Chapter 4: Microeconomic objectives Flashcards
What is allocative efficiency?
Allocative efficiency is achieved when society produces a combination of goods and services that maximises its welfare. Occurs when MSB=MSC or when P=MC.
What happens when there is a case of underconsumption/ underproduction?
For any output level lower than Qs (MSB=MSC) where MSB>MSC or P>MC, society values each additional unit of the good more than the additional cost of consuming/ producing it. Thus there is under-allocation of resources to the consumption/ production of the good, resulting in a DWL (mkt failure)
What happens when there is a case of overconsumption/ overproduction?
For any output level higher than Qs (MSB=MSC) where MSB<MSC or P<MC, society values each additional unit of the good less than the additional cost of consuming/ producing it. Thus there is an over-allocation of resources to the consumption/ production of the good, resulting in a DWL (mkt failure)
What is productive efficiency?
Productive efficiency is achieved when the output is produced at the lowest average cost in the long run, at the given state of technology (min. point of LRAC curve)
What is equity?
Equity is a normative issue on how resources should be distributed amongst various groups of people and requires a value judgement to be made.
What is market failure?
Market failure occurs when the free market is unable to allocate resources efficiently
What are the types of market failure?
- Partial market failure
- externalities
- information failure
- factor immobility
- market dominance - Complete market failure
- public goods
What are public goods?
Public goods are non-excludable, non-rivalrous and non-rejectable in consumption.
Define non-excludability
Non-excludability means that it is technically impossible or extremely costly to prevent non-payers from consuming the good once it is provided
Define non-rivalry
Consumption of the good by one person does not reduce the amount of the good available for others.
Define non-rejectability
The inability of consumers to refuse the consumption of the good once it has been provided
What are the implications of non-excludability?
Non-excludability gives rise to a free rider problem where people would hope to free ride on the provision made by others. If those who don’t pay cannot be prevented from consuming the good, people will not be willing to reveal their preferences for the good. This will result in a concealed demand. Thus producers cannot change the prices of their goods and therefore will not be motivated to produce the good.
What are the implications of non-rivalry?
Once the good is produced, the marginal cost of providing the good to an additional person is 0. Since allocative efficiency is achieved when P=MC, since the MC=0, the efficient P is also 0. Producers should not change the price. However if left to the free market, the producers will not be willing to charge at 0 price.
What are negative externalities?
Negative externalities arising from an economic activity are the costs to third parties who are not involved in the production or consumption of a good and these third parties are not compensated for the costs incurred.
What are the 6 steps to explain why market failure occurs due to negative externalities? (Production)
- Explain MPC and identify free mkt eqm
- Self interested producers only consider their MPC (give eg). Hence the equilibrium in the free market will lie at Qe where MPC=MPB - Explain -ve externality
- However the production of (give eg) generates negative externalities (give eg), identify 3rd party + cost to 3rd party - Divergence between cost curves
- The existence of negative externalities results in a divergence between MPC and MSC - Identify Qs where MSB=MSC
- The socially optimal level of output Qs is where MSB=MSC - Compare Qe and Qs
-Between Qe and Qs, society values an additional unit of the good less than what it costs to produce it - Explain DWL
- Therefore there is an overproduction of Qs-Qe, resulting in a DWL to society as shown by the shaded area on the diagram
