Economic Policy
and Market Regulation
Part 2
Dr. Stefan Kooths
BiTS Berlin
(winter term 2013/2014)
www.kooths.de/bits-ep
KOOTHS | BiTS: Economic Policy and Market Regulation (winter term 2013/2014), Part 2
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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
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Pareto efficiency
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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
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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)
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2-2-2 model: Two consumers, two products, two factors
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Criteria 1: Efficiency of exchange
(Edgeworth box and contract curve)
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Criteria 2: Efficiency of factor use
(efficiency line and production-possibility frontier)
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Criteria 3: Optimal composition of production
(consumer sovereignty)
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Equilibrium: Market clearing and social welfare
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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
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The markets’ navigation system:
Prices as universal information carriers
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Static and dynamic efficiency
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Primary income distribution
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Flexible adjustment to changing conditions
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Technological progress
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“Perfect” competition and reality:
Nirvana critique and the theory of second best
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Market prices, revealed preferences and the impossibility of
calculation under Socialism (Mises)
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Potential market failures and economic policy
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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
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Price ceilings and market outcomes (example: rent controls)
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Price floors and market outcomes (example: minimum wages)
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Escaping price controls
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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
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Taxes on sellers
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Taxes on buyers
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Elasticity and tax incidence: Who really pays the tax?
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Excess burden (deadweight loss) of taxation
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The Laffer curve: Tax rates vs. tax revenues
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Administrative burden
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Marginal tax rates vs. average tax rates
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Lump-sum taxes
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Principles of taxation: Benefits vs. ability-to-pay
 Benefits principle
 Ability-to-pay principle
» Horizontal equity
» Vertical equity
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