Models and Assumptions

Defining Key Economic Assumptions

1. Scarcitiy
2. Trade-offs
3. Self-interest
4. Rationality
5. Economic models match reality

Defining Types of Market Structures

1. Monopoly
2. Oligoply
3. Monopolistic competition
4. Perfect competition

Relevant Notes

• Perfectly competetive models of markets make assumptions

  • Many real-life markets aren't perfectly competitive
• Markets are usually a good way to organize economy activity. 
• In absence of market failures, the outcome of a perfectly competitive market is efficient, maximizing total surplus
• However, self-interested buyers and sellers neglect the external benefits/costs of their actions, so the market outcome is not efficient. 
• Governments can sometimes improve market outcomes
• In presence of externalities, public policy can improve efficiency
• If market failure exists, then the key question is whether the costs of intervening in the markets to address the failure outweigh the benefits
• Milton Friedman acknowledged that market failures exist
• However, he believed there were only a few scenarios where the cost of intervening outweighed the benefit of addressing the market failure
• Markets are effective at allocating scarce resources, assuming these markets are perfectly competitive

• Perfect competition ensures:

  • Everyone has perfect information

    • i.e. knowledge is shared evenly between buyers and sellers
    • e.g. intermediary third-party insurance companies between buyers and sellers in healthcare market

  • No barriers to entry

    • i.e. no individual firms can influence price
    • e.g. monopolies
  • Transaction costs are low
  • There aren’t externalities
  • There aren’t public goods being sold
• Very few markets or industries in the real world are perfectly competitive
• However, it is still useful in some respects.
• Many primary and commodity markets, such as coffee and tea, exhibit many of the characteristics of perfect competition