Transcript Figure 2.1 Efficient Output

Chapter 2
Efficiency Markets and
Government
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PLAN
 ÉCONOMIE NORMATIVE ET POSITIVE
 LE CRITÈRE D’EFFICACITÉ
 LES CONDITIONS D’EFF.
 FF. DU MARCHÉ
 INEFF. DU MARCHÉ (CAS DU
MONOPOLE)
 INEFF. DE L’INTERVENTION DE L’ÉTAT
SUR LE MARCHÉ (IMPôTS ET
SUBVENTIONS)
 ÉQUITÉ ET EFFICACITÉ
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Positive and Normative
Economics
 Positive Economics explains “what is”
without making judgments about the
appropriateness of “what is.”
 Normative Economics: designed to
formulate recommendations on what
should be.
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Normative Evaluation of Resource
Use:
The Efficiency Criterion
 Pareto Optimality
 The efficiency criterion is satisfied
when resources are used over any
given period of time in such a way as to
make it impossible to increase the wellbeing of any one person without
reducing the well-being of any other
person.
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Marginal Conditions for
Efficiency




Total Social Benefit
Total Social Cost
Net Benefit = TSB – TSC
Maximum Net Benefit occurs where
MSB = MSC
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Price, Benefit, and
Cost (Dollars)
Figure 2.1 Efficient Output
A
B
2.00 = P
E
1.50 = P*
1.00 = P2
D
A
Q1 = 10,000
Total Social Benefit
and Cost
MSC
C
B
MSB
Q* = 15,000
Q2 = 20,000
TSC
TSB
Z
TSB – TSC
0
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Q*
Loaves of Bread per Month
Conditions under which the
Market is Pareto Optimal
 All productive resources are privately owned.
 All transactions take place in markets and in each
separate market many competing sellers offer a
standardized product to many competing buyers.
 Economic Power is dispersed in the sense that no
buyers or sellers alone can influence prices.
 All relevant information is freely available to buyers
and sellers.
 Resources are mobile and may be freely employed
in any enterprise.
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If These Conditions are Met
P = MPB = MSB
and
P = MPC = MSC
so
P = MSB = MSC
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When Does the Market
Interaction Fail to Achieve
Efficiency?
 Monopoly
 Taxes
 Subsidies
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Market Failure: A Preview of the
Basis for Government Activity
Government intervention may be warranted if there
is:
 Monopoly power.
 Effects of market transactions on third parties.
 Lack of a market for a good where MSB>MSC
(i.e. a public good).
 Incomplete information about goods being sold.
 An unstable market.
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Figure 2.2 Loss in Net Benefits Due to Monopolies
Price, Benefit, and
Cost (Dollars)
D
MSB = P
B
E
MSC
F
MSCM
Loss in Net Benefits
A
D = MSB
G
0
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MR
QM Q*
Output per Month
Figure 2.3 Taxes and Efficiency
New Supply = MPC + T > MSC
Price (Cents per
Message Unit)
Supply = MSC = MPC
E'
6
E
5
4
B
Demand = MSB
0
3 4
Billions of Message Units per Month
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Figure 2.4 Subsidies and Efficiency
Price (Dollars per Bushel)
Supply = MSC
5
A
E
4
C
3
Demand = MSB
0
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Q* QS
Bushels of Wheat per Year
Equity vs. Efficiency
 Equity: perceived fairness of an outcome.
 Horizontal equity is achieved when equal
people are treated equally.
 Vertical equity is achieved when people are
treated fairly along a socio-economic
continuum.
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Annual Well-Being of A
Figure 2.5 Utility Possibility Curve
UA
UA2
UA1
Z
E1
X
E2
E3
0
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UB1 UB2
UB
Annual Well-Being of B
Positive Analysis Trade-off
Between Equity and Efficiency
 When making choices about public policy
issues we are usually faced with the
inevitable situation that you make one person
worse off while making another better off.
(Taxes must be paid by some in order that
public goods can be purchased and these
benefits accrue to others.) Some economists
attempt to overcome this with the
Compensation Criteria.
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Compensation Criteria
 An attempt is made to compare the dollar
value of the gain to the gainers and the dollar
value of the loss to the losers.
 If the gainers gain more than the losers lose
then the gainers can pay the losers enough to
compensate the losers for their loss.
 Everyone can be made at least as well off as
they were without the change as long as
there is compensation.
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International View: Agricultural
Subsidies, International Trade
Restrictions and Global
Efficiency
 Many nations subsidize farmers with
 Production subsidies
 Export subsidies
 Import constraints
 This results in reduced agricultural efficiency
 Since WTO agreements, such subsidies and
import constraints have been reduced
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