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388 CHAPTER 10 COMPETITIVE MARKETS: APPLICATIONS
10.1 Before we turn to the analysis of specific government interventions, it is important to

THE INVISIBLE preview how we will be conducting our analysis. In this chapter, we will use a partial
equilibrium approach, usually focusing on only a single market. For example, we may
HAND, EXCISE
examine the effect of rent controls on the market for housing. A partial equilibrium
TAXES, AND approach will not allow us to ask how rent controls affect prices in other markets, in-
SUBSIDIES cluding the market for housing that is not rented and the markets for furniture, auto-
mobiles, and computers. To examine how a change in one market affects all markets
simultaneously, we would need to employ a general equilibrium model. A general
partial equilibrium equilibrium analysis determines the equilibrium prices and quantities in all markets
analysis An analysis simultaneously. We will introduce you to this more complex form of analysis in
that studies the determina- Chapter 16. The conclusions we draw from a partial equilibrium analysis may not
tion of equilibrium price always be the same as those found with a general equilibrium approach. Nevertheless,
and output in a single mar-
ket, taking as given the a partial equilibrium framework can often be used to gain important insights about the
prices in all other markets. primary effects of government intervention.
In this chapter we examine markets that would be perfectly competitive absent
general equilibrium government intervention. As we observed in Chapter 9, in a competitive market all
analysis An analysis producers and consumers are fragmented; that is, they are so small in the market that
that determines the equilib-
rium prices and quantities they behave as price takers. If decision makers have the ability to influence the price in
in more than one market the market, we cannot use supply and demand analysis. Instead, we would need to apply
simultaneously. an appropriate model of market power, such as the ones discussed in Chapters 11–14.
As we also learned in Chapter 9, in a perfectly competitive market consumers
have perfect information about the nature of the product being provided, as well as
the price of the product. Sometimes governments intervene in markets because con-
sumers are unable to gather enough information about the products in the market.
For example, the health care sector would seem to have a competitive structure, with
many providers and consumers of health care services. Yet health care products, in-
cluding medication and medical procedures, can be so complex that the average con-
sumer finds it difficult to make informed choices. Government intervention in this
sector is often designed to protect consumers in such a complicated market.
externality The effect Furthermore, in perfectly competitive markets there are no externalities.
that an action of any deci- Externalities are present in a market if the actions of either consumers or producers
sion maker has on the well- lead to costs or benefits that are not reflected in the price of the product in that mar-
being of other consumers ket. For example, a production externality will be present if a producer pollutes the
or producers, beyond the environment. Pollution creates a social cost that might be ignored by a producer
effects transmitted by
changes in prices. absent government intervention. A consumption externality exists when the action of
an individual consumer imposes costs on, or leads to benefits for, other consumers.
For example, zoning ordinances in housing markets are often intended to ensure that
consumers of housing do not undertake activities that reduce the value of property
owned by others in a neighborhood. In this chapter we do not consider the effects of
externalities; instead, we will address them in Chapter 17.
Finally, throughout this chapter we use consumer surplus to measure how much
better off or worse off a consumer is when intervention affects the price in the mar-
ket. As we showed in Chapter 5, when income effects are negligible (as they typically
would be for goods that represent a small fraction of a consumer’s budget), changes in
consumer surplus will often serve as a good measure of the impact of price changes on
the well-being of consumers. However, we also saw in Chapter 5 that consumer surplus
may not always be a good way to measure the impact of a price change on a consumer.
For goods with large income effects it may be important to measure the effects of
price changes on consumers by examining compensating or equivalent variations in-
stead of using changes in consumer surplus.