Perfect Markets

& the “World Truth”

Group 11
Arun Mantena – GMAY08BM061
Kumar Gaurav – GMAY08WM125
Parul Sharma – GMAY08IT027
Pravin Surianarayanan – GMAY08IT028
Shivanand 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
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
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
 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
 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
 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
X              
Y                  
Z                

• Income distribution in a society

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
X                
Y                
Z                

• 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
 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
P
ST

Se

De
Q

• But what about low-income elderly?

• Governments generally lower taxes on fuel => inefficiency
 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