Efficiency [25]
Introduction (economic efficiency) Allocative efficiency (AE) Productive efficiency (PE) Price mechanism in a market economy
—relates to how well an economy uses —firms produce a combination of g&s —[diagram] firms produce at the lowest —functions to allocate resources
its scarce resources to satisfy the such that the greatest possible level of possible average cost; producing at the lowest efficiently through signalling, rationing
greatest possible level of infinite consumer demand is being met point on AC and acting as an incentive
consumer wants —happens when P=MC; the price of —employs all resources that are available to —largely able to achieve AE without GI
produce g&s
—achieved when MSC=MSB or when PE good reflects the true economic cost of —[diagram] all points on PPC represent PE since
—[diagram] PE and AE achieved in PC
and AE coexist producing another unit of good the economy is making full use of its resources in the long run
—[diagram] MSB=MSC —[diagram] P=MC —not possible for a country to produce more ——firms are price takers, g&s are sold
—only one point on PPC represents AE; of one good without producing less of another at the market price determined by the
consumer preferences are unknown price mechanism
Market failure Public goods Monopolies Merit goods
—free market may not always produce —complete market failure; give rise to the free —no competitive pressure to be AE and —underproduced and under-consumed
the best outcome rider problem because of its 3 characteristics PE; abuse of market power —consumers do not perceive the full
—competitive outcome of free markets —non excludability in consumption; non-paying —charge prices where P>MC and benefits of these goods; information
is not efficient from society’s point of users cannot be excluded from consuming the MR=MC to maximise profits; above the failure
good; impossible to prevent others from
view consuming for free once it is supplied, private
socially optimum level —underproduction and
—benefits that the free market confers firms unable to supply at a profit —[diagram and analysis] compare prices underconsumption cause a problem in
on individuals and businesses diverge —non rivalry in consumption; supply of public and output to in a PC society as these goods generate
from the benefits to the society as a goods is not depleted by an additional user, MC Implement laws or regulations positive externalities
whole of producing the good is zero, thus the price —price ceiling; ensures that consumers —GI in order to provide these goods
charged must also be zero, based on condition can purchase g&s at a reasonable price for those who are deemed needed for
for AE(P=MC) them; provide example (education)
Direct provision by the government Subsidies
—can prevent underconsumption and under- —increase production and lower prices
provision; can improve social welfare
Demerit goods Government failure Imperfect information Conclusion (market failure provides
—over-consumed and overproduced; —GI may worsen the inefficient —governments may have inaccurate justification for GI)
most of these goods are cheap, allocation of resources information; may introduce policies that —free market is incapable of achieving
addictive and readily available —providing public goods can cause lead to greater economic inefficiency an efficient allocation of resources;
—without GI, these products bring more issues regarding budget deficits if tax —lack of information about the true justification for GI
negative externalities to the consumer finances are insufficient; public good value of a negative externality; difficult —not always necessary that GI could
than the individual is aware of investments must be strategic to impose the correct value of tax bring about efficient allocation of
—definition of a negative externality —state owned industries tend to lack —wrong level of taxes or subsidies will resources
Imposing indirect taxes profit motive; tend to be run lead to the wrong level of production —governments may lack information
—[diagram (MSC/MPC)] to meet the inefficiently and resources
socially efficient level of production
, Efficiency (PPC) [12/13]
Introduction (economic efficiency) Allocative efficiency (AE) Productive efficiency (PE) PPC
—relates to how well an economy uses —firms produce a combination of g&s —[diagram] economy produces at the —both types of economic efficiencies
its scarce resources to satisfy the such that the greatest possible level of lowest possible average cost; producing at can be illustrated by the PPC
greatest possible level of infinite consumer demand is being met the lowest point on AC —PPC: an economic model which shows
consumer wants —happens when P=MC; the price of —not possible to produce more of one the maximum potential output an
good without producing less of another
—achieved when MSC=MSB or when PE good reflects the true economic cost of —economy employs all resources that are economy can produce at full
and AE coexist producing another unit of good available to produce g&s employment of resources
—[diagram] MSB=MSC —[diagram] P=MC
Assumptions of the PPC model Diagram Diagram analysis (within the PPC) Diagram analysis (on the PPC)
—model is constructed based on —economy that is producing within its PPC (x) —economy said to be PE when
several assumptions: is not fully utilising all available resources production moves to a point on the PPC
——closed economy —level of output could have been greater if all (y); all resources used efficiently
——only two types of goods are available resources/FOP are employed and not —AE (Pareto E) achieved when an
left idle
produced —country that is operating within its PPC is
individual cannot be made better off
——factors of production not equally wasteful, not PE without another individual being made
productive —combination of output at (x) is also not AE; worse off
——limited resources not producing all the possible combinations of —on the PPC, a movement signifies
——constant state of technology goods most wanted by consumers more consumption of one good and less
of another
Conclusion
—economy which moves from a point
within its PPC to a point on its PPC is
considered to be engaging in both PE
and AE
—improvement in consumer welfare;
they can now enjoy the greatest
amount of goods that they want at
minimal cost
Introduction (economic efficiency) Allocative efficiency (AE) Productive efficiency (PE) Price mechanism in a market economy
—relates to how well an economy uses —firms produce a combination of g&s —[diagram] firms produce at the lowest —functions to allocate resources
its scarce resources to satisfy the such that the greatest possible level of possible average cost; producing at the lowest efficiently through signalling, rationing
greatest possible level of infinite consumer demand is being met point on AC and acting as an incentive
consumer wants —happens when P=MC; the price of —employs all resources that are available to —largely able to achieve AE without GI
produce g&s
—achieved when MSC=MSB or when PE good reflects the true economic cost of —[diagram] all points on PPC represent PE since
—[diagram] PE and AE achieved in PC
and AE coexist producing another unit of good the economy is making full use of its resources in the long run
—[diagram] MSB=MSC —[diagram] P=MC —not possible for a country to produce more ——firms are price takers, g&s are sold
—only one point on PPC represents AE; of one good without producing less of another at the market price determined by the
consumer preferences are unknown price mechanism
Market failure Public goods Monopolies Merit goods
—free market may not always produce —complete market failure; give rise to the free —no competitive pressure to be AE and —underproduced and under-consumed
the best outcome rider problem because of its 3 characteristics PE; abuse of market power —consumers do not perceive the full
—competitive outcome of free markets —non excludability in consumption; non-paying —charge prices where P>MC and benefits of these goods; information
is not efficient from society’s point of users cannot be excluded from consuming the MR=MC to maximise profits; above the failure
good; impossible to prevent others from
view consuming for free once it is supplied, private
socially optimum level —underproduction and
—benefits that the free market confers firms unable to supply at a profit —[diagram and analysis] compare prices underconsumption cause a problem in
on individuals and businesses diverge —non rivalry in consumption; supply of public and output to in a PC society as these goods generate
from the benefits to the society as a goods is not depleted by an additional user, MC Implement laws or regulations positive externalities
whole of producing the good is zero, thus the price —price ceiling; ensures that consumers —GI in order to provide these goods
charged must also be zero, based on condition can purchase g&s at a reasonable price for those who are deemed needed for
for AE(P=MC) them; provide example (education)
Direct provision by the government Subsidies
—can prevent underconsumption and under- —increase production and lower prices
provision; can improve social welfare
Demerit goods Government failure Imperfect information Conclusion (market failure provides
—over-consumed and overproduced; —GI may worsen the inefficient —governments may have inaccurate justification for GI)
most of these goods are cheap, allocation of resources information; may introduce policies that —free market is incapable of achieving
addictive and readily available —providing public goods can cause lead to greater economic inefficiency an efficient allocation of resources;
—without GI, these products bring more issues regarding budget deficits if tax —lack of information about the true justification for GI
negative externalities to the consumer finances are insufficient; public good value of a negative externality; difficult —not always necessary that GI could
than the individual is aware of investments must be strategic to impose the correct value of tax bring about efficient allocation of
—definition of a negative externality —state owned industries tend to lack —wrong level of taxes or subsidies will resources
Imposing indirect taxes profit motive; tend to be run lead to the wrong level of production —governments may lack information
—[diagram (MSC/MPC)] to meet the inefficiently and resources
socially efficient level of production
, Efficiency (PPC) [12/13]
Introduction (economic efficiency) Allocative efficiency (AE) Productive efficiency (PE) PPC
—relates to how well an economy uses —firms produce a combination of g&s —[diagram] economy produces at the —both types of economic efficiencies
its scarce resources to satisfy the such that the greatest possible level of lowest possible average cost; producing at can be illustrated by the PPC
greatest possible level of infinite consumer demand is being met the lowest point on AC —PPC: an economic model which shows
consumer wants —happens when P=MC; the price of —not possible to produce more of one the maximum potential output an
good without producing less of another
—achieved when MSC=MSB or when PE good reflects the true economic cost of —economy employs all resources that are economy can produce at full
and AE coexist producing another unit of good available to produce g&s employment of resources
—[diagram] MSB=MSC —[diagram] P=MC
Assumptions of the PPC model Diagram Diagram analysis (within the PPC) Diagram analysis (on the PPC)
—model is constructed based on —economy that is producing within its PPC (x) —economy said to be PE when
several assumptions: is not fully utilising all available resources production moves to a point on the PPC
——closed economy —level of output could have been greater if all (y); all resources used efficiently
——only two types of goods are available resources/FOP are employed and not —AE (Pareto E) achieved when an
left idle
produced —country that is operating within its PPC is
individual cannot be made better off
——factors of production not equally wasteful, not PE without another individual being made
productive —combination of output at (x) is also not AE; worse off
——limited resources not producing all the possible combinations of —on the PPC, a movement signifies
——constant state of technology goods most wanted by consumers more consumption of one good and less
of another
Conclusion
—economy which moves from a point
within its PPC to a point on its PPC is
considered to be engaging in both PE
and AE
—improvement in consumer welfare;
they can now enjoy the greatest
amount of goods that they want at
minimal cost
