Basic Economic Problem

Question 1

What Is Economic Efficiency?

Answer 1

It refers to a situation where scarce resources are used in the “best” or most efficient possible way to achieve the maximum possible output at the lowest cost.

It occurs when there is allocative and productive efficiency.

Efficiency could also be described in relation to the concept of optimality - the best situation or outcome possible in a particular situation. Thus to achieve an efficient allocation of resources it is necessary to achieve economic efficiency.

Question 2

What Is Social Efficiency?

Answer 2

It is the best or optimal use of resources. It is called the socially optimum resource allocation.

An efficient allocation of resources is achieved when marginal social benefit marginal social cost.
(MSB = MSC).

Question 3

What Is MSB?

Answer 3

MSB is the additional social benefit resulting from consuming one more unit of a good.

Question 4

What Is MSC?

Answer 4

MSC is the additional social cost resulting from consuming one more unit of a good.

Question 5

What Is Productive Efficiency?

Answer 5

It occurs when products are made with the least possible amount of scarce resources.

Question 6

When Is Does Productive Efficiency Occur In A Firm?

Answer 6

It occurs when the firm produces output at the lowest/minimum average cost. The firm operates
at the lowest point in the average cost curve.

It makes best use of scarce resources by producing each unit of output at the lowest possible cost.

Question 7

What Is Technical Efficiency?

Answer 7

It occurs when a given amount of output is produced with the minimum number of resources.

Question 8

When Does Productive Efficiency Occur In An Economy?

Answer 8

Productive efficiency is achieved when an economy operates along the PPC. All resources are used up to produce a given combination of goods.

Question 9

What Is Allocative Efficiency?

Answer 9

It exists when scarce resources are used to produce a combination of goods which satisfies consumer preferences and maximises their welfare/utility.

Firms produce goods and services that are most wanted by consumers. This leads to the best satisfaction (utility) for consumers.

Question 10

What Is Marginal Cost Of Production?

Answer 10

Is the cost of producing one more unit of a product.

Question 11

How Can Allocative Efficiency Be Explained?

Answer 11

In terms of the relationship between the marginal cost of production and the price of a product.

When marginal cost of production is equal to the price charged for the product, allocative efficiency is said to exist. This is because the value put on the resources by the producer (marginal cost) is equal to the value put on the product by the consumer (price).

Question 12

What Is Pareto Optimality?

Answer 12

A condition where it is impossible to make someone better off without making someone else worse off.

It occurs when resources are allocated in the most efficient way to produce the maximum output
of products such that it is not possible to increase output of one product without reducing the
output of other products.

Question 13

What Is Needed For Pareto Optimality To Be Achieved?

Answer 13

Both productive and allocative efficiency must exist.

This means that inputs into the production process are used in the most efficient way (productive efficiency) and that the output produced yields the maximum possible utility/satisfaction to consumers (allocative efficiency)

Question 14

How Can/Is Pareto Optimality Be Illustrated On The PPC?

Answer 14

When an economy is operating along the PPC it is not possible to increase the output of capital goods without reducing the output of consumer goods. Pareto optimality is achieved.

Points inside the PPC would be Pareto inefficient. They indicate that there are unused resources in the economy. It would be possible to increase the output of either good without reducing the output of the other.

Question 15

What Is Dynamic Efficiency?

Answer 15

Occurs when resources are allocated efficiently over time.

It the greater efficiency that results from improvement in productive efficiency over time.

Question 16

What Indicates Dynamic Efficiency?

Answer 16

The appearance of new products on the market resulting from research and development.

Introduction of new methods of production using the latest technology.

Changes in management styles resulting from investment in human capital.

Question 17

What Is X - inefficiency?

Answer 17

It occurs when a firm does not minimize costs. It does not produce a given level of output at the lowest possible cost.

It is also referred to as organizational slack.

Question 18

What Are Causes Of X - inefficiency?

Answer 18

Failure to reduce costs by employing too many workers or buying inputs/capital equipment at higher prices.

Stakeholders within the firm claiming benefits greater than what the firm should to pay e.g. high bonuses paid to directors and managers.

Trade unions bargaining for wage rates higher than the market rate.

Environmental pressure groups putting pressure on the firm to adopt strict environment standards.

Workers’ pressure groups putting pressure on the firm to improve the working environment and safety standards.

Question 19

What Is The Concentration Ratio (CR)?

Answer 19

It is a measure of the share of the market by the largest firms in the industry. It shows the extent to which to which an industry is dominated by a few large firms.

Question 20

What Does CR Measure?

Answer 20

Measures the proportion of the total sales produced by the largest (3 to 5) firms in the industry e.g. the 3-firm CR measures the proportion of the total sales produced by the 3 largest firms in the industry.

The higher the CR the more concentrated the industry and the fewer the firms that dominate the market. This implies that there is limited competition and could lead to allocative and productive inefficiency.