Transcript Producer efficiency

Economics 2010
Lecture 9
Markets and efficiency
Competition and Efficiency
 The
Key Question
 Allocative Efficiency
 The Invisible Hand
 Obstacles to Efficiency
The Key Question
 In
a market, millions of individuals each
make their own decisions about what to
sell and what to buy
 Nobody coordinates these individual
plans
 Nobody
thinks about other agents’
welfare
 They are trying to get the best deals for
themselves!
The Key Question
 Do
markets produce the efficient
quantities of goods and services?
 Or do they produce too much of some
items and too little of others?
 This is the key question
Allocative Efficiency
 Allocative
efficiency occurs when no
resources are wasted
 In more technical language, allocative
efficiency occurs when no agent can
be made better off without some
other agent being made worse off
Allocative Efficiency
 Three
conditions are met when the
allocation of resources is efficient:



Consumer efficiency
Producer efficiency
Exchange efficiency
Consumer Efficiency
 Consumer
efficiency occurs when
consumers cannot make themselves
better off by reallocating their budgets
 by reorganizing the way they spend
their money
Consumer Efficiency
 consumer
efficiency occurs when
consumers are on their demand
curves
 The demand curve tells us the quantity
that consumers plan to buy at a given
price
Consumer Efficiency
 Also,
the demand curve tells us the
maximum amount that consumers are
willing to pay for a given quantity
 In the absence of external benefits, the
demand curve is a marginal social
benefit curve
Consumer Efficiency
 Marginal
social benefit is the amount
that a consumer is willing to pay for the
last unit bought plus the value of the
last unit bought to other people
 The value to other people of the last unit
bought is called an external benefit. An
example is the benefit from new
knowledge
Producer Efficiency
 Producer
efficiency occurs when firms
cannot increase their profits by
changing the quantity produced or by
changing the method of production
 Equivalently, we will see later in the
year that producer efficiency occurs
when firms have maximized profit
Producer Efficiency
 Profit
is maximized when the marginal
cost equals marginal revenue
 In perfect competition, marginal revenue
equals price
 So, producer efficiency is achieved
when marginal cost equals price
 the marginal cost is given by the supply
curve, as you know
Producer Efficiency
 Producer
efficiency occurs when firms
are on their supply curves
 The supply curve tells us the quantity
that producers plan to sell at a given
price when they are maximizing profit
Producer Efficiency
 Also,
the supply curve tells us the
minimum amount that producers are
willing to accept for a given quantity
 In the absence of external costs, the
supply curve is a marginal social cost
curve
Producer Efficiency
 Marginal
social cost is the cost of the
last unit bought plus the cost imposed
on other people
 The costs imposed on other people are
called external costs. They are
opportunity costs that fall on third
parties. Examples are the costs of
pollution or congestion
Exchange Efficiency
 Exchange
efficiency occurs when all
the available gains from trade have
been realized.
 The gains from trade for consumers are
measured by consumer surplus
 Consumer surplus is explained in
Chapter 6, which we skipped
 However, the concept is very easy...
Exchange Efficiency
 Here,
consumer
surplus is shown
by the green
triangle
 Consumer surplus
is the value placed
on the good minus
the amount paid
for it
Exchange Efficiency
 The
gains from trade for producers are
measured by producer surplus
 Producer surplus is total revenue minus
the opportunity cost of production
Exchange Efficiency
 Here,
producer
surplus is shown
by the blue
triangle
 Producer surplus
is the revenue
received minus
the cost of
production
Exchange Efficiency
 The
total gains from trade are the
sum of consumer surplus and
producer surplus
Allocative Efficiency
 Allocative
efficiency occurs when all
three conditions:



consumer efficiency
producer efficiency
exchange efficiency
are satisfied
Allocative Efficiency
 We
show here
allocative
efficiency
 Consumer
efficiency is
achieved at all
points along the
demand curve, D
 they are happy
there...
Allocative Efficiency
 Producer
efficiency is
achieved at all
points along the
supply curve, S
 they are happy
there...
Allocative Efficiency
 Exchange
efficiency is
achieved at the
quantity Q* and
the price P*
 At this price and
quantity, the
gains from trade
are maximized
The Invisible Hand
 When
firms are producing on their
supply curves and households are
consuming on their demand curves,
each is doing the best they can with
their resources, given the prices
prevailing in markets
 Competitive markets bring these two
sets of decisions together
The Invisible Hand
 Equilibrium
in a competitive market
occurs at the price that equates the
quantity demanded and the quantity
supplied
 In a competitive equilibrium,
producers’ marginal costs equal
consumers’ marginal benefits for all
goods and services
The Invisible Hand
 When
there are no external costs, a
firms’ marginal cost equals marginal
social cost
 When there are no external benefits,
the price paid by the household is the
marginal social benefit
 In the absence of externalities, the
competitive market is efficient
The Invisible Hand
 Competitive
markets send resources to
their highest-value uses