Harvard University Harvard Kennedy School

Fall 2009 Graduate School of Design

Markets and Market Failure with Cases

HKS API-105B & GSD 5203

Class Meetings: Mondays and Wednesdays, 10:10-11:30 AM, GSD Gund 111

Review Sessions: Fridays 12:10-1:30 PM at GSD Gund 111

Faculty: Prof. Jose A. Gomez-Ibanez (GSD and HKS)

Taubman 380 (HKS) and Gund 325 (GSD)
617-495-1341, jose_gomez-ibanez@harvard.edu

Office Hours: Mondays, 4:00-5:40 PM at HKS Taubman 316

and Wednesdays, 4:00-5:40 PM at GSD Gund 325
(Sign-up sheets on office doors)

Faculty Assistant: Linda Miklosko-Davis

HKS Taubman 357
617-384-9001, linda_miklosko-davis@ksg.harvard.edu

Teaching Assistants: TF: Zheng Chang, Office hours and location: TBD
zhc838@mail.harvard.edu
CA: Carl Allen, Office hours and location: TBD
carlallen55@yahoo.com
CA: Alexandra Miller, Office hours and location: TBD
alexandra.p.miller@gmail.com

OVERVIEW
This course provides an introduction to how markets operate, criteria for assessing their
performance, and the circumstances under which they perform well or poorly. The first half of the
course covers market behavior including supply, demand, and market prices; the strategies of
consumers and firms; and the effects of taxes, subsidies, price controls and other kinds of
government interventions. The second half covers the assessment of market performance, the
problems caused by monopoly, externalities, public goods, and asymmetric information, and the
types of policy solutions that might be applied to correct such market failures.
At the GSD, the course is open to all but strongly recommended for MUP and MDES real
estate students. Students can not take both this course and API-101 for credit. At the HKS, this
course covers the same topics as API-101 but is taught with extensive use of case discussions.
MC/MPA and MPA2 students can use this course to satisfy their quantitative methods requirement
and MPP/UP students can use this course to fulfill their API-101 requirement (other MPP students
can do so with the permission of the instructor).
 The course is taught in two sections—A and B—that cover the same concepts, use identical
problem sets and midterms and very similar exams. The main difference is that the A section is
taught by Joseph Kalt at HKS and the B section is taught by Jose Gomez-Ibanez at GSD. Four of the
ten cases are different, however, so students should be sure to use the syllabus and case packet for
the correct section. This is the syllabus for the B section.

PREREQUISITES
This course assumes no prior exposure to economics and is open to any graduate student. In
the event of space limitations, the HKS spaces will be assigned through the HKS lottery and GSD
spaces will be assigned with preference to those students taking the course to fulfill a degree
requirement. Overall enrollment in the B section will be limited to 65 students and enrollment in the
A section will be limited to the number of seats in the classroom.

REQUIREMENTS
Students are expected to come to class and prepared to participate in case discussions. No
mobile phones, PDAs or laptops may be used in class. In addition, there is a short problem set due
(almost) every week, an in-class mid-term exam on Monday, October 19. There will be a three-hour
written final exam on Tuesday, December 15, 2:00-5:00 PM at location to be announced.
The final course grade in the B section is based on the mid-term exam (20 percent), class
participation (30 percent) and the final exam (50 percent). Problem sets are graded on an advisory
basis, but do not count toward the final grade unless the student fails to turn in problem set
assignments.

READINGS
The text is Principles of Microeconomics, 5th Edition, by N. Gregory Mankiw and is for sale
at the Coop under HKS API-105. There are also many used copies of the third and fourth editions in
circulation at the GSD and HKS libraries; and the fourth edition is almost identical to the fifth. The
earlier editions will be adequate.
In addition, there is a case packet. The A section’s packet will be available from the
Kennedy School’s Course Materials Office (CMO). The B section’s packet will be available from
FlashPrint at 99 Mt. Auburn Street, Harvard Square (opposite Peet’s Coffee) starting August 31. If
FlashPrint runs out of packets they will make additional copies on 24-hours notice.

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HKS API-105B & GSD 5203 Syllabus – Version as of 08/25/09
 COURSE CALENDER
MONDAY WEDNESDAY
SEPTEMBER August 28: 2: Caselet supply and
Orientation-no class demand
7: Labor Day holiday 9: Lecture: surpluses
and elasticties
14: Case: Coffee Crisis 16: Lecture:
government
intervention
21: Case: Portland 23: Lecture:
Housing consumer choices
OCTOBER 28: Case: Liconsa Milk 30: Lecture: costs,
Assistance technology, and firm
size
5: Case: Nicaragua 7 : Lecture: profit
Electricity maximizing P and Q
12: Columbus Day 14: Case: Sullivan
holiday Gray Rait
19: Mid term exam 21 Lecture: perfect
competition, long run
equilibrium and the
supply curve
26: Lecture: efficiency 28: Case: Parking in
and equity; trade San Francisco
NOVEMBER 2: Lecture: monopoly 4: Lecture: oligopoly
and its remedies and game theory
9: Case: Microsoft on 11: Veteran’s Day
Trial holiday
16: Case: Subprime 18: Lecture:
externalities and
public goods
23: Case: Arsenic in 25: Lecture:
Drinking Water alternative remedies
to externalities
DECEMBER 30: Case: Climate 2; Case: Vancouver
Change Regional Plan
7 9
14 TUESDAY, DEC. 15 16
Final Exam, 2:00-5:00 PM,
Location TBA
FRIDAY
4:
11: Problem set 1:
supply, demand and
elasticties
18: Problem set 2:
price controls,
subsidies and taxes
25: Problem set 3:
indifference curves
and budget lines a
2: Problem set 4:
isoquants and isocost,
cost curves
9: Problem set 5: profit
maximizing P and Q
16: Mega review
session
23: Problem set 6: long
run equilibrium
30: Problem set 7:
trade, information
asymmetry
6: Problem set 8:
monopoly
13: Problem set 9:
game theory
20: Problem set 10:
externalities, public
goods
27: Thanksgiving
holiday
4 Exam period begins
11
18
 CLASS MEETINGS, READINGS AND ASSIGNMENTS
I. MARKETS
A. Supply, Demand, and Market Equilibrium

Class 1 – Wed., Sept 2: Supply, demand, and market equilibrium

Read: Mankiw, Chapters 1-4

Mon., Sept. 7: Labor Day Holiday – No Class

Class 2 – Wed., Sept 9: Consumer and producer surpluses and elasticities

Read: Mankiw, Chapters 5 and 7

(PS 1) Fri., Sept 11: Problem Set 1 due

Class 3 – Mon., Sept. 14: Predicting prices: The Coffee Crisis case
Read: The Coffee Crisis*, HKS case 1776.0 and Learning by the Case Method, HKS note
N15-86-1136.00
(*Note The Coffee Crisis case is posted on the GSD and HKS course websites as well as in
the reading packet)
Assignment: Imagine that you are the Minister of Agriculture for some relatively high-cost
arabica producer, such as El Salvador or Costa Rica. Would you advise your farmers to get
out of coffee or not? In formulating your answer, please consider:
1. What influences the demand for coffee on the part of consumers in the short run (in
the next year or two)? In the long run (in five or more years)? How sensitive is consumption
to wholesale coffee prices?
2. What are the determinants of the supply of coffee in the short run? In the long run?
How sensitive is supply to prices?
3. Do you think Arabica prices are likely to rise or fall in the next five years? By how
much?

Class 4 – Wed., Sept. 16: Government intervention: price controls, subsidies, and taxes
Read: Mankiw, Chapters 6 and 8

(PS 2) Fri., Sept. 18: Problem Set 2 due

Class 5 – Mon., Sept. 21: Zoning: Portland’s Urban Growth Boundary case
Read: Portland’s Urban Growth Boundary and Housing Prices (A): The Debate, HKS case
1703.0, Portland’s Urban Growth Boundary [UGB] and Housing Prices (B): Note on
Measuring Housing Prices, HKS case 1704.0, and Ed Glaeser and Joseph Gyourko, “The
Steep Price of Zoning”, pp. 2-3 in Taubman Center for State and Local Government, Annual
Report, 2003.

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 Assignment: Please come to class prepared to explain whether or not you would support the
proposed expansion of the UGB boundary by 17,000 acres, mostly in southeast Clackamas
County. In thinking about your decision, please consider:
1. What benefits supporters claim for the UGB? What are the costs detractors
attribute to the UGB?
2. In theory, how would a UGB affect housing prices? How would exclusionary
zoning affect housing prices?
3. What are the other factors that might account for differences in average
housing prices among metropolitan areas? Please distinguish between factors that
might cause price differences in the short run from those that might cause price
differences in the long run.
4. Do you think that the UGB has caused long-run pressure on housing prices in
Portland?

B. The Consumer

Class 6 – Wed., Sept. 23: Choice and valuation

Read: Mankiw, Chapter 21

(PS 3) Fri., Sept. 25: Problem Set 3 due

Class 7 – Mon., Sept. 28: Assisting the poor: Liconsa and the Program of Social Assistance for Milk case
Read: Liconsa and the Program of Social Assistance for Milk, HKS case 1766.0
Assignment: Please come prepared to explain whether you think Liconsa's milk program should
be replaced by Oportunidades/Progressa program or not. In formulating your position please
consider:
1. What are the advantages and disadvantages of Liconsa's milk program as a means of
helping the poor?
2. Would giving the poor money be better or not?
3. Is the Oportunidades/Progressa program better?

C. The Firm

Class 8 – Wed., Sept 30: Costs, technology, and firm size

Read: Mankiw, Chapter 13.

(PS 4) Fri., Oct. 2: Problem Set 4 due

Class 9 – Mon., Oct. 5: The structure of costs: Rural Electrification in Nicaragua case
Read: Rural Electrification in Nicaragua, (abridged) HKS case 1705.3
Assignment: Come to class prepared to advise the National Commission on Energy on whether
its consultants have chosen the appropriate technologies for the El Ayote pilot communities.
In fashioning your advice, please consider:
1. How much do you think residents might be willing to pay for electricity
service from a diesel- or hydro-powered mini-grid or from a PV system?

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 2. How do the costs of solar, diesel, and hydro compare? What are the marginal
costs of each technology? What are the fixed costs?
How does electricity demand vary during the day in these communities? What problems does this
create for the design of the electricity system?

Class 10 – Wed., Oct. 7: Profit maximization and the firm’s choice of quantity and price
Read: Mankiw, Chapter 14, pp. 289-300, and Chapter 15, pp. 311-322

(PS 5) Fri., Oct. 9: Problem Set 5 due

Mon., Oct. 12: Columbus Day Holiday – No Class

Class 11 – Wed., Oct. 14: Pricing and competitive strategy: Sullivan, Gray, Rait case
Read: Sullivan Gray Rait, GSD case.
Assignment: Come to class prepared to explain the price you would quote to Max Reptan for the
Gahanna job if you were Gary Gray or Mike Whaley. In formulating your position please
consider:
1. How did Gary Gray and Mike Whaley justify their original $56,000 bid? On
what basis are they now considering dropping the bid to $41,000?
2. What role should costs play in their calculation? What is the relevant cost?
3. What other considerations besides costs are important in formulating the bid?

Fri., Oct. 16: Mega review session – time and place TBA

Class 12 – Mon., Oct. 19: In-class mid-term exam

II. MARKET FAILURE

A. Efficiency and Competitive Markets

Class 13 – Wed., Oct. 21: Perfect competition, long run equilibrium, and the supply curve
Read: Mankiw, Chapter 14, pp. 300-307

(PS 6) Fri., Oct. 23: Problem Set 6 due

Class 14 – Mon., Oct. 26: Pareto optimality and the maximization of surpluses
Read: Mankiw, Chapters 7 and 9

Class 15 – Wed., Oct. 28: Efficiency and equity: Parking in San Francisco case
Read: Parking in San Francisco, HKS case no. 1877.0
Assignment: Come prepared to explain whether you support the proposals for more market-
based parking policies. In formulating your position please consider:
1. If the prices for on-street spaces were set by the market, how much would they be?
2. In what respects is the current system of free on-street parking inefficient? In what
respects efficient?

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Markets and Market Failure with Cases Fall 2009
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 3. Would a shift to market prices for on-street spaces be Pareto-improving?
4. Is there an economic rational for either minimum or maximum off-street parking
standards?

(PS 7) Fri., Oct. 30: Problem Set 7 due

B. Monopoly and Oligopoly

Class 16 – Mon., Nov. 2: Monopoly and its remedies

Read: Mankiw, Chapter 15, 322-339

Class 17 – Wed., Nov. 4: Oligopoly and game theory

Read: Read Mankiw, Chapter 17; skim Chapter 16

(PS 8) Fri., Nov. 6: Problem Set 8 due

Class 18 – Mon., Nov. 9: Assessing market power: Microsoft on Trial case

Read: Microsoft on Trial, HKS case no. 1522.0
Assignment: Come to class prepared to discuss the following questions.
1. Is Microsoft a monopoly (or, more accurately, does Microsoft have market
power)? What evidence do you have to support this proposition?
2. Is Microsoft’s behavior predatory or not? How do you distinguish predatory
behavior from an aggressive competitive response?
3. Assuming that Microsoft is a monopoly, what remedy would you
recommend?

Wed., Nov. 11: Veterans Day Holiday – No Class

(PS 9) Fri., Nov. 13: Problem Set 9 due

C. Information, Externalities, and Public Goods

Class 19 – Mon., Nov. 16: Information asymmetries: The Sub-prime Crisis

Read: The Subprime Mortgage Crisis, HKS draft case
Assignment: Much of the public discussion focuses on ameliorating the immediate aftermath of
the sub-prime crisis, such as the large number of foreclosures and the potential bankruptcy of
Fannie Mae and Freddic Mac. But come to class prepared to explain whether and how you
think we need to change the system to prevent a similar crisis in the future. In preparing
your answer, please consider:
1. Why did the government begin to regulate banking in the 19th century? How and why did
banking regulation change in the Great Depression of the 1930s?
2. What caused the current subprime crisis? Which actors might have averted it?
3. What, if anything, should we do to avert future problems?

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Markets and Market Failure with Cases Fall 2009
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Class 20 – Wed., Nov. 18: Externalities and public goods
Read: Mankiw, Chapter 10, pp. 200-209 and Chapter 11.

(PS 10) Fri., Nov. 20: Problem Set 10 due

Class 21 – Mon., Nov. 23: How much to clean up: Arsenic in Drinking Water case
Read: Arsenic in Drinking Water, HKS 1680.0
Assignment: What standard should Administrator Whitman set for arsenic in drinking water? In
formulating your recommendation, please consider:
1. What principles would you use in setting the rule?
2. What are the major costs and benefits of the proposed rules? How uncertain are they?
3. How should non-quantifiable benefits be incorporated into EPA’s analysis?
4. What should EPA do about small drinking water systems?

Class 22 – Wed., Nov. 25: Alternative remedies to externalities

Read: Mankiw, Chapter 10, pp. 209-220

Thanksgiving Holiday, Thurs. and Fri., Nov. 26 and 27

Class 23 – Mon., Nov. 30: Public goods: Global Climate Change and Emissions Trading case
Read: Global Climate Change and Emissions Trading, HBS case no. 9-707-015
Assignment: Please come to class prepared to discuss:
1. The vast majority of nations that signed the Kyoto Protocols are now failing to meet
the agreed-upon targets. Why do you think that is the case?
2. What international policy options are available for dealing with climate change?
3. What policy options are available to local governments (cities, states, provinces,
nations, etc.)?

Class 24 – Wed., Dec. 2: Metropolitan planning: Vancouver’s Livable Region Plan case
Read: Vancouver’s Livable Region Plan, HKS case no.1361.
Assignment: Come to class prepared to explain whether you would support Vancouver’s regional
plan if you were a concerned citizen of the region. In formulating your answer, please
consider:
1. To what extent are you sympathetic with the plan’s goal?
2. What are the benefits and costs of the plan?
3. Do you think the plan is practical or realistic?

Final Exam – Tuesday, December 15 from 2:00-5:00 PM at location to be announced.

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Markets and Market Failure with Cases Fall 2009
HKS API-105B & GSD 5203 Syllabus – Version as of 08/25/09