regardless of how much they sell. This does not affect the MC or AVC because it is like a fixed cost, so the profit-maximizing quantity of the firm does not change. However, the ATC does shift upward because the total costs for the firm increase, which can reduce the profits of the firm and cause some firms to exit in the long run.

As we saw in Chapter 2.8, another way that governments intervene in perfectly competitive markets is with price floors and price ceilings. A price floor is when they set a minimum price for a good, and a price ceiling is when they set a maximum price for it. If the floor is below equilibrium or the ceiling is above equilibrium, then the intervention would have no effect. However, if the price floor is above the equilibrium, then the quantity supplied at that price will be higher than the quantity demanded, leading to a surplus. This can also be applied to labor markets, as a minimum wage is a type of price floor.

Similarly, if a price ceiling is below the equilibrium price, then the quantity demanded at that price will be higher than the quantity supplied, leading to a shortage. Both of these result in a deadweight loss.

Sometimes, when there is a natural monopoly, governments do allow monopolies, but regulate (make rules for) them to try to maximize net social benefit. As we have seen, in the chart below, an unregulated monopoly would produce at point A, where MC = MR. However, the socially optimal point would be where MC = D, at point C and price P2. If the monopoly sells at P2, however, it will make a loss, because the ATC is higher than the price, so it would not do this unless the government intervenes.

So, the government has a few options to address this.

1) It can set a price ceiling at the fair return level, at the price where ATC = D, giving the firm a normal profit. This reduces the deadweight loss from the triangle under points A, C, and the demand curve to the triangle under points B, C, and the demand curve.

2) It can set a price ceiling at the socially optimal price, and then offer a subsidy to the monopolist firm to ensure it receives a fair return. The subsidy would need to be equal to the difference between the ATC and the price at the socially optimal quantity.

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