Transcript Managerial Economics Lecture Six winter 2015

ECONOMIC EFFICIENCY
Managerial Economics
Jack Wu
ECON EFFICIENCY: CONDITIONS
for all users, same marginal benefit
 for all suppliers, same marginal cost
 marginal benefit = marginal cost

EQUAL MARGINAL BENEFIT
if not equal
 provide more to user with higher marginal
benefit
 take away from user with lower marginal benefit
EQUAL MARGINAL COST
if not equal
 supplier with lower marginal cost should produce
more
 supplier with higher marginal cost should
produce less
MARGINAL BENEFIT/COST
if marginal benefit > marginal cost, produce more
of the item
 if marginal benefit > marginal cost, produce less
of the item

ECONOMIC EFFICIENCY V.S. TECHNICAL
EFFICIENCY
Contrast economic efficiency vis-à-vis technical
efficiency
 Technical efficiency

producing at lowest possible cost
 doesn’t consider how much benefit the item provides

ADAM SMITH’S INVISIBLE HAND: PRICE
Competitive market achieves three sufficient
condition for economic efficiency:
 buyers and sellers in a market system act
independently and selfishly, yet the overall
outcome is efficient

i) users buy until marginal benefit equals price;
 ii) producers supply until marginal cost equals prices;
 iii) users and producers face same price.

INVISIBLE HAND
 Outcome
of price
competition in market
 Marginal
benefit = price
 Marginal cost = price
 Single price in market
EXAMPLE OF INVISIBLE HAND






Major policy issue: how to allocate licenses for 3G
wireless telecommunications;
“beauty contest” -- France
auction – Germany, UK, US
pioneer: in early 1990s, US Federal
Communications Commission showed that
spectrum licenses were worth billions;
created pressure on other governments to allocate
by auction and not favoritism.
Auction ensures that item goes to user with highest
marginal benefit.
INVISIBLE HAND
Market system (price system): Economic system
in which resources are allocated through the
independent decisions of buyers and sellers,
guided by freely moving prices.
 Successes of market system

West/East Germany
 North/South Korea
 China after Deng Xiaoping’s reforms

DE-CENTRALIZATION
create internal market
 if there is a competitive market for an item, set
transfer price equal to market price
 consuming units should be allowed to outsource

Note:
 Transfer price: price charged for the sale of an
item within an organization;
 Outsourcing: purchase of services or supplies
from external sources

DECENTRALIZATION

Within organization
For all users, marginal benefit = transfer price
 For all producers, marginal cost = transfer price
 Marginal benefit = transfer price = marginal cost

UCLA ANDERSON SCHOOL, 1989
Half an invisible hand is worse than none
 priced photocopying paper
 free bond paper
PRICE CEILING
Upper limit that sellers can charge and buyers can
pay
 rent control
 regulated price for electricity
Price ($ per month)
RENT CONTROL: EQUILIBRIUM
1100
b
1000
900
0
supply
equilibrium
excess demand
290
300
demand
310
Quantity (Thousand units a month)
Price ($ per month)
RENT CONTROL: SURPLUSES
buyer surplus gain = cfeg
buyer surplus loss = dgb
seller surplus loss = cfeg + geb
d
1100
1000 c
900
f
b
g
supply
e
demand
0
290
300
310
Quantity (Thousand units a month)
RENT CONTROL: LOSSES
deadweight losses -- sellers willing to provide
item at price that buyers willing to pay, but
provision doesn’t occur
 price elasticities of demand and supply
_demand more inelastic --> larger loss
_ supply more elastic --> larger loss

PRICE FLOOR
Lower limit that sellers can charge and buyers can
pay
 minimum wage
 agricultural price supports
Wage ($ per hour)
MINIMUM WAGE: EQUILIBRIUM
a
excess supply
supply
4.20
b
4.00
equilibrium
c
0
demand
8
10
11
Quantity (Billion worker-hours a week)
Wage ($ per hour)
MINIMUM WAGE: SURPLUSES
seller surplus gain = fdge
seller surplus loss = ghb
buyer surplus loss = fdge + egb
a
4.20
4.00
f
d
supply
e
b
g
h
c
0
demand
8
10
11
Quantity (Billion worker-hours a week)
MINIMUM WAGE: LOSSES
deadweight losses -- sellers willing to provide
item at price that buyers willing to pay, but
provision doesn’t occur
 price elasticities of demand and supply
_supply more inelastic --> larger loss
_demand more elastic --> larger loss

TAX: COMMODITY TAX
“the only two sure things in life are death and
taxes”
 buyer’s price - tax = seller’s price
 payment vis-à-vis incidence
US: airlines pay tax
 Asia: passengers pay

Price ($ per ticket)
TAX: EQUILIBRIUM
804
$10
e
800
794
0
supply
b
h
900
demand
920
Quantity (Thousand tickets a year)
TAX: SURPLUSES
Price ($ per ticket)
buyer surplus loss = fdge + egb
seller surplus loss = djhg + ghb
revenue gain = fdge + djhg
804 f
800 d
794
0
j
$10
e
g
b
h
900
supply
demand
920
Quantity (Thousand tickets a year)
INCIDENCE
incidence and deadweight loss depend on price
elasticities of demand and supply
 ideal tax (no deadweight loss): inelastic
demand/supply
 who pays the tax not relevant

RETAILING: HOW SHOULD MANUFACTURER
CUT PRICE?
Wholesale price cut: Will retailers pass on the
price cut?
 Coupons: Will this provide consumers with more
effective price cut?

INCIDENCE: REDUCING RETAIL PRICES
DISCUSSION QUESTION

Consider a company that manages a network of
hospitals across several counties in one state.
Household incomes and the cost of living are
higher in urban than rural areas. The company,
however, has set the same prices for
pharmaceuticals and services in all of its
hospitals. It has also paid the same salaries for
doctors, nurses, and other professional staff
throughout the state.
DISCUSSION
QUESTION:CONTINUED
Management has noticed that there are long waiting
lists for treatment at its urban hospitals. Can you
explain this problem?
 The company has had great difficulty in recruiting
professional staff for its urban hospitals. Can you
explain this problem?
 What advice would you give to management?
