Social welfare is maximum in case of imperfect competition

• 1. Contents:Whatis social welfare in Economics.Two approaches of social economicsPerfect & Imperfect competition.A Perfection Benchmark to the rescue.

2. Welfare economics is a branch of economics that usesmicroeconomic techniques to evaluate economic well-being,especially relative to competitive general equilibrium withinan economy as to economic efficiency and the resultingincome distribution associated with it. Social welfare refers to the overall welfare of society. Withsufficiently strong assumptions, it can be specified as thesummation of the welfare of all the individuals in the society.Welfare may be measured either cardinally in terms of"utils" or dollars, or measured ordinals in terms of Paretoefficiency. 3. The cardinal method in "utils" is seldom used in puretheory today because of aggregation problems that makethe meaning of the method doubtful, except on widelychallenged underlying assumptions. In applied welfareeconomics, such as in cost-benefit analysis, money-value estimates are often used. 4. There are two mainstream approaches to welfare economics:the early Neoclassical approach and the New welfareeconomics approach. The early Neoclassical approach was developed byEdgeworth, Sidgwick, Marshall, and Pigou. It assumes that:Utility is cardinal, that is, scale-measurable by observation orjudgment. Additional consumption provides smaller and smallerincreases in utility (diminishing marginal utility). 5. The New Welfare Economics approach is based on thework of Pareto, Hicks, and Caldor and Prof. T Scitovsky. It explicitly recognizes the differences between theefficiency aspect of the discipline and the distributionaspect and treats them differently. Questions of efficiency are assessed with criteria such asPareto efficiency and the Kaldor-Hicks compensationtests, while questions of income distribution are coveredin social welfare function specification. 6. Further, efficiency dispenses with cardinal measures of utility, replacing it with ordinal utility, which merely ranks commodity bundles (with an indifference-curve map, for example). Scitovsky derived a third version to the Compensation Principle in his novel A note on the Welfare Proposition in Economics called the Scitovsky Paradox or Reversal Test. 7. PERFECT COMETITION:- perfect competition describes markets such that noparticipants are large enough to have the market powerto set the price of a homogeneous product. Because theconditions for perfect competition are strict, there are fewif any perfectly competitive markets.Still, buyers and sellers in some auction-type markets,say for commodities or some financial assets, mayapproximate the concept. Perfect competition serves asa benchmark against which to measure real-life andimperfectly competitive markets 8. 1. Large number of buyers and sellers.2. Homogeneous product.3. Free entry and exit of firms.4. Perfect knowledge.5. Perfect mobility of the factors of production.6. Absence of transport costs.7. Government non-intervention8. Only one price 9. Markets or industries with two or more sellers and buyers thatfail to match the criteria of perfect competition.The most noted examples of imperfect competition are the twomarket structures with selling-side control--monopolisticcompetition and oligopoly. Lesser known market structureswith buying-side control--monopsonistic competition andoligopsony--are also considered as imperfect competition.Facing no competition, monopoly and monopsony are notincluded. Most real world markets can be considered imperfectcompetition. 10. Imperfectcompetition is the general term for competitive markets that do not match the criteria of perfect competition. They are competitive, but they are imperfect. Market structures with no competition--monopoly and monophony--are excluded 11. This is where the benchmark of perfect competitionis most important. By comparing specific, realworld, imperfectly competitive markets with perfectcompetition, the degree of inefficiency can beindicated. If a monopolistically competitive markethas a price of $10,001 and a quantity of9,999,999, while the comparable price and quantityfor perfect competition are $10,000 and10,000,000, then inefficiency exists, but theproblem is relatively small. Undertaking imperfectcorrective government actions is likely to makematters worse. 12. In contrast, if an oligopolistic market has a price and quantityof $20,000 and 5,000,000, compared to a price and quantityfor perfect competition of $10,000 and 10,000,000, theninefficiency also exists, and this inefficiency IS DEFINITELYmore severe. Even imperfect corrective government policieshave a good chance of improving upon this inefficiency. In real world, inefficiency problems and the need for correctivegovernment policies are extremely diverse. And with thisdiversity comes differences of opinion and controversy. Infact, a number of the more interesting economic discussionsinvolve questions about what, if any, actions governmentshould take to correct the inefficiencies of imperfectcompetition. 13. Imperfectcompetition is when a firm has too much control over the market of a particular good or service and can therefore charge more than its market value. When the market for a certain good or service doesnt have very many competitors, the sole or few firms control the market. For example, suppose you need to get gas and the only place around is XYZ corporation and you dont have enough to get to the next station. They can charge you more than the market value, even $10 per gallon, because theres no competing gas station that you can buy from instead. 14. Some forms of imperfect competition are good for society.One of these is a "natural monopoly"; this occurs when thegovernment grants a certain company sole market powerover a specific area for a certain service. The government does this for services when the marginalcosts of providing the particular service are really high withjust a few customers; because of this, the governmentensures that the particular company has enough customersto drive down the companys average costs without having tocharge too low of a price so that theyll still find it profitable toprovide the service. Otherwise, if companies stand to lose more than gain, certainservices will be under-provided. For example, you may havenoticed that most people where you live all use the same gasand electric company. Thats an example of a desirablesituation of imperfect competition. 15. There are different ways of defining perfect competition : however, for our purposes in this chapter, we can pick out two important features:(a) all agents are price takers,(b) prices adjust to equate desired supply and demand. When we say that agents are price takers, we mean that they treat the market price as given, they believe that they have no ability to influence the market price. Thus, when perfectly competitive firms decide how much output to produce, they treat the price as given and choose the output that equates supply with demand. This decision defines their supply function, which tells us how much they wish to supply at different prices. Similarly with consumers in deciding demand. When we say that prices adjust to equate supply and demand, we mean that the market price is determined (somehow!), at the point where the supply and demand curves intersect at point E in 16. Figure, at price p* and quantity x*. One of the mostimportant points to note about the competitive equilibriumis that it is in some senses a socially optimal outcome (in the absence of externalities etc.). In particular, we cansay that it maximize s the sum of consumer andproducer surplus or more simply maximize s total surplus 17. Figure,at price p* and quantity x*. One ofthe most important points to note about thecompetitive equilibrium is that it is in somesenses a socially optimal outcome (in theabsence of externalities etc.). In particular, we can say that it maximize sthe sum of consumer and producer surplusor more simply maximize s total surplus 18. To see this, note that if we consider the competitiveequilibrium in Figure, the producer surplus, which is bestthought of as profits, is given by the area between thehorizontal price line p=p* and the supply curve, representedby the triangle between points ABE. 19. The consumer surplus is given by the triangleACE, the area between the demand curve and thehorizontal price line p=p*. Total surplus is then thetriangle BEC. From the point of view of social welfare, the netgain to an additional unit of output is the verticaldistance or gap at that output between thedemand curve (which represents the marginalvalue of output) and the marginal cost curve(which represents the marginal cost of output): atxa this gap is GF. The total loss in surplus when we compare xa to x*is the triangle GEF. 20. Nowlet us consider an imperfectly competitive equilibrium, for example a monopoly. A monopolist will set its price as some mark-up over marginal cost. For example, assume the profit maximizing price of the monopolist is pm , with resultant output xm. As can be seen if we compare Figure a and Figure b, the monopoly outcome involves a loss in total surplus as compared to the competitive outcome: the net gain in producer surplus to the monopolist is more than offset by the loss of consumer surplus. 21. The total loss is the triangle GEF in Figure b, which is often called the social cost of monopoly. Thus if we compare the monopoly outcome to the competitive outcome, we observe that in comparison to the competitive outcome (a ) the level of economic activity is lower, and (b) the level of welfare is lower. However the difference does not end there: if for some reason the output is increased beyond xm, then of course total surplus will increase. For example, if output increases to x in figure b, then the gain in total surplus will be the shaded area GFKJ. Thus if we start from an imperfectly competitive equilibrium, then an increase in output will increase welfare. 22. Hencewe can see that there are two fundamental differences between the perfectly competitive equilibrium and the monopolistic equilibrium. First,the monopolistic equilibrium involves alower level of welfare than the perfectlycompetitive equilibrium. Second starting from the monopolisticequilibrium, an increase in output increaseswelfare, a reduction reduces welfare. 23. Whilst the analysis of this section has beencast in terms of simple microeconomics, itslessons will carry over into macroeconomics. The extra dimension added inmacroeconomics is that the approach isgeneral equilibrium: we have to considerequilibrium of all of the markets in theeconomy, and how they interact 24. To get More of Social welfare in Economics please refer to book Economic Efficiency & social welfareBy E.J. Mishan.THANK YOU.