Systems & Institutions¶

Economic Systems¶

Arrangement of economic activity to produce and distribute goods & services

Firms: Organizations that use land, labor and capital to produce goods and services to generate profit

Functions of Market¶

1. Organizing economic activity
2. Determining the optimal price
   • supply reflects the availability/abundance of the commodity
   • demand reflects the willingness for purchasing commodity
   • price for a product without a market(demand/supply) for it is undefined
3. Encourage efficiency and specialization
4. Signaling of availability
   • Seasonality: Seasonal food
5. Allocation of resources

Not all market signals are pure market signals Distortion of market signal: when govt creates policies to change pricing in a free market Eg: subsidies

Market Power¶

It is the power of firms to control their selling price. It allows them to determine their own profits. It depends on

• type and intensity of competition
• costs of production
  • this influences the type of competition in market, because it is cheaper for one firm to produce at a larger scale
  • big companies threaten small by lowering their price, to make them run out of business; otherwise acquire their company
  • eg: Facebook-Instagram

Sometimes, consumer may have greater market power. This occurs when there is only a sole consumer, but many sellers eg: Dubai Metro

Market Failure¶

• Reasons why market is not functioning the way it is 'supposed' to be
• Prices do not capture the effects of individual actions
  • Public goods
  • Externalities
  • Monopolies
  • Missing markets
  • Asymmetric information

Market fails when it comes to non-excludable commodity

Example - Fraud - Imperfect information

Competition in Markets¶

Type				Example
Monopoly	1 seller				Monopoly supplier produces at the quantity where Marginal Revenue & Marginal Cost intersect
Duopoly	2 sellers
Oligopoly	few sellers have control, but not as much as monopoly/duopoly			eg: telecom
Monopolistic	there are large no of sellers but no of sellers is small enough that if one seller changes their price, other sellers will tend to change their price also in reaction			aviation industry, snacks
Perfectly-competitive Market	when there are large no of sellers and buyers - no of sellers large enough such that change in price by one seller should not affect other sellers’ decision - no of buyers large enough such that decision by one buyer should not affect other buyers’ decision Demand elasticity for a single firm is perfectly elastic: if a seller inc price, then the demand for their product becomes 0, as no one will be willing to buy from them.	Producers are price-takers	1. Identical substitutes exist 2. Perfect information 3. Low search & transaction costs	- agricultural industry: one farmer stops producing rice does not affect other rice farmers - food consumption: one buyer stops eating rice does not affect other buyers of rice

Monopoly¶

• private monopoly: unfair situation for consumers where there is only a sole producer of a product

• natural monopoly: situation where there is a single producer (like govt), but not necessarily bad; eg: Railways

• monopoly can be addressed through govt subsidies for the monopoly

• the monopoly company will tend to increase output to attain the new maximum marginal net benefit
• hence, the level of optimal output will be greater after subsidies than without it, and hence the producers increase the supply
• this will reduce the price and benefit the consumers

Duopoly¶

A situation with multiple buyers, but only 2 sellers

Nash equilibrium (by John Nash) says that

An agent who has a competitor will always design the best policy, with the assumption that the competitor will also design its own best policy

Institutions¶

Rules for the system

Coordination: Invisible hand: Everyone working in their own self-interest drives the collective market

Democracy¶

3 key characteristics 1. Rule of law 2. Civil liberties 3. Inclusive, free, and decisive elections

Government¶

Govt is the only actor allowed to use legitimate force

Govt responsibilities 1. Protect property, civil & human rights of citizens 2. Maximize surplus/efficiency 3. Generate efficient outcomes, such as prevent 1. Monopoly 2. Tragedy of Commons for CPR For community resources(like fishing ponds, forests), the govt comes in to prevent over-utilization of the resources; supports sustainability 3. Market failure: Govt interferes in fields where private investors are not interested 4. Promote equality/equity 1. prevention of trade of whatever is socially harmful (alcohol, drugs) 2. keeps market's obsession with efficiency at the expensive of equity in check 3. reduces economic inequality 5. Socially desirable outcomes

Dangers - Use of force to silence opponents: companies - Rent-seeking - Oligarchy - Self-Enrichment

Well-designed governments have limits on government power - Elections - Constitution

Government Failure¶

• Failure of political accountability
  • Economic infeasibility: Public policy may not be effective if it does not provide efficient incentives (Nash equilibrium)
  • Administrative infeasibility: Public policy may not be effective if there is not sufficient state capacity or limited information
  • Political infeasibility: Public policy may not be effective due to vote (incentives, intransitivity, Condorcet paradox), short-termism, unequal access, lobbyists

How to increase public participation¶

• Prevent large groups from free-riding by changing individual gains
  • Coercion: Increase cost of not acting
  • Selective incentives: Increase the benefits of acting
  • Federation: Make big group feel small

Ideal Institutional Mix for Capitalism¶

Democracy is not the requirement

• Incentives for innovation
  • Secure private property
  • Competitive markets
• Efficient firms:
  • Competent leadership
  • Create goods at low cost
• Public policy
  • Govt policies that foster these conditions
• Public good provision
  • Govt fills gaps missed by private sector

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