AL Basic Economic Ideas and Resource Allocation Flashcards
Productive efficiency
Occurs when resources are used to give the maximum possible output at the lowest cost. This helps maximise consumer welfare but it can be wasteful if the goods and services consumers want are not produced. Benefiting one consumer by allocating more resources to them means another consumer loses out because all resources are used to their maximum productive potential so there is no spare capacity
Productive efficiency graphically
When firms produce at the lowest point on the average cost curve. Since the MC curve cuts the AC curve at the lowest point, MC = AC is a point of productive efficiency. All point on the PPC curve are productively efficient
Allocative efficiency
Occurs when resources are allocated to the best interests of society where there is maximum social welfare and maximum utility. The goods and services consumers want might be produced where there is allocative efficiency but they also need to be affordable. Productive efficiency helps keep the price down
Allocatively efficiency graphically
It exists at P=MC which means that consumers pay for the value of the marginal utility they derive from consuming the good or service. Free markets are considered to be allocatively efficient
Pareto optimality
Occurs when resources are allocated optimally so every consumer benefits and waste is minimised. At this point it is impossible to allocate resources to benefit one person without making another person worse off. This occurs on the PPC so there is a trade off between producing two different goods and services
Dynamic efficiency
When all resources are allocated efficiently over time and the rate of innovation is at the optimum level which leads to falling long run average costs. The market is dynamically efficient if consumer needs and wants are met as time goes on. It is related to the rate of innovation which might lead to lower costs of production in the future or the creation of new products
Influences on dynamic efficiency
Affected by short run factors such as demand, interest rates and past profitability. Short run costs might be increased in order to cause long run costs to fall
Evaluation of dynamic efficiency
The long time lag between making an investment and having falling average costs and by considering how factors change in the long run. Some firms will face a trade off between giving shareholders dividends and making an investment
Reasons for market failure
Market failure occurs whenever a market leads to a misallocation of resources which is when resources are not allocated to the best interests of society. There could be more output in the form of goods and services if the resources were used in a different way. Economic and social welfare is not maximised where there is market failure
Externalities
An externality is the cost of benefit a third party receives from an economic transaction outside of the market mechanism. It is the spillover effect of the production or consumption of a good or service. Negative externalities are caused by the consumption of demerit goods and positive externalities are caused by the consumption of merit goods
The under provision of public goods
Public goods are non-excludable and non-rival and they are under-provided in a free market because of the free rider problem
Information gaps
It is assumed that consumers and producers have perfect information when making economic decisions. This is rarely the case and this imperfect information leads to a misallocation of resources
Monopolies
Since the consumer has very little choice where to buy the goods and services offered by a monopoly the are often overcharged. This leads to the under-consumption of the good or service and therefore there is a misallocation of resources since consumer needs and wants are not fully met
Inequalities in the distribution of income and wealth
There is an inequitable distribution in income and wealth. Income refers to a flow of money whilst wealth refers to a stock of assets. This can lead to negative externalities such as social unrest
Complete market failure
Occurs when there is a missing market. The market does not supply the products at all
Partial market failure
Occurs when the market produces a good but it is the wrong quantity or the wrong price. Resources are misallocated where there is partial market failure
Negative externalities
Caused by demerit goods. These are associated with information failure since consumers are not aware of the long run implications of consuming the good and they are usually over-provided
Positive externalities
Caused by merit goods. These are associated with information failure too because consumers do not realise the long run benefits to consuming the good. They are under-provided in a free market
Evaluation of externalities and market failure
The extent to which the market failure involves a value judgement so it is hard to determine what the monetary value of an externality is. Different individuals will put a different value on externalities depending on their experiences which also makes determining government policies difficult
Private costs
Producers are concerned with private costs of production. This determines how much the producer will supply. It could refer to the market price which the consumer pays for the good
Marginal private cost
The cost to a firm of producing one extra unit
Social costs
Calculated by private costs plus external costs. External costs are the vertical distance between the two curves (difference between private costs and social costs). It can be seen that marginal social costs and marginal private costs diverge from each other. External costs increase disproportionately with increased output
Marginal social costs
The extra cost on society derived per extra unit consumed.
Marginal external cost + marginal private cost
Private benefit
Consumers are concerned with the private benefit derived from the consumption of a good. The price the consumer is prepared to pay determines this. Private benefits could also be a firms revenue from selling a good
