Market Decisions Essay
“The Power of Markets: Who Feeds Paris?” begins with the story of Coca Cola in East Germany. The story takes place at a time when the East German currency is entirely worthless. Regardless of the health benefits or risks of the beverage, the head of Coca Cola Europe decides that the drink must be given away for free as a friendly introduction. Free coolers are also given merchants that agree to sell Coca Cola. When the drink starts to sell well in East Germany, it is not because of its health benefits. Rather, it is because East German consumers have started to enjoy the beverage. After all, in a perfectly competitive market, the consumers’ goal is to maximize utility, while maximization of profits is the goal of producers – regardless of whether the product or service in question appears to be beneficial for everybody at the same time.
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When the author of “The Power of Markets: Who Feeds Paris?” mentions markets, perfect competition is his or her focus. In perfect competition, prices are known to automatically move to economic equilibrium and the quantity demanded equals the quantity supplied. If the price is raised beyond the equilibrium price, market forces push the demand of the product or service down, as buyers turn to substitute products or services. When prices are below the equilibrium – a standard (or balanced) price at which buyers and sellers are equally satisfied – the demand of the product or service is expected to increase. This is the basic law of demand and supply, an interaction between market forces including regulations, consumers, sellers and their competitors. “The Power of Markets: Who Feeds Paris?” explains this basic law of microeconomics with various examples, including the market for diamonds. It is not as though the market for diamonds has a single supplier or a monopoly. Because diamonds are rare, their low supply dictates their price, usually set quite high because suppliers cannot sell enough diamonds for a price that almost everybody can afford. The concepts of scarcity and opportunity cost may also be used to explain the dynamics of the diamond market. But these concepts constitute the fundamentals of microeconomics and may be used to explain Coca Cola’s behavior in East Germany as well.
“The Power of Markets: Who Feeds Paris?” refers to markets as “amoral” simply because producers do not necessarily produce goods or services that the people need for the price they find affordable (18). For example, even as Hollywood stars get facelifts and nose jobs at the most expensive health clinics in the United States, there are millions of people that cannot afford health insurance in the country. If maximization of benefits for society as a whole was the goal of markets, this would not happen. It is for this reason that the government must step in to either convert private healthcare firms into publicly owned companies or establish the latter without changing the private healthcare system. Governments also take responsibility for various public goods, after all; for example, military protection for the entire nation. Likewise, governments must step in with regulation when private firms appear to display behavior that is inconsonant with the principles of perfect competition. Even unethical behavior, such as high pollution around a manufacturing plant, must be checked by the government.
The author of “The Power of Markets: Who Feeds Paris?” refers to barriers to entry as well. If a firm produces a good that nobody else has the technology to produce, there is a barrier to entry because other firms are not equipped to compete with the firm that produces the unique good. Regulation may also act as a barrier to entry. But, regulation may be applied in any number of ways as an interruption for the free market. Perhaps the government would ban Coca Cola if it is found that some of the chemicals used to manufacture it are very harmful to human health. As another example, governments may step in to regulate monopolistic behavior on the part of firms. In a perfectly competitive market there are many firms supplying a product or service. A monopoly, on the contrary, is the only firm in a particular market. The market price in the industry is determined by the supply and demand for the product or service in question. As the market supply decreases, the price of the product increases.
A monopoly is in a very good position to decrease supply and thereby increase the price that it charges for the product or service that it supplies. Since it has no competitors, there is no compulsion to decrease the price in order to beat competition. All the same, the monopolist faces a loss because now there are fewer buyers for its products or services, given that the price has increased. So as to offset the decrease in profits, the monopolist would decide on a price that is higher than its marginal cost. If the marginal cost is represented by the supply curve, the monopolist would decide to produce a quantity that is less than the quantity at the intersection of the demand and supply curves, that is, the quantity produced in a state of perfect competition.
According to economists, the Dead Weight Loss of a monopoly must be borne by the entire economy seeing as the monopoly is charging a price that is higher than the price at the intersection of the demand and supply curves in a state of perfect competition, and also producing a quantity that is lower than the quantity produced in a state of perfect competition. The monopolist may decide to continue increasing the price by reducing the quantity that it supplies, and thereby increase the Dead Weight Loss to society. This is exactly why the U.S. Justice Department or the EU anti-trust chief must intervene to put an end to monopolistic practices or market failure in favor of pure or perfect competition. Then again, governmental departments may step in at any time seeing that perfect competition would make “amoral” markets anyway (“The Power of Markets: Who Feeds Paris?” 18).
“The Power of Markets: Who Feeds Paris?” Chapter 1. Naked Economics.