Technological advantage and efficiency

      Technological advance contributes enormously to economics efficiency. New and better products and processes enable the society to produce more goods at a less price, and produce a higher-valued mix of output.

 Productive efficiency
       Technological advance improves productive efficiency by increasing the productivity of inputs and by reducing the average total costs. In enables society to produce the same amount of goods and services by using fewer resources, so that it frees unused resources and produce something else from them. If society needs now more less-expensive goods, process of innovation helps to gain greater quantity of output by sacrifying fewer resources used as input. We may state that process innovation increase productive efficiency: it reduces society’s cost of whatever mix of goods and services it wants and thus it is an important factor that shifts economy’s production possibilities curve by shifting it rightwards.
Allocative efficiency
   Technological advance used at production process of various goods increase the allocative efficiency by giving society more desired mix of goods and services.  Consumers are willing to buy a new product rather than an older one only if the new one increases the total utility obtained from usage of the same quantity of scarce resources. That’s obviously that new product (and new mix of products) will create a higher total utility for society. That’s why demand for old product declines and demand for the new one increases. High economic profit gained from the new product attracts resources away from less-wanted by society uses to the production of new item.  This shifting of resources continues until marginal cost and marginal benefit equalize each other.
   However, innovation (either of product or price) may create a monopoly power in the market through patents and through other advantages of being first. When a new monopoly power results from an innovation, society may lose a part of its efficiency it otherwise would have gained from this innovation.  The reason is that monopolist may keep product’s price above marginal cost.
   Innovation may reduce or even destroy monopoly power by providing competition somewhere it didn’t previously exist. Economic efficiency is enhance after this event occurs, because this new product helps to push the prices down, close to marginal cost and minimum average total costs (ATV). Innovation that leads to greater competition in an industry reduces output-restrictions and monopoly prices.

Creative Destruction
   Innovation may even generate a creative destruction, in which creation of new products and production methods simultaneously destroys the market position of existing monopolies and old ways of doing business.
   Examples of creative destructions: movies brought new competition to theatres, which can be shown one at a time, but movies latter were challenged by television, aluminum cans and plastic bottles also displaced glass bottles in many uses, e-mail has challenged the postal service.
   Schumpeter says that an innovator will displace any monopolist that no longer delivers superior performance, but this idea is most treated as a wishful thinking nowadays. In this view, idea that creative destruction is automatic, but it neglects somehow the ability of well-established firms to provide shelter by themselves or by lobbying government to do it. This idea ignores differences between legal freedom of entry and economic reality of entering potential newcomers to concentrated industries.
   In this case dominant firm(s) may use strategies as buyouts, selective price-cutting, massive advertising to block the entry and competition from existing rivals and appearing innovative firms. Moreover, some firms may be able to persuade government to give them subsidies, tax-break, tariff-protection to strengthen their market power.
   In conclusion, while innovation increases economic efficiency; in some cases it may lead to expanding of monopoly power. Moreover, innovation may destroy monopoly power, but this process is neither automatic nor inevitable. However, technological change, innovation and efficiency doesn’t always bring monopoly power.

Obstacles to collusion

     Cartels (that are a formal agreement among various firms in industry to set the prices of products and establish the outputs of the individual firms or to divide the market among them) and other arrangements are difficult to create and to maintain. Let’s describe some barriers to collusion for various industries:
Demand and Cost differences
   Oligopolists face different cost of production and demand curves, so it’s difficult for them to agree on price, which is true for industries that produce differentiated products and change them frequently. Even if firms have standardized products, they usually have different market shares and operate at different degrees of productive efficiency. That’s why even homogeneous oligopolistic firms may have different demand and cost curves.
   Differences in demand and cost mean that even profit-maximizing price and output will be different among firms; there will be no single price acceptable by all firms. Price collusion depends on concessions and compromises which are not easily to obtain, since there are many obstacles to collusion.
     Number of Businesses
       So, it’s obvious the fact that more firms being present in an industry, harder is to create a cartel or other kind of price collusion. An agreement on price set is relatively hard to accomplish when there are 3 or 4 firms, but what if there are 10 firms that share each about 10% of the market, or there is Big Four that has about 70 percent of market share, and there are 4-5 small firms that have other 30% of this market share.
Cheating
     As it was explained in Game Theory model (previous article), there is a high-temptation for collusive oligopolistic firm to make a secret cut in price that may result in increased revenues. So buyers that are getting price cut by one supplier may wait for price-cut for another. Buyers may attempt to create a play between these two firms, so that it may transform into a real war. Even if cheating between collusive oligopolists may be profitable, this act is destructing it over time. However, collusion is more likely to succeed when cheating is easier to observe and punish.
Possible Entry
   Greater revenues may result in attracting new firms in this industry. Since this may create increased market supply and reduced prices, successful collusion of oligopolists requires them to block the entry for new producers.
Recession
   Recessions serves as enemies to collusion, since markets will increase average total costs (ATC), because oligopolists’ demand and marginal revenues (MR) will decrease in response to this recession. Firms will find out that the quantity supplied by them is in excess, so these firms will have to avoid great profit reductions (or losses) after cutting prices and thus they will gain sale at expense of rivals.
Anti-combined law (legal barrier)
   Many countries have anti-combined laws that prohibit this price-fixing collusion, so this means that they have a system of price control.

Technological advance: invention, innovation, and diffusion.

       In economics technological advantage is new and better goods and services and new and better ways of producing or spreading them. This process occurs over a theoretical time called very long run, than can be as short as few weeks or as long as many years. Let’s recall that in all our market systems (pure competition, monopolistic competition, oligopoly and pure monopoly), the short run is a period in which technology, plant are fixed, however in the long run , technology is constant but the firms can change their plant size and are free to enter and exit the industry. In contrast, very long run is a period in which technology can change and firm can develop and supply totally new products.
   It’s known that technological advantage shifts product possibility curve upward, enabling economy to achieve more goods and more services. Technological advantage can be is made up of three parts: invention, innovation, and diffusion.
 Invention
   The first step to technological advantage is invention: the discovery of product or process of producing by using imagination, thinking and experimenting. Invention is a process and the result of it is also called invention. Invention is based in scientific knowledge and it is the result of work of individuals who work on their own or as members of Research and Development (R&D) departments in firms. Government encourages invention by providing patents, right to sell any innovative process of production, machines or products in a set time.
Innovation
Innovation is directly related to invention. While invention is “discovery and proof of workability”, innovation is the successful introduction of new product (invention) in the market, the first use of a new method of producing, or the creation of new form of business firm. There are two types of innovation: product innovation, improving products and services, and process innovation, which is improved ways of production and spreading of these inventions in the market.
In contrast to invention, innovations cannot be patented. Innovation needs not to weaken or destroy the existing firms. Because new products and processes threaten firms’ survival, existing firms have a high incentive to engage into research and development (R&D) process continuously. These innovative products and processes enable firm to earn higher revenue or to maintain the present ones. Innovation can strengthen or weaken market power.
 Diffusion
   Diffusion is the process of spreading of inventions through imitating or copying. To take the advantage of new profits or to slow down disappearing of others, all firms try to implement the innovations. In most of the cases innovation leads to widespread imitation (that’s diffusion) of inventions. For example, soon after McDonald’s introduced the fast-food hamburger, Burger Kings also started to produce it, since it offered high revenues for the firms that supplied this good.
Research and Development (R&D) Expenditures
When it’s related to business research and development means the efforts towards inventions, innovations and diffusion. Many countries engage in R&D of national defense, so that annually they spend thousands of billions of dollars.
Importance of Technological Advantage
   Technological advances for many centuries were viewed ad external to economies, like a force to which economies adjust. Periodically new advances in scientific and technological knowledge occurred. Firms and industries, incorporated new technology into their products and production process to increase or to maintain their revenues. After making some adjustments, they continue to settle into long-run equilibrium position. Economists believe that technological advantage is related to advance of science, which is very important for market system. Some of economists see capitalism is the as driving force of technological advantage. Technological advantage arises from rivalry among individuals and firms that motivates them to seek and exploit new opportunities of profit and of expanding. This rivalry occurs between new firms and existing ones. Entrepreneurs and innovators are viewed as heart of technological advantage.

Monopolistic Competition

So, monopolistic competition is characterized by differentiated products (promoted by advertising), a relatively large number of seller, easy entry and exit from the industry.  First characteristic is an aspect of monopolistic industry, but second and third are an aspect pure completion industry. In general monopolistically competitive industries are more competitive then monopolistic.
 Differentiated Product
In this type of market system, in contrast to pure competitive one, products diverse, that’s why we say that monopolistic competition is described by product differentiation. So firms produce variations of a specific product.  They may change, for example, some physical characteristics, or they have different attitudes towards customers’ service, even may proclaim some qualities of the product that may be real or imaginary ones.
Product Characteristics
Products may have diverse physical or qualitative aspects. Real difference in design, functions, resources used as a raw materials or quality of work provides vital aspects for product differentiation. For example, car producers try to differentiate their products by offering cars with different aspects of engine power, safe system, and design to attract more buyers.

Service
Service and conditions that characterize selling of the products are some kind of product differentiation too. For example, some shops’ directors may stress more on providing some environment-friendly bags and have a higher price of goods, but others may offer the service of their clerks who will carry your products to your car for free. Prestige of the firm, appeal of the products, and helpfulness of the clerks are examples of product differentiation.
Location
Goods may also be differentiated by their accessibility and location. For example, some mini-markets may compete with super-markets, even if their offer small amount of products and charge higher prices for goods, because their location is very convenient for buyers. So a lot of firms in monopolistically competition industry compete on the basis of location.
Brands
Product differentiation can be made by using brand names, trademarks, and celebrity ads. For example, a lot of producers are supplying sugar, but consumer’s choice may be influenced by superiority of some firms (who are known to have higher quality than others, even if it is real or not). For example, when a celebrity’s name is related with some clothing stuff or shoes, buyers may be willing to increase their demand for that product.  Beautiful Packaging of some jewelry, natural water or gifts may attract additional costumers.

 Price control
Even if there are a lot of firms in monopolistic competitive industries, they may have some control over price, because of price differentiation. If the consumers love the products of a specific seller, then they may pay higher prices to satisfy willingness to by that good. So, sellers and demanders aren’t connected randomly, like in a competitive market. So, monopolistic competitors may have some control over price, but it is quite limited, since there are a lot of substitutes for the goods they produce.

Entry and Exit
Entry and exit into monopolistically competitive industries is relatively easier than in pure monopoly and oligopoly. Because monopolistic competitors are typically very small, then economies of scale and capital resources are small enough for new firms to entry. But there may be some financial barriers when these firms will develop and advertise their products from rival’s. Some firms may possess even patents or copyrights, so the entry in this kind of industry will be quite difficult.
However, exit from this kind of market system is very easy. Nothing prevents an unprofitable firm to shut-down their activity.

Advertising
The product’s differentiation policy would be inefficient if the firm won’t be able to tell consumers about them. That’s why monopolistic competitors sometimes advertise their products heavily. So the goal is “non-price” competition which means that prices are a small factor in buyers’ purchases.

Barriers to entry in a Pure Monopoly

   A pure monopoly is a market model in which entry is blocked. So what factors (barriers to entry) prohibit firms to enter this industry?

Economies of Scale
   Modern technology in some industries is such that it permits extension of economies of scale- declining ATC (average total cost). So a firm’s production price will decline if a wide range of output is produced. Given a market demand, only a few large firms, or even a single one, can achieve low average total costs. When long-run ATC is declining only a single producer, a pure monopolist will be able to produce any particular output at minimum total cost.
   If pure monopoly exists in an industry, then economies of scale will serve as entry barriers and will protect the monopolist from competition. New firms will try to enter the industry as small-scale producers but they won’t be able to produce the output at that small price produced by monopolists, so these small firms won’t be able to obtain normal profits needed for survival. A new firm might try to enter as a big producer, but the massive plant output will require very huge amount of financing, which for a new and untried firm will be very difficult to get. In most cases the financial obstacles and risks to start a big business are hinders, that’s why entering in a pure monopoly market system is rarely successful.
   There may be some cases in which market demand curve is cutting long-run ATC curve in a point where ATC curve is still declining  we say that in this case a natural monopoly exists.  So if ATC curve is declining we might say that this firm may set a lower price for its products, but this doesn’t really happen. Conversely, a natural monopolist might set its product’s price far above ATC, so that it obtains an economics profit, that’s why government has to regulate price charged by natural monopolists.

Patent
    A patent is investor’s right to use his or her own invention. Patent and patent’s law protects inventor from rivals who use the invention without helping with expenses or effort at developing it.
   Research and development is what provides our world with new amazing inventions. Firms may get monopoly power by researching or purchasing patents from other firms so they may strengthen current market position.
   The profit from one patent can finance the research for other patentable products. So, monopoly power achieved through patents may self-sustain firm, even if they eventually expire.

Licenses
   Government may limit entry into an industry by licensing. In a country only a small number of licenses for telephone operators may exist. That’s why new telephone operators can’t enter this industry. In some cases government may license itself at providing some products and that’s how it creates a pure monopoly.

Private Property
   A monopolist may use private property as an obstacle to eliminate rivals. So a firm that controls an important resource needed for production of a specific good may effectively block entry of new rival firms.

Pricing
   In some cases a monopolist may create entry barriers by cutting products’ prices, stepping up advertising, or taking other strategic actions to make entrance for a new firm difficult.

Four Market Systems (summary)

  

  There are four models of market system: pure competition, pure monopoly, oligopoly, monopolistic competition.

Let’s describe them briefly:

• Pure competition– is a market structure that is composed of a very big number of firms that produce a standardized product. Entry and exit from this type of market is very easy.
• Pure monopoly- is a market structure in which one firm (or a very few ones) is single seller of a product or service. Entry to this kind of market system is blocked, so one firm can rule the entire industry. Monopolists produce unique product and there is not any reason to difference it, since there are not competitors.
• Monopolistic Competition-is characterized by relatively large number of suppliers who produce differentiated products. There is nonprice competition (each firm is trying to distinguish its product or service by some characteristics like quality, price). Entry to monopolistically competitive industry is relatively easy.
• Oligopoly- is made up of sellers with identical or similar products so that the change in price of one may affect future decisions of other firms.

Pure monopoly, oligopoly and monopolistic competition are considered as imperfect competition.

Market’s Flaws

 

   Market system has many positive characteristics, but there are also some things that make it to failure. This failure may occur when market produces the wrong quantity of goods or even fails to allocate resources to produce some goods and services. First failure results from spillovers but second one is related to public goods.

  Spillover
   When we talk about efficiency of a market, we thinks that all costs and benefits related to the production of it are showed on PPC, indeed sometimes certain benefits and costs aren’t showed by PPC. A spillover situation may happen when the benefits or costs are passed to someone else than immediate buyer or seller. Spillover is also called externality.

 

Spillover Costs
   Spillover costs are some costs that are related to a third person or group of people, and they are not compensated by initial seller or buyer. An example can be the harsh sounds produced by a factory to environment. So the habitat of some organisms may be destroyed.
So what are the economical effects? Since these costs aren’t included to PPC then this curve lies further to the right. So the price of the product is too low, but output is too large to achieve allocative efficiency. Then there happens an over-allocation of resources.

Eliminating Spillover Costs
   There are two ways by which government can correct this over-allocation of resources:

• Legislation– Government is adopting some laws which enforce factory owners to pay for the disturbing of animal’s habitat, by installing better isolation materials or buying better equipment.
• Specific taxes-Government might include levy specific taxes from factory owners. So this will be included in the total cost of production. Then the amount of this tax will be equal to the spillover tax.

       Spillover Benefits
   Sometimes, spillovers can be turned into benefits to the third person or group of people. These benefits aren’t paid to the immediate producer or consumer of that good and services. An example can be education. More educated people receive higher wages. But education has an impact over society. Education lowers crime possibility and promotes fast growing economy.
Spillover benefits make demand curve lie farther to the left, because benefits are underestimated, so a smaller amount of good or service will be produced, then an under-allocation of resources will occur.

Eliminating Spillover Benefits.
   Again government has to solve this problem of under-allocation of resources. Here are two solution subsidize consumers(increase demand), subsidize producers(lower the price) or in other case government has to produce it.

• Subsidize consumers. To correct the problem of under-allocation of resources government has to give some loans or grants to students, so they will be able to afford more education.
• Subsidize producers. Sometimes government finds it more useful to subsidize producers what means that they will be able to increase budget places at colleges and universities. Such subsidies reduce the price of “producing” higher education.
• Provide goods by government.  The last solution for government is to own these industries.

Public Goods.
   Certain goods are private goods because they can be divisible. However, public goods are indivisible. Private goods can be subjected to exclusion principle, so demanders who are willing and able to pay obtain it, others are excluded from getting this product and its benefits. Exclusion principle isn’t applied to public goods since you can’t exclude someone from using this good. To get benefits from private good you need to buy it, but to get benefits from public goods then it just should be available. For example acquiring the Eiffel Tower isn’t economically justified. Since its ratio of total utility over price is very small in comparison to total utility gained from all people who see it. Also if you buy it you can’t stop everyone to see it. In economics this is called free-rider problem, when a group of people receive benefit from a good without paying for it.
Because services of Eiffel Tower can’t be bought or sold there is no reason to buy it. So here is a service which could yield benefits for a nation as a whole but no reason for someone to allocate resource for it. Other public goods are public health, national defense. Society wants like these goods that’s why it supports some political parties.

Quasi-Public Good
   However, there are some public goods for which exclusion principle may apply, they are called quasi-public goods. Such goods may be education, streets, police, and museums. They could be provided by private firms.

Production of Public Goods
   From where government takes resources to produce public goods? As you may guess, it collects money by levying taxes to firm, businesses and households. With less money households and businesses must buy and produce fewer goods. So, demand for goods and demand for resources diminishes. So by decreasing purchasing power, taxes remove resources from private usage. Governments spend these money on purchasing public goods and quasi-public goods, so it changes the composition of economy’s total output.

Key Terms:
Spillover Costs-A cost imposed without compensation on third parties by the production or con­sumption of sellers or buyers.
Spillover Benefit-A ben­efit obtained with­out compensation by third parties from the production or consumption of sellers or buyers.
EXCLUSION PRINCIPLE-The ability to exclude those who do not pay for a product from receiving its benefits.
Public Good-A good or service that is indivisible and to which the exclusion principle does not apply.
Free-rider problem- The inability of potential providers of an eco­nomically desirable but indivisible good or service to obtain payment from those who benefit, because the exclu­sion principle is not applicable