Transcript Chapter Twelve

General Equilibrium and the
Efficiency of Perfect Competition
Chapter 12
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Partial Equilibrium Analysis
Partial equilibrium analysis refers to the process
of examining the equilibrium conditions in
individual markets and for households and firms
separately.
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General Equilibrium and Efficiency
General equilibrium is the condition that exists
when all markets in an economy are in
simultaneous equilibrium.
Efficiency is the condition in which the economy
is producing what people want at least possible
cost.
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Technological Change and the
Economy
A significant - if not sweeping - technological
change in a single industry affects many
markets. Households face a different structure
of prices and must adjust their consumption of
many products. Labour reacts to new skill
requirements and is reallocated. Capital is also
reallocated.
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Cost-Saving Technological Change in
the Calculator Industry
As technology made it possible to produce at lower costs in the calculator
industry, cost curves shifted downwards. As new firms entered the industry
and existing firms expanded, output rose and market price dropped.
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General Equilibrium Impacts of a Shift
in Consumer Preferences (Table 12.1)
Consumer preferences in Canada shifted dramatically towards
wine between 1965 and 1980. This has dramatic effects on a two
industry economy; wine industry (X) and other industries (Y).
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Adjustment in an Economy with Two
Sectors: Wine Industry Impact (Figure 12.3)
Initially, demand for X shifts from D0x to D1x. This shift pushes the price of
X up to P1x, creating economic profits. Firms enter and expand in sector X
which shifts supply to S1x, reducing price and eliminating profits.
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Adjustment in an Economy with Two
Sectors: Other Industry Impact (Figure 12.3)
Initially, demand for Y shifts from D0y to D1y. This shift pushes the price of
Y down to P1y, creating economic losses. Firms exit sector Y which shifts
supply to S1y, increasing price and eliminating the losses.
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Allocative Efficiency and Competitive
Equilibrium
Competitive Market Assumptions
Both output markets and input markets are perfectly
competitive.
Firms and households are price takers.
Households have perfect information and firms have
perfect knowledge.
Decision-makers consider all costs and benefits;
there are no externalities.
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Pareto Efficiency
Pareto efficiency is a condition in which no
change is possible that will make some
members of society better off without making
some other members of society worse off
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The Three Basic Questions of a
Competitive Economy
 What will be produced?
 How will it be produced?
 Who will get what is produced?
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Efficient Allocation of Resources
under Perfect Competition
Firms have incentives to use the best available
technology.
Individual firms maximize profits, and so they
must minimize costs.
Each firm uses inputs such that MRPa = Pa.
Therefore, the marginal value of each input to
each firm is just equal to its market price.
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Efficient Distribution of Outputs
under Perfect Competition
Households shop freely in the same markets.
Households attempt to maximize their own
utility.
Each household maximizes utility where
MUa / MUb = Pa / Pb.
Therefore, the marginal rate of substitution for
each household is equal to the price ratio.
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Efficient Mix of Output under Perfect
Competition
Firms find their profit maximizing levels of
output where MC = P.
MC represents the marginal value of the other
things that could be produced with the same
resources.
P represents the marginal value of the product
to society.
Under these conditions no changes can improve
social welfare.
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Market Failure
A market failure occurs when resources are
misallocated, or allocated inefficiently. The
result is waste or lost value.
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Sources of Market Failure




Imperfect competition
Public goods
Externalities
Imperfect information
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Imperfect Competition
Imperfect competition refers to an industry in
which single firms have some control over price and
competition. Imperfectly competitive industries give
rise to an inefficient allocation of resources.
A monopoly is an industry comprised of only one
firm that produces a product for which there are no
close substitutes and in which significant barriers
exist to prevent new firms from entering the
industry.
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Public Goods
Public goods, or social goods are goods or
services that bestow collective benefits on
members of society; they are, in a sense,
collectively consumed.
Generally, no one can be excluded from their
benefits.
Classic example: national defense.
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Externalities
An externality is a cost or benefit resulting from
some activity or transaction that is imposed or
bestowed upon parties outside of the activity or
transaction.
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A Classic Example of a Negative
Externality is Air Pollution
Country
Canada
United States
Germany
China
India
Chad
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Metric Tonnes per person
13.8
20.0
10.5
2.8
1.1
0.0
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Imperfect Information
Imperfect information is the absence of full
knowledge regarding product characteristics,
available prices, and so forth.
The absence of full information can lead to
transactions that are ultimately
disadvantageous.
Buyers of services that require expertise often
have imperfect information e.g. car repair.
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Review Terms & Concepts
 efficiency
 externality
 general equilibrium
 imperfect competition
 imperfect information
 market failure
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 monopoly
 Pareto efficiency
 Pareto optimality
 partial equilibrium
analysis
 private goods
 public goods
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