Perfect Markets & the “World Truth”

Group 11Arun Mantena – GMAY08BM061

Kumar Gaurav – GMAY08WM125Parul Sharma – GMAY08IT027

Pravin Surianarayanan – GMAY08IT028Shivanand Chukka – GMAY08WM142

Vijay N – GMAY08WM152

Introduction

• Free markets force you to tell the truth

• Efficiency is always not fair

• Taxes are like lies : they interfere with the world

Prices are optional

• Prices reveal information• Stores and consumers can always opt out• People don’t buy things that are worth less to

them than the asking price• Most transactions make both parties better off• For customer: Value >= Price• For producer: Value <=Price• Free choices produce information about

priorities and preferences and market prices aggregate these priorities and preferences of us all

Perfect markets. Perfect markets are extremely competitive markets.

There is a sufficiently large number of participants so that no individual can affect the market.

Competition will force the price of the goods to marginal cost.

Profits in a competitive market are just enough to pay workers and persuade entrepreneurs that their money isn’t better off in a savings account.

If the Price is high, new firms will enter and if price is low, firms would go until they find price is appealing.

Perfect markets do not convey a vague fact but it conveys the precise truth, true representation of cost to firms and true representation of value to customers.

What if other industry also becomes perfectly competitive?• Every product would be linked to every other

product through an ultra complex network of prices, so when something changes somewhere in the economy everything else would change - may be imperceptibly, may be a lot-to adjust.

• Ex. A frost in brazil causes reduction of coffee output ,thereby leading to following sequence of events:

• Demand for alternate products like tea would rise a little causing extra supply of tea.

• Demand for Complementary products like coffee creamer would fall a little.

• Kenyan farmer earning bumper profits and invest the money in aluminium roofings, causing the rice in price of aluminium.

• Some would wait till the prices fall down and deposit in bank account, thereby increasing the demand for bank accounts and safe deposits.

Perfect markets

Competitive Market Model. Customer’s choice based on the opportunity cost of the goods. Manufacturer aligns themselves based on the requirements of

people. Change in consumption pattern causes ripples in price system

continue outward causing seismic shifts in related areas. Results of Set of perfectly Competitive market model.

Companies are making the thing right way.Companies are making the right things.Things are being made in the right proportions.Things are going to the right people.In Conclusion if the right things are made right in the right

quantity and going to the right people who value them the most ,

there is no room for any gains of efficiency.

Life without markets• Non market system is flat, that is, neither one can

gain any extra service by paying more nor they forgo services if they can’t pay

• Thus non-market system leads to equality and stability• Unlike market system the best pie doesn’t go to the

people who are willing(able to pay most)• In a non-market system, truth about value, costs and

benefits disappears• Channeling of money is not in the right direction• Examples of non-market: Government provided

schooling, police service, Government Healthcare, Defense, non-market services of recreational and cultural activities etc

The signaling function of prices

• Prices provide a way of deciding - who enjoys the

limited supply

• Prices also have signaling effect on demand and

supply

• Prices reveal information since they are optional

Efficiency vs Fairness• Efficiency

– When Price Equals Cost -- Cost Equal Value to customer –- Keeps things efficient

• Fairness– Purposefully making everyone to benefit in & from society through Tax

• Tax reduce Efficiency– Example 1

• Price of coffee in Perfectively competitive market - 90 cents• Price after Tax - 1 dollar• Willingness to pay for coffee by customer - 95 cents• Coffee sold - NONE• Tax raised – NONE

– Example 2• Price of BMW 7 series car in US market – 60

lakhs• Price after Tax in India (excise tax, import duty, sales tax etc etc…) – 1

crore 42 lakhs• Willingness to pay for BMW 7 series car by customer - 70 to

75 lakh• BMW 7 series sold –

NONE• Tax raised – NONE

Efficiency vs Fairness (contd…)

• Efficiency and Fairness has to be handled hand to hand in economics, or else wealth will be accumulated at one end– Example,

• Bill Gates, Mukesh Ambani, Karunanidhi and Large scale Politicians

• Fairness can be introduced into economics by taxation, Tax can make sure that wealth is at least somewhat evenly spread– Example

• High taxes for Price-sensitivity low products, ex Cigarettes, Alcohol

• Low taxes for commodities and basic need products

Fairness

• Government intervention to make a fair society

at the cost of being inefficient

• Kenneth Arrow - Proved that perfect markets

can bring in efficiency and fairness

• Head Start Theorem – Adjust the starting

positions.

100 – Metre Sprint

Vijay                       5

Ravi                   1

Bhalotia                     3

Bandhan                   2

Chandra                     4

• If all sprinters have to cross the line together• Fast Runners have to slow down • Waste of Talent• No motivation to run fast• Fairness at the cost of efficiency

100 meter Sprint

Vijay                       F

Ravi                       A

Bhalotia                     I

Bandhan                     R

Chandra                    

• Adjust the starting position• Fast runners will continue to run fast• Slow runners will run at their strength (No change in consumer behaviour)• All runners will cross the FINISH line at the same time•No loss of efficiency

Lump-Sum Tax & Subsidies

• Income distribution in a society

X              

Y                  

Z                

X              

Y                  

Z                

X                

Y                

Z                

• A lump-sum tax is levied on everybody• No change in consumer behaviour as there is nothing one can do to avoid it• Does not lead to inefficiency

• Redistribution by subsidies • Fair outcome with efficiency prevailing

Head-start – Practicality?

• “Head-start Theorem” – Impractical implementation▫ One-time Lump-sum Tax

The idea – impose a one-time tax on high earners The effect

Move the starting point backwards for faster sprinters Sprinters still run at their best speeds Taxed consumers will still be willing to pay the same value as before the

tax No change in behavior; equivalent efficiency; more fairness

▫ Practicality Assume one-time tax on Tiger Woods Over his career, his behavior would not change But effect on aspirants? – fewer people would want to take up golf Although no change in the taxed individuals’ behavior, there is a

change in the behavior of the larger population Such tax can cause a change in behavior of the market, hence is

impractical.

Head-start – Practicality?

• “Head-start Theorem” – Practical implementation– Case of taxes on domestic fuel during winters

• Domestic fuel is very important for consumers during winter• Inelastic demand => Governments should increase taxes to raise

revenue, no change in consumer behavior

• But what about low-income elderly?• Governments generally lower taxes on fuel => inefficiency

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Head-start – Practicality?

• “Head-start Theorem” – Practical implementation▫ Normal taxation, but targeted redistribution

The idea Impose higher taxes on everyone for fuel – an inelastic product Distribute extra money to elderly

The effect Gives a head-start to the low-income elderly Elderly able to pay taxes AND enjoy benefits of fuel Consumer behavior does not change Increased government revenues, more efficiency, more fairness

▫ Practicality Easy to implement Does not change individual or population behavior Allows each person to use money to its full value as they

deem fit

Thank You