KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 2 1

Economic Policy and Market Regulation

Part 2

Dr. Stefan KoothsBiTS Berlin

(winter term 2013/2014)www.kooths.de/bits-ep

KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 2 2

Outline

1. Introduction and Overview

2. Market Mechanisms and Government Interventions Market-based coordination and welfare

economics Price controls Taxes

3. Externalities and Public Goods

4. Competition Policy and Regulation

5. Ordoliberalism and the Social Market Economy

6. Summary: The Key Lessons Learnt

KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 2 3

Pareto efficiency

KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 2 4

Conditions for „perfect“ competition (1/2)

Atomistic market structure» Infinite number of buyers and sellers (no market power)» Price taker/autonomous decisions

Rationality» Consumers/households: Utility maximization» Producers/enterprises: Profit maximization» Self-interest with fair means (no opportunistic behavior)

Homogenous goods (products and factors)» No personal/spatial/physical preferences» No indivisibility

Stationary world» Given resources, constant technology» No growth analysis, no process/product innovations

KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 2 5

Conditions for „perfect“ competition (2/2)

World without frictions» Zero transaction costs (no costs for making an exchange of goods)» Perfect factor mobility (unrestricted market entry/exit)

Freedom of choice» No involuntary/compulsory transactions» No technological external effects

Perfect information/total transparency» Full knowledge/free information about alternatives and prices» No uncertainty

Infinite speed of response» Focus on equilibrium analysis» Transactions only at equilibrium prices (no “false” trading)

KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 2 6

2-2-2 model: Two consumers, two products, two factors

KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 2 7

Criteria 1: Efficiency of exchange(Edgeworth box and contract curve)

KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 2 8

Criteria 2: Efficiency of factor use(efficiency line and production-possibility frontier)

KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 2 9

Criteria 3: Optimal composition of production(consumer sovereignty)

KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 2 10

Equilibrium: Market clearing and social welfare

KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 2 11

Fundamental theorems of welfare economics

Theorem 1:Competitive markets tend toward an efficient allocation of resources (= fulfill criteria 1 to 3)

Theorem 2:Any particular Pareto-efficient outcome can be achieved via lump-sum wealth redistributions and then letting the market take over

KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 2 12

The markets’ navigation system:Prices as universal information carriers

KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 2 13

Static and dynamic efficiency

KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 2 14

Primary income distribution

KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 2 15

Flexible adjustment to changing conditions

KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 2 16

Technological progress

KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 2 17

“Perfect” competition and reality:Nirvana critique and the theory of second best

KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 2 18

Market prices, revealed preferences and the impossibility of calculation under Socialism (Mises)

KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 2 19

Potential market failures and economic policy

KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 2 20

Outline

1. Introduction and Overview

2. Market Mechanisms and Government Interventions Market-based coordination and welfare economics Price controls Taxes

3. Externalities and Public Goods

4. Competition Policy and Regulation

5. Ordoliberalism and the Social Market Economy

6. Summary: The Key Lessons Learnt

KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 2 21

Price ceilings and market outcomes (example: rent controls)

KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 2 22

Price floors and market outcomes (example: minimum wages)

KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 2 23

Escaping price controls

KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 2 24

Outline

1. Introduction and Overview

2. Market Mechanisms and Government Interventions Market-based coordination and welfare economics Price controls Taxes

3. Externalities and Public Goods

4. Competition Policy and Regulation

5. Ordoliberalism and the Social Market Economy

6. Summary: The Key Lessons Learnt

KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 2 25

Taxes on sellers

KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 2 26

Taxes on buyers

KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 2 27

Elasticity and tax incidence: Who really pays the tax?

KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 2 28

Excess burden (deadweight loss) of taxation

KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 2 29

The Laffer curve: Tax rates vs. tax revenues

KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 2 30

Administrative burden

KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 2 31

Marginal tax rates vs. average tax rates

KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 2 32

Lump-sum taxes

KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 2 33

Principles of taxation: Benefits vs. ability-to-pay

Benefits principle Ability-to-pay principle

» Horizontal equity» Vertical equity