3.4 Flashcards
What is economic efficiency?
- It is about society making optimal use of scarce resources to help satisfy changing wants and needs.
- There are several meaning of efficiency, but they all basically link to how well a market system allocates our scarce resources to satisfy consumers.
- Normally the market mechanism is good at allocating inputs, but there are occasions when markets can fail.
What is allocative efficiency?
- It occurs when the value that consumers place on a good or service, equals the cost of the factor resources used up in production.
- The main condition required for allocative efficiency in a market is that market price= marginal cost of supply/ AR=MC
What is productive efficiency?
- A fir is productively efficient when it is operating at the lowest point on its average cost curve i.e. unit costs have been minimised.
- Productive efficiency exists when producers minimise the wastage of resources.
- It relates to when an economy is on their productive possibility frontier.
- An economy is productively efficient if it can produce more of one good only by producing less of another.
What is social efficiency?
- The socially efficient level of output and/or consumption occurs when marginal social benefit= marginal social cost. Same as allocative efficiency.
- The existence of negative and positive externalities means that the private level of consumption or production differs from social optimum.
- The price mechanism doesn’t always consider social costs and benefits.
What is dynamic efficiency?
- It occurs when businesses supplying a market successfully meets our changing needs and wants over time. Crucial dynamic efficiency is whether the market generates rapid innovation both in the processes of supply and the range of products available.
What is product and process innovation?
Product innovation is small- scale and subtle changes to the characteristics and performance of a good or a service.
Process innovation is changes in the way in which production takes place or is organised. It could be changes in business models and pricing strategies.
What is perfect competition?
It describes a market structure who’s assumptions are strong and therefore unlikely to exist in the vast majority of real-world markets.
What are the assumptions of a perfectly competitive market?
- Homogenous products- there is no product differentiation at all
- All firms have access to the same quality factors of production
- Large number of buyers and sellers and all sellers act independently i.e. no price collusion.
- free entry into and exit from the market i.e. no barriers to entry and exit
- Perfect knowledge/ information for buyers and sellers.
- Profit maximisation is assumed as the key objective of firms- and consumers are assumed to be utility maximisers when making their purchasing decisions.
Explain allocative efficiency in perfect competition.
In both the SR and the LR, price is equal to marginal cost and thus, allocative efficiency is achieved.
What is productive efficiency like in perfect competition?
It occurs when the equilibrium profit maximising output is supplied at minimum average cost. This is attained in the LR for a competitive market.
Output is at lowest point of AC. If a firm is producing at the lowest point of their AC curve, this also means that the firm must be X efficient.
Why are competitive markets good for economic efficiency?
- lower prices as lots of firms competing. XED will be high.
- low barriers for entry- the entry of new firms provide competition and ensures prices are kept low.
- Lower total profits and profit margins than in monopoly
- Greater entrepreneurial activity. Needs genuine desire to innovate and invent to drive markets.
- competition will ensure that firms move towards productive efficiency and avoid X inefficiency.
- The threat of competition should lead to a faster rate of technological diffusion, as firms have to be responsive to the changing needs of consumers. Dynamic efficiency.
Evaluate the assumptions of the perfect competition model.
- Most firms have some amount of price setting power- they are price makers
- Dominance in real world markets of differentiated/ branded products
- Highly complex products, there are always information gaps between buyers and sellers.
- It is impossible to avoid search costs even with the spread of digital/ web technology
- Parents, control of intellectual property control of key inputs are all ignored by the perfect competition model
- Rare for entry and exit in an industry to be costless.
- It assumes that there are no externalities; in reality, there are often 3rd party effects of every market.
What are the pros of perfectly competitive markets?
- Consumers aren’t exploited by firms, in terms of higher prices.
- Equality- products are the same regardless of where they are bought, so all consumers are able to buy the same products.
- No ‘wasted’ costs in terms of advertising ect.
What are the cons of perfectly competitive markets?
- Consumers lack choice and cannot necessarily find a product that perfectly meets their needs.
- Firms are unlikely to be able to grow large enough to benefit from economies of scale.
