7.3 Efficiency and market failure Flashcards
What is the definition of productive efficiency?
This occurs when a firm is operating at their lowest point on the AC curve. This is when there is full exploitation of all potential economies of scale.
What are the conditions of productive efficiency?
This is when firms produce at the lowest point of the AC (average cost) curve.
Productive efficiency occurs when:
* Producers minimise the wastage of resources
* An economy is on its production possibility frontier
* An economy can produce more of one good only by producing less of another
Productive efficiency helps maximise consumer welfare but it can be wasteful if the goods and services consumers want are not produced
What is the definition of economic efficiency?
where scarce resources are used in the most efficient way to produce maximum output
Allocative, productive and dynamic all come underneath this
What are the conditions of allocative efficiency?
D = S
P = MC
AR = MC
It occurs where resources follow consumer demand and so society surplus is maximised
where net social benefit is maximised
consumers pay for the value of the marginal utility they derive from consuming the good or service.
What is Pareto optimality?
Pareto optimality occurs when it is impossible to make someone better off without making someone else worse off.
It is an optimal situation, with resources allocated in the most efficient way
What is dynamic efficiency?
Reinvestment of long-run SNP back into the business in the form of new and upgraded capital, technology, R&D, innovation, etc.
A type of productive efficiency
There is a time lag between making the investment and falling average costs. Some firms will face a trade-off between giving their shareholders dividends and making an investment
What is X efficiency?
X efficiency occurs when a business is minimising waste. No excess costs
It occurs at ANY point on the AC curve
When would there be X inefficiency?
It will be when monopolists lack competitive drive which allows complacency and waste. But they are prof maximisers so it doesn’t make much sense for waste to creep in. However to reduce x inefficiency it is difficult and unpopular. Could be wage cuts etc
It will also be when public sector firms aren’t profit-motivated enough, they only want to maximise societal welfare. Due to a lack of profit drive, x inefficiency creeps in as a result
Allocative efficiency analysis
This is when D = S, when society surplus is being maximised
Occurs when P = MC or AR = MC
Consumer analysis :
Resources are following consumer demand getting exactly what they want
Low prices –> maximisation of consumer surplus
High choice —-> gives consumers what they desire
High quality
Producer analysis:
It is a way to retain or increase market share which means you can stay ahead of your rivals
You can increase profits as you bring more consumers to yourself
Productive efficiency analysis
This is when maximisation of output at the lowest possible cost. There is full exploitation of EoS. Max output at the lowest cost
Occurs at the minimum point of the AC curve or when MC = AC as Mc cuts the AC curve at its lowest point.
Consumer analysis:
You will have lower prices for consumers if the lower costs are passed on
You will have a higher consumer surplus due to the full exploitation of EoS
Producer analysis:
You will get more production at lower costs which means there will be higher profits
Lower prices can let you stay ahead of your rivals which can help you retain or increase your market share
Dynamic efficiency analysis
This is when you reinvest supernormal profits into innovation, R&D and new technology to lower LRAC over time.
Supernormal profit is needed in the Long run.
Consumer analysis:
New innovative products which means greater choice and the best quality for consumers
Lower prices over time due to new tech and better production processes. New entrants can push prices down too which increases consumer surplus
Producer analysis:
Long run profit maximisation is allowed. By continually innovating you can stay ahead of rivals and keep high profits
Lower costs over time
Retain/increase market share
A way to stay ahead of rivals which can help create monopoly power
X efficiency analysis
Production with no waste
Production takes place at any point on the AC curve
Consumer analysis:
Lower prices which means higher consumer surplus
Producer analysis:
Lower costs which meant higher profits
Lower prices to pass on to consumers to increase market share to stay ahead of rivals
