Ch. 7 - Market Efficiency & Failure

Question 1

What is Positive Analysis? What is Normative Analysis?

Answer 1

Positive Analysis - Describes what IS happening, explaining why or predicting what will happen

Normative Analysis - Prescribes what SHOULD happen, which involves value judgement

Question 2

What is Economic Efficiency? Efficient Outcome? Equity?

Answer 2

Economic Efficiency - An outcome is more economically efficient if it yields more economic surplus

Efficient Outcome - The efficient outcome yields the largest possible economic surplus

Equity - An outcome yields greater equity if it results in fairer distribution of economic benefits

Question 3

What is Consumer Surplus? Producer Surplus? Where are they on the demand/supply curve? What are their formulas?

Answer 3

Consumer Surplus - The economic surplus you get from buying something
- Consumer Surplus is the area below the demand curve and above the price
- Consumer Surplus = Marginal Benefit minus Price

Producer Surplus - The economic surplus you get from selling something
- Producer Surplus is the area above the supply curve and below the price
- Producer Surplus = Price minus Marginal Cost

Question 4

What is a Voluntary Exchange?

Answer 4

Buyers & sellers exchange money for goods only if they both want to

Question 5

What is Efficient Production?

Answer 5

Producing a given quantity of output at the lowest possible cost, which requires producing each good at the lowest marginal cost

Question 6

What is Efficient Allocation?

Answer 6

Allocating goods to create the largest economic surplus, which requires that each good goes to the person who’ll get the highest marginal benefit from it

Question 7

What is Efficient Quantity?

Answer 7

The quantity that produces the largest possible economic surplus

Question 8

What is the Rational Rule for Markets?

Answer 8

Produce more of a good if its marginal benefit >= marginal cost

Question 9

What is Market Failure?

Answer 9

When the forces of supply & demand lead to an inefficient outcome

Question 10

What are the 5 main sources of market failures?

Answer 10

1. Market power undermines competitive pressure
2. Externalities create side effects
3. Information problems undermine trust
4. Irrationality leads to bad decisions
5. Government regulations impede market forces

Question 11

What is Deadweight Loss?

Answer 11

How far economic surplus falls below the efficient outcome

DWL = economic surplus at efficient quantity - actual economic surplus