Introduction To EconomicsIntroduction To Economics

Chapter 7Chapter 7

Coordination After Changes In Coordination After Changes In Market ConditionsMarket Conditions

J. Patrick GunningJ. Patrick GunningFebruary 20, 2007February 20, 2007

IntroductionIntroduction

Purpose of the chapter: next two chapters: to Purpose of the chapter: next two chapters: to present some simple examples of present some simple examples of entrepreneurial adjustment to change in entrepreneurial adjustment to change in demand and supply conditions.demand and supply conditions.

Structure of the chapter:Structure of the chapter: Part 1: The entrepreneurial coordination that occurs Part 1: The entrepreneurial coordination that occurs

after a change in demand conditions.after a change in demand conditions. Part 2: The entrepreneurial adjustments that results Part 2: The entrepreneurial adjustments that results

from a change in supply conditions.from a change in supply conditions. Part 3: How government price controls may interfere Part 3: How government price controls may interfere

with the communication process and thereby inhibit with the communication process and thereby inhibit entrepreneurial coordination.entrepreneurial coordination.

Part 1:Part 1: Entrepreneurial Adjustment To A Entrepreneurial Adjustment To A Change In Demand ConditionsChange In Demand Conditions

A change in the quantity demanded due to a A change in the quantity demanded due to a change in price is shown by a movement along change in price is shown by a movement along a demand curve.a demand curve.

In figure 7-1, a decrease in the sellers’ price In figure 7-1, a decrease in the sellers’ price from $10 to $5 causes an increase in quantity from $10 to $5 causes an increase in quantity demanded from 590 to 1530 loaves.demanded from 590 to 1530 loaves.

An increase in sellers’ price from $5 to $10 An increase in sellers’ price from $5 to $10 decreases quantity demanded from 1530 to decreases quantity demanded from 1530 to 590 loaves.590 loaves.

The Demand For White BreadThe Demand For White Bread(Figure 7-1)(Figure 7-1)

A change in quantity demanded caused by a change in price.

Figure 7-2Figure 7-2

An increase in demand: the marginal consumer is willing topay a higher price for each quantity.

Explanation Of Figure 7-2Explanation Of Figure 7-2

The increase in demand is shown by an The increase in demand is shown by an upward shift of the demand curve from Dupward shift of the demand curve from D11 to to DD22..

This means that at each price, the quantity This means that at each price, the quantity demanded is greater.demanded is greater.

Examine the quantities demanded at $10 and Examine the quantities demanded at $10 and $8 per unit, $8 per unit, beforebefore the increase in demand. the increase in demand.

Examine the quantities demanded at $10 and Examine the quantities demanded at $10 and $8 $8 afterafter the increase in demand. the increase in demand.

Decrease In Demand:Decrease In Demand:Figure 7-3Figure 7-3

A decrease in demand shifts the curve downward to the left.Consumers are willing to buy less at each price.

A Change in the Demand and the A Change in the Demand and the Marginal Consumer (Figure 7-4)Marginal Consumer (Figure 7-4)

Explanation Of Figure 7-4Explanation Of Figure 7-4

An increase in demand also means that for any An increase in demand also means that for any quantity, the price that the marginal consumer is quantity, the price that the marginal consumer is willing to pay is higher than before.willing to pay is higher than before.

For the quantity 590, if the demand is DFor the quantity 590, if the demand is D11, the marginal , the marginal consumer is willing to pay a maximum of $10. If the consumer is willing to pay a maximum of $10. If the demand is Ddemand is D22, the marginal consumer is willing to pay a , the marginal consumer is willing to pay a maximum of $13.90. maximum of $13.90.

For the quantity 980, the marginal consumer is willing For the quantity 980, the marginal consumer is willing to pay $8 if the demand is Dto pay $8 if the demand is D11 and $11.80 if the demand and $11.80 if the demand is Dis D22. .

Representing How Producers Adjust: Representing How Producers Adjust: Two PartsTwo Parts

1. Compare a completely coordinated 1. Compare a completely coordinated market before the change with a market before the change with a completely coordinated market after the completely coordinated market after the change.change.

2. Describe the communication and the 2. Describe the communication and the incentive to adjust.incentive to adjust.

The Completely CoordinatedThe Completely CoordinatedIndustry (1) Industry (1) (From Chapter 6)(From Chapter 6)

The Completely CoordinatedThe Completely CoordinatedIndustry (2) Industry (2)

The price of each good equals the The price of each good equals the marginal cost.marginal cost.

Each seller of the good sells at exactly Each seller of the good sells at exactly the same price.the same price.

The marginal cost rises because in order The marginal cost rises because in order to produce more bread, bakers must bid to produce more bread, bakers must bid specialized resources away from other specialized resources away from other entrepreneurs. entrepreneurs.

Effects Of An Increase In Demand Effects Of An Increase In Demand (Figure 7-5)(Figure 7-5)

An increase in demand would cause a shortage if producersdo not raise price.

The Completely Coordinated Industry: The Completely Coordinated Industry: Before And After (Figure 7-5)Before And After (Figure 7-5)

The increase in demand is represented The increase in demand is represented by a shift from Dby a shift from D11 to D to D22..

The increase causes the completely The increase causes the completely coordinated price and quantity to change coordinated price and quantity to change from position 1 to position 2. from position 1 to position 2.

Communication And Incentives to Adjust Communication And Incentives to Adjust (Figure 7-5)(Figure 7-5)

The increase in demand by The increase in demand by consumersconsumers raises raises quantity demanded at the price of $.99 from quantity demanded at the price of $.99 from 600 to 1360 loaves.600 to 1360 loaves.

This leads This leads producersproducers to try to produce a larger to try to produce a larger amount.amount.

To obtain the additional resources,To obtain the additional resources, producers producers must pay more per unit for resources.must pay more per unit for resources.

Producers Producers communicate this to consumers by communicate this to consumers by raising their price.raising their price.

As the price rises,As the price rises, consumers consumers demand less demand less than 1360 at the higher price.than 1360 at the higher price.

What If Producers Did Not RaiseWhat If Producers Did Not RaiseThe Price?The Price?

If producers did not raise price, the quantity If producers did not raise price, the quantity would fall to 600 units.would fall to 600 units.

The utility of the marginal consumer (the price The utility of the marginal consumer (the price she was willing to pay) ($1.38) would be higher she was willing to pay) ($1.38) would be higher than the marginal cost ($.99).than the marginal cost ($.99).

Consumers would give producers an incentive Consumers would give producers an incentive to produce more because they are willing to to produce more because they are willing to pay a higher price. Otherwise, there would be a pay a higher price. Otherwise, there would be a shortage.shortage.

Who Is To Blame For TheWho Is To Blame For TheHigher Prices?Higher Prices?

The ultimate responsibility for bidding up these prices The ultimate responsibility for bidding up these prices lies with lies with the consumersthe consumers themselves. themselves.

Consumers of white bread have decided that they are Consumers of white bread have decided that they are willing and able to buy more at each price.willing and able to buy more at each price.

Other consumers are unwilling to give up the other Other consumers are unwilling to give up the other goods that could be produced with the resources goods that could be produced with the resources needed to satisfy the increased demand for bread.needed to satisfy the increased demand for bread.

What happens in effect is that the consumers of white What happens in effect is that the consumers of white bread must bid higher prices because they must bread must bid higher prices because they must compete for resources with the consumers of other compete for resources with the consumers of other consumer goods. consumer goods.

Effects Of An Decrease In Demand Effects Of An Decrease In Demand (Figure 7-6)(Figure 7-6)

Explanation Of Figure 7-6Explanation Of Figure 7-6

The decrease in demand is represented The decrease in demand is represented by a shift from Dby a shift from D11 to D to D22..

The decrease causes the completely The decrease causes the completely coordinated price to fall from position 1 to coordinated price to fall from position 1 to position 2. position 2.

Communication In TermsCommunication In TermsOf Figure 7-6 (1)Of Figure 7-6 (1)

The decrease in demand by consumers for white bread The decrease in demand by consumers for white bread may lead producers to reduce output but not to reduce may lead producers to reduce output but not to reduce price. If so, there would be a surplus of 430 loaves price. If so, there would be a surplus of 430 loaves (600 – 170). Price and quantity would temporarily move (600 – 170). Price and quantity would temporarily move from position 1 to position 3.from position 1 to position 3.

As producers reduced their output, they would lay off As producers reduced their output, they would lay off resources.resources.

Competition among the owners of the resourcesCompetition among the owners of the resources for for employment, particularly among the owners of employment, particularly among the owners of specialized resources, would causes the prices of specialized resources, would causes the prices of these resources to fall.these resources to fall.

The marginal cost at 170 loaves would fall to $.49 while The marginal cost at 170 loaves would fall to $.49 while the price remained at $.99.the price remained at $.99.

Communication In TermsCommunication In TermsOf Figure 7-6 (2)Of Figure 7-6 (2)

Competition among producersCompetition among producers for customers for customers would would reduce the price.reduce the price.

Competition would also bid up the prices of Competition would also bid up the prices of resources.resources.

CConsumers would demand more than onsumers would demand more than otherwiseotherwise due to the lower price. due to the lower price.

Falling prices of bread and the increasing Falling prices of bread and the increasing amount of bread produced would cause a amount of bread produced would cause a movement from position 3 to position 2.movement from position 3 to position 2.

Part 2:Part 2: Entrepreneurial Adjustments Entrepreneurial AdjustmentsTo A Change In SupplyTo A Change In Supply

We first show how to represent a change We first show how to represent a change in the conditions of production.in the conditions of production.

Then we show the effects of a change Then we show the effects of a change that causes marginal costs to rise.that causes marginal costs to rise.

Figure 7-7Figure 7-7

Change In Quantity SuppliedChange In Quantity Supplied(Figure 7-7)(Figure 7-7)

A change in the quantity supplied due to a change in A change in the quantity supplied due to a change in price is shown by a movement along a demand curve .price is shown by a movement along a demand curve .

In figure 7-7, an increase in the price that producers In figure 7-7, an increase in the price that producers expect to receive from $.99 to $1.25 causes an expect to receive from $.99 to $1.25 causes an increase in quantity supplied from 600 to 830 loaves. increase in quantity supplied from 600 to 830 loaves. The price and quantity supplied move from position A The price and quantity supplied move from position A to B.to B.

An decrease in the expected price from $1.25 to $.99 An decrease in the expected price from $1.25 to $.99 causes a decrease in quantity supplied from 830 to 600 causes a decrease in quantity supplied from 830 to 600 loaves. The price and quantity supplied move from loaves. The price and quantity supplied move from position B to A.position B to A.

A Decrease In Marginal Cost Causes A Decrease In Marginal Cost Causes An Increase in Supply (Figure 7-9)An Increase in Supply (Figure 7-9)

An increase in supply is shown on a graph by a shift of the An increase in supply is shown on a graph by a shift of the supply curve downwards and to the right.supply curve downwards and to the right.

Explanation Of Figure 7-8Explanation Of Figure 7-8

At each quantity, the marginal cost is lower At each quantity, the marginal cost is lower than before the increase.than before the increase.

Producers are willing to supply more at each Producers are willing to supply more at each price.price.

Before the change, producers are willing to Before the change, producers are willing to supply 46 loaves at a price of $.80 per loaf; supply 46 loaves at a price of $.80 per loaf; afterwards, they are willing to supply 95 loaves.afterwards, they are willing to supply 95 loaves.

Before the change, producers are willing to Before the change, producers are willing to supply 78 loaves at a price of $1.18 per loaf; supply 78 loaves at a price of $1.18 per loaf; afterwards, they are willing to supply 128 afterwards, they are willing to supply 128 loaves. loaves.

An Increase In Marginal Cost Causes A An Increase In Marginal Cost Causes A Decrease in Supply (Figure 7-9)Decrease in Supply (Figure 7-9)

A decrease in supply is shown on a graph by a shift of the supply curve upwards and to the left.

Explanation Of Figure 7-9Explanation Of Figure 7-9

At each quantity, the marginal cost is higher than At each quantity, the marginal cost is higher than before the increase.before the increase.

Producers are willing to supply less at each price.Producers are willing to supply less at each price. Before the change, producers are willing to supply 78 Before the change, producers are willing to supply 78

loaves at a price of $1.18 per loaf; afterwards, they are loaves at a price of $1.18 per loaf; afterwards, they are willing to supply 70 loaves only if the price is $1.72.willing to supply 70 loaves only if the price is $1.72.

Before the change, producers are willing to supply 102 Before the change, producers are willing to supply 102 loaves at a price of $1.44 per loaf; afterwards, they are loaves at a price of $1.44 per loaf; afterwards, they are willing to supply 102 loaves only if the price is $2.02. willing to supply 102 loaves only if the price is $2.02.

Effects Of A Decrease InEffects Of A Decrease InMarginal Cost (Figure 7-11)Marginal Cost (Figure 7-11)

Effects Of A Decrease In Marginal CostEffects Of A Decrease In Marginal Cost

Explanation Of Figure 7-11Explanation Of Figure 7-11

A decrease in marginal cost would cause the A decrease in marginal cost would cause the completely coordinated price to fall from $.92 to $.78. completely coordinated price to fall from $.92 to $.78. The completely coordinated quantity would rise from The completely coordinated quantity would rise from 1280 to 1480 loaves. From position 1 to position 2.1280 to 1480 loaves. From position 1 to position 2.

Suppose that producers did not reduce price. Then Suppose that producers did not reduce price. Then consumers would only buy 11280 loaves. At 1280 consumers would only buy 11280 loaves. At 1280 loaves MU > MC, as shown in the figure.loaves MU > MC, as shown in the figure.

Some entrepreneur would perceive that he could profit Some entrepreneur would perceive that he could profit by hiring more resources to produce a larger quantity. by hiring more resources to produce a larger quantity. To sell the large quantity, he would have to reduce To sell the large quantity, he would have to reduce price.price.

Effects Of An Increase InEffects Of An Increase InMarginal Cost (Figure 7-12)Marginal Cost (Figure 7-12)

Effects Of An Increase In Marginal CostEffects Of An Increase In Marginal Cost

Explanation Of Figure 7-12Explanation Of Figure 7-12

An increase in marginal cost would cause the An increase in marginal cost would cause the completely coordinated price to rise from $.78 to $.92. completely coordinated price to rise from $.78 to $.92. The completely coordinated quantity would fall from The completely coordinated quantity would fall from 1480 to 1280 loaves. From position 1 to position 2.1480 to 1280 loaves. From position 1 to position 2.

Suppose that producers did not raise price. Then they Suppose that producers did not raise price. Then they would want to reduce their quantity supplied 630 would want to reduce their quantity supplied 630 loaves, as shown in the figure.loaves, as shown in the figure.

But at this quantity, consumers would bid up the price. But at this quantity, consumers would bid up the price. The price would become $1.08 per loaf.The price would become $1.08 per loaf.

Some entrepreneur would perceive that he could profit Some entrepreneur would perceive that he could profit by raising price and hiring more resources to produce a by raising price and hiring more resources to produce a larger quantity.larger quantity.

The Scenario Through The Eyes Of A The Scenario Through The Eyes Of A Surviving BakerSurviving Baker

Before the change, the typical baker was barely making enough profit to continue in this activity.

After marginal costs rise, she adjusts in the short run by reducing the amount of bread that she produces and sells.

In the meantime, other bakers leave the industry. This increases her customers and reduces her costs because owners of the laid off resources are willing to supply them at lower prices.

This combination of more customers and falling costs ultimately enables the surviving baker to earn a minimal profit again.

Part 3:Part 3: How Price Controls Block How Price Controls Block Communication And Coordination (1)Communication And Coordination (1)

Retailers communicate with consumers Retailers communicate with consumers and producers of goods by offering and and producers of goods by offering and accepting goods and resources for prices.accepting goods and resources for prices.

Communication by means of markets and Communication by means of markets and pricesprices enables the plans and decisions of enables the plans and decisions of consumers to be coordinated with the consumers to be coordinated with the plans and decisions of producers.plans and decisions of producers.

How Price Controls Block CommunicationHow Price Controls Block CommunicationAnd Coordination (2)And Coordination (2)

Price controlsPrice controls: laws that deter actors in : laws that deter actors in market interaction from changing the market interaction from changing the prices as they would do under the prices as they would do under the conditions of a pure market economy.conditions of a pure market economy.

We consider two types of price controls:We consider two types of price controls: A price ceiling.A price ceiling. A price floor.A price floor.

How Price Controls Block CommunicationHow Price Controls Block Communication And Coordination (3) And Coordination (3)

Price controls are likely to interfere with Price controls are likely to interfere with communication and, therefore, with communication and, therefore, with coordination.coordination.

They may eliminate the incentive to shift They may eliminate the incentive to shift resources in response to a change in resources in response to a change in market conditions.market conditions.

A Theory Of The Effects Of A Price CeilingA Theory Of The Effects Of A Price Ceiling

Price ceilingPrice ceiling: a maximum price above : a maximum price above which sellers are prohibited from selling.which sellers are prohibited from selling.

Beginning with a completely coordinated Beginning with a completely coordinated economy, suppose that you are a economy, suppose that you are a neighborhood baker and that there is an neighborhood baker and that there is an increase in demand for white bread.increase in demand for white bread.

Assume that the ceiling price is exactly Assume that the ceiling price is exactly equal to the price that retailers are now equal to the price that retailers are now charging.charging.

Unwillingness To Respond To Unwillingness To Respond To An Increase In DemandAn Increase In Demand

Before the increase in demand, you are Before the increase in demand, you are earning a small profit.earning a small profit.

Because there is a price control, you cannot Because there is a price control, you cannot afford to offer higher prices to resource afford to offer higher prices to resource suppliers.suppliers.

So you are unwilling to respond to the increase So you are unwilling to respond to the increase in demand by shifting resources.in demand by shifting resources.

The effect is a The effect is a shortage. shortage. The quantity The quantity demanded is greater than the quantity supplied demanded is greater than the quantity supplied at the current price.at the current price.

Shortages In Markets Without Shortages In Markets Without Price ControlsPrice Controls

Shortages are common in market interaction, Shortages are common in market interaction, particularly among goods that take a long time particularly among goods that take a long time to produce.to produce.

They lead sellers to raise the price and to give They lead sellers to raise the price and to give resource suppliers incentives to shift resources resource suppliers incentives to shift resources in and out of industries in response to changes in and out of industries in response to changes in market conditions.in market conditions.

The resource shift tends to The resource shift tends to eliminate the eliminate the shortageshortage..

Shortages In Markets With Price Shortages In Markets With Price ControlsControls

A price ceiling can prevent adjustment to A price ceiling can prevent adjustment to an increase in demand.an increase in demand.

A A shortage may be permanentshortage may be permanent..

A Graph To Represent A Shortage Due A Graph To Represent A Shortage Due to a Price Ceiling (Figure 7-13)to a Price Ceiling (Figure 7-13)

Under a price ceiling, an increase in demand may cause a shortage. In Under a price ceiling, an increase in demand may cause a shortage. In the graph the shortage is 720 loaves, as quantity demanded rises from the graph the shortage is 720 loaves, as quantity demanded rises from 610 to 1330 loaves at the ceiling price of $2.610 to 1330 loaves at the ceiling price of $2.

Dis-coordinationDis-coordination

The price ceiling prevents producing entrepreneurs The price ceiling prevents producing entrepreneurs from receiving the message that they “should” shift from receiving the message that they “should” shift resources so that the higher consumer demand can be resources so that the higher consumer demand can be accommodated with more production.accommodated with more production.

To achieve a completely coordinated market, To achieve a completely coordinated market, producing entrepreneurs would have to shift resources producing entrepreneurs would have to shift resources away from the production of other goods and into the away from the production of other goods and into the production of the good for which demand has risen.production of the good for which demand has risen.

But this cannot occur because the entrepreneurs do But this cannot occur because the entrepreneurs do not receive the price signals that are necessary to give not receive the price signals that are necessary to give them incentives to shift.them incentives to shift.

Incentive To Act IllegallyIncentive To Act Illegally

The gap between the price that the marginal The gap between the price that the marginal consumer is willing to pay and the marginal consumer is willing to pay and the marginal cost at 600 units (see figure 7-13) implies an cost at 600 units (see figure 7-13) implies an incentive to break the law by selling at a price incentive to break the law by selling at a price that is higher than the ceiling.that is higher than the ceiling.

Would-be law-breakers balance the Would-be law-breakers balance the prospective gain against the prospective gain against the risk costrisk cost..

Law-breaker’s risk costLaw-breaker’s risk cost: a law-breaker’s : a law-breaker’s estimate of the harm he would incur if he was estimate of the harm he would incur if he was caught times the probability that he would incur caught times the probability that he would incur that harm.that harm.

The Prospect for CorruptionThe Prospect for Corruption

A prospective law-breaker may be able to A prospective law-breaker may be able to reduce her risk cost by bribing a police reduce her risk cost by bribing a police officer, prosecutor, judge, or prison officer, prosecutor, judge, or prison official.official.

In the real world, some types of In the real world, some types of exchanges are banned.exchanges are banned.

The ceiling price is zero.The ceiling price is zero. This leads to crime and corruption.This leads to crime and corruption.

A PuzzleA Puzzle

Suppose that the government controls Suppose that the government controls the price of airline tickets.the price of airline tickets.

A holiday arrives and there is an increase A holiday arrives and there is an increase in demand for tickets. The result is a in demand for tickets. The result is a shortage of flights.shortage of flights.

What caused the shortage?What caused the shortage? Was it the increased holiday demand?Was it the increased holiday demand? Was it the price ceiling?Was it the price ceiling?

Shortage Due To An Increase In Shortage Due To An Increase In Marginal Cost (Figure 7-14)Marginal Cost (Figure 7-14)

Under a price ceiling, an increase in cost may cause a shortage.Under a price ceiling, an increase in cost may cause a shortage. In In the graph the shortage is 720 loaves, as quantity supplied falls from the graph the shortage is 720 loaves, as quantity supplied falls from 1330 to 610 loaves, at the ceiling price of $2.1330 to 610 loaves, at the ceiling price of $2.

A Shortage Due To An A Shortage Due To An Increase In CostsIncrease In Costs

Example: a bad growing season causes the Example: a bad growing season causes the prices of wheat flour to rise.prices of wheat flour to rise.

This, in turn, raises the costs to bakers. What This, in turn, raises the costs to bakers. What caused the shortage?caused the shortage? 1. Was it the bad weather?1. Was it the bad weather? 2. Was it the price control?2. Was it the price control?

Governments cannot change the weather, but Governments cannot change the weather, but they can change a price control.they can change a price control.

Dis-coordinationDis-coordination

The price ceiling causes more resources The price ceiling causes more resources to shift out of the industry than are to shift out of the industry than are necessary to achieve complete necessary to achieve complete coordination.coordination.

Because sellers do not communicate that Because sellers do not communicate that marginal price is higher than marginal marginal price is higher than marginal cost at 610 units, producing cost at 610 units, producing entrepreneurs allow too many resources entrepreneurs allow too many resources to leave the industry.to leave the industry.

A Theory Of The Effects Of A A Theory Of The Effects Of A Price FloorPrice Floor

Price floorPrice floor: a minimum price, established by : a minimum price, established by law, below which sellers are prohibited from law, below which sellers are prohibited from selling.selling.

The price floor is often used in industries like The price floor is often used in industries like farm products.farm products.

Assume that the floor price on milk is exactly Assume that the floor price on milk is exactly equal to the price that milk producers are now equal to the price that milk producers are now charging.charging.

There is a decrease in industry demand.There is a decrease in industry demand.

What Would Happen In the Absence of What Would Happen In the Absence of a Price Floor?a Price Floor?

Milk producers would order fewer dairy workers Milk producers would order fewer dairy workers and other resources.and other resources.

Competing for employment, the owners of Competing for employment, the owners of those resources would reduce their prices.those resources would reduce their prices.

Competing milk producers would respond by Competing milk producers would respond by reducing their milk prices.reducing their milk prices.

In figure 7-15, the price and quantity would In figure 7-15, the price and quantity would tend toward the complete coordination at tend toward the complete coordination at position 3. position 3.

Graph Of A Price Floor (Figure 7-15)Graph Of A Price Floor (Figure 7-15)

EFFECTS OF A DECREASE IN DEMAND ON PRICE AND QUANTITYEFFECTS OF A DECREASE IN DEMAND ON PRICE AND QUANTITY

The Price Floor Causes A GapThe Price Floor Causes A GapBetween Price and MCBetween Price and MC

The price floor prevents price from falling. Milk The price floor prevents price from falling. Milk producers move from position 1 to position 2, producers move from position 1 to position 2, since consumers demand only 180 liters.since consumers demand only 180 liters.

But at position 2, there is a gap between price But at position 2, there is a gap between price and MC.and MC.

It would seem that milk producers would be It would seem that milk producers would be making profit on the units they produce.making profit on the units they produce.

Alternative Ways To CompeteAlternative Ways To Compete

Milk producers would like to compete for Milk producers would like to compete for customers by reducing price. But they cannot.customers by reducing price. But they cannot.

They have alternative ways to compete:They have alternative ways to compete: Maintain higher inventories. Maintain higher inventories. Increasing their advertising.Increasing their advertising. Offer other services, like greater convenience or Offer other services, like greater convenience or

delivery, that would otherwise not be offered.delivery, that would otherwise not be offered. Evade the law by offering discount prices on Evade the law by offering discount prices on

complementary goods or other products.complementary goods or other products. Each of the alternatives is likely to cause costs Each of the alternatives is likely to cause costs

to be higher than otherwise.to be higher than otherwise.

Dis-coordinationDis-coordination

These competing actions would increase the marginal These competing actions would increase the marginal cost of supplying milk. cost of supplying milk.

Marginal cost may even reach the point where it equals Marginal cost may even reach the point where it equals the price of the product.the price of the product.

If so, there would be no surplus and the market would If so, there would be no surplus and the market would become coordinated.become coordinated.

However, there would not be a completely coordinated However, there would not be a completely coordinated economy because costs would be higher than they economy because costs would be higher than they need to be.need to be.

Not enough resources would be used to produce other Not enough resources would be used to produce other goods.goods.