The analysis of welfare economics is built around the concept of Pareto efficiency. However, this efficiency criterion does not always represent a satisfactory answer. Other times, certain optimality conditions cannot be satisfied, and therefore Pareto efficiency simply cannot be reached. In order to solve this problem, and to find a new way to establish which allocation is best, economists have been since searching for new criteria to make a more informed decision.

In this Learning Path we’ll learn about some of these criteria, in order to understand them and being able to use them. In this LP we’ll learn about:

Pareto efficiency, the cornerstone of welfare economics.

Compensation criteria

Definition: what they are and how to use them. More precisely, we’ll talk about:

Kaldor’s criterion, Hicks’ criterion, Scitovsky’s criterion, Little’s criterion, and Samuelson’s criterion.

Theory of the…

Second best, a theory by economists Kelvin Lancaster and Richard Lipsey.

Welfare economics analyses different states in which markets or the economy can be. Its main objective is to find an indicator or measure in order to guarantee that markets are behaving optimally, thus also guaranteeing that consumer welfare is as high as possible. Even though welfare was already analysed by economists such as Adam Smith or Jeremy Bentham, it was economists from the Classical School who thoroughly analysed the subject: Alfred Marshall saw a relationship between welfare and wealth, while other economists such as Vilfredo Pareto and Arthur C. Pigou analysed welfare in terms of  better resource allocation and efficiency.

In this Learning Path, we’ll learn about the basics of welfare economics.  More specifically, we’ll learn about:

Definition and main economists

Welfare economics, a short definition;

Arthur C. Pigou, the first economist to thoroughly analyse welfare issues;

Vilfredo Pareto, who developed models in order to seek efficiency.

Efficiency and optimal allocation

Pareto optimality, a concept devised by Vilfredo Pareto;

Edgeworth box, an important analytical tool;

Production possibility frontier, which we derive from the Edgeworth box;

General equilibrium, an analysis of how to properly allocate resources;

Fundamental theorems, the two main conclusions of welfare economics.

The analysis of monopolies, oligopolies and perfect competition shows us that neither is real. Monopolies and oligopolies (when collusion exists) are illegal and considered as really harmful for the economy and consumer’s welfare. On the other hand, if perfect competition was real, firms would not make any profits, and therefore prices will be lower (yes, let’s face it: it does not take around 9 dollars to cook and serve a Big Mac menu). That’s where monopolistic competition comes in.

Monopolistic competition basically covers all the flaws in monopoly and perfect competition models. Edward Chamberlin and Joan Robinson can be considered as parents to this subject.

In this LP we’ll learn about:

“Competition”

Monopolistic competition, a quick definition;

Chamberlin’s model, which represent the economist’s view;

Characteristics demand, a theory by Kelvin Lancaster.

Differentiation

Product differentiation, or how to sell something different;

Linear city model, by economist Harold Hotelling;

Circular city model, by Steven C. Salop;

Shaked-Sutton model, which illustrate vertical differentiation.

In the previous Learning Path on oligopolies we learned what they are and what kinds of oligopolies exist. In this LP, we’ll learn about how oligopolists can collude in order to maximise their profits, even though this agreement will not likely last. Also, we’ll see what entry and exit barriers are, and how they affect the number of oligopolists in the market. Finally, we’ll also learn about contestable markets, which mean competitive results can also be reached in oligopolistic markets.

More precisely, in this LP we’ll learn about:

Cooperation:

Collusion, when two or more competitors agree to cooperate;

Folk theorem, indicates how likely the collusion is to last;

Repeated games, which analyses for how long it will last.

Stability:

Entry and exit barriers will determine the number of oligopolists in the market;

Contestable market, which explains why even oligopolies can reach perfect competition results.

The bigger a firm is, the more efficient. Therefore, bigger and fewer firms in the market should mean lower prices and more goods produced. However, as we can see everyday, this is not really the case, since firms can be greedy. In this first Learning Path on Oligopolies, we’ll see what oligopolies are, and how their behaviour affects the economy. We’ll also see what different types of duopolies there are, and which ones are best suited to analyse this kind of market structure.

In this LP, we’ll look at:

Basic definitions:

Oligopoly, when few firms have great power;

Duopoly, a market structure with only two firms.

Types of duopoly:

Cournot duopoly, the analysis of simultaneous duopolies;

Stackelberg duopoly, the analysis of sequential decision making;

Bertrand duopoly, which analyses price competition;

Edgeworth duopoly, which solved the Bertrand paradox.

In the first Learning Path on monopolies, we learned about what they are, how they affect social welfare and we learned about a few types. In this second LP on monopolies, we’ll learn about a few more types, quite particular ones. We’ll learn about discriminating monopolies, how the implement different prices in order to extract all consumer surplus. We’ll also learn about natural monopolies, which are tricky since they are actually good for society.

In this LP we’ll learn about:

Discriminating monopolies:

Price discrimination, implemented by monopolies, can be either really harmful, or really sweet;

First degree price discrimination, really harmful, but quite impossible to implement;

Second degree price discrimination, it may hide an entrance fee in the form of discounts;

Third degree price discrimination, the good kind, takes the form of discounts to some people such as students;

Two-part tariff, which consist of an entrance fee and a price per unit.

Natural monopolies:

Subadditivity, the reason why natural monopolies exist;

Natural monopoly, which should not be regulated.

Irving Fisher described monopolies as market structures where there is no competition. To neoclassical economists, a monopoly is the exact opposite to perfect competition. And an even simpler definition would be that a monopoly is just a market where there is only one seller. However, monopolies must be well understood, in order to understand why they are so harmful. In this Learning Path we’ll learn about monopolies, starting with a few basic definitions and starting to learn about a few types of monopolies.

Basic definitions:

Monopoly, the polar opposite to perfect competition;

Surplus, diminished for consumers, increased for the firm;

Lerner index, a good way to measure market power.

Types of monopolies:

Monopsony, not some kind of monopoly, but its opposite;

Bilateral monopoly, when a monopoly and monopsony meet;

Multiproduct monopoly, when monopolies produce multiple goods;

Multiplant monopoly, when monopolies produce in multiple plants.

Firms in a perfectly competitive market may encounter some problems that can decrease their competitiveness and may even force them out of the market. The way they deal with problems such as taxes or other factors that increase their costs will determine whether they can stay in the market. In this Learning Path we’ll learn about these problems, how firms’ cost structures change, and how an equilibrium is reached in the market.

In order to understand all this, we’ll learn about:

Comparative analysis:

Comparative statics, used to analyse changes in equilibriums;

Economic surplus, which determines how well a firm is doing;

Cost variations may force a firm out of the market;

Taxes, imposed to consumers, producers or both.

Market clearing:

Supply and demand, how to determine them and how they behave;

Market clearing, which determines how the equilibrium is reached;

Cobweb models, a strange way to get to the equilibrium.

Even though perfect competition is hard to come by, it’s a good starting point to understand market structures. It’s been used to analyse markets for centuries. From Adam Smith and his invisible hand, to economists such as Edward Chamberlin and Joan Robinson, who analysed different market structures, perfect competition has been used to compare different competitive situations, and to understand how marketplaces work. A deep understanding of how competitive markets work and are formed is the cornerstone to understand why it’s so hard to reach them.

In this first Learning Path on perfect competition, we’ll start by analysing firms’ cost structure, before analysing their interaction in the market. We’ll learn about:

Perfect competition, a basic definition.

The firm:

Period analysis, in order to understand how time affects cost functions;

Short run cost analysis, how fixed factors determine cost structures;

Long run cost analysis, which considers variable factors.

The industry and the market:

Supply and demand, the basics of how markets work;

Short run supply curve, or how firms react to changes in market supply or demand;

Long run supply curve, which considers also potential entry of new firms.

The analysis of market structures is of great importance when studying microeconomics. How the market will behave, depending on the number of buyers or sellers, its dimensions, the existence of entry and exit barriers, etc. will determine how an equilibrium is reached. Even though market structures were thoroughly analysed by economists from the early 20^th century on, its study can be traced back to economists such as Antoine Cournot, Alfred Marshall or even Adam Smith.

In this Learning Path we’ll learn about the main market structures, which we’ll analyse more in depth in future LPs. This is what we’ll be learning about:

Market structure, a basic definition;

Perfect competition:

Perfect competition, a perfect but theoretical market structure;

Imperfect competition:

Imperfect competition, which can take different forms, such as:

Monopolies, when there is only one seller;

Oligopolies, with a few sellers which have price-setting power;

Duopolies, with only two sellers, it makes it easy to study oligopolies;

Monopolistic competition, when many sellers have monopolistics power over small share s of the market;

Buyer’s price setting powers:

Monopsony, when there is only one buyer;

Oligopsonies, with few buyers with great negotiating powers.