Chapter 7 Flashcards
Define economic efficiency
Producing highest possible output with lowest possible input used. [Allocative efficiency + productive efficiency.]
Productive efficiency
Achieved when firms produce the highest maximum output possible while operating at minimum cost. It involves both technical and cost efficiency. (E.O.S)
Technical efficiency -> Best possible use of resources to produce highest output
Cost efficiency -> Picking best set of input
Allocative Efficiency
Producing with the lowest average cost, and charging consumers lowest price possible. This is ONLY applicable in perfect competition markets, where marginal cost is equal to price.
Dynamic Efficiency
Firms lower their average cost by being productive and efficient through investing in R&D department and through technological advancements.
Define pareto optimality
It is impossible to make someone else better off without making someone else worse off.
Any point along PPC is Pareto efficient.
Define efficiency
Efficiency is making full use of resources, but there must be opportunity cost.
Define social cost
Private cost + External Cost
Define private cost
Cost that is paid by the first party in process of consumption or production. Like, cost of wages, rent…
Define external cost
Cost that is paid by the third party in the process on consumption or production. Like, pollution from factories.
Define social benefit
Private benefit + External benefit
Define private benefit
Benefit that’s gained by the first party in the process of consumption or production. Like, revenues from production
Define external benefit
Benefit that’s gained by the third party in the process of consumption or production. Like, job opportunities.
Define cost-benefit analysis
A decision making tool used to analyze whether a project or a policy is worth implementing by analyzing costs and benefits. The benefits must exceed the costs.
It ensures resources are allocated efficiently in ways that maximize net benefits.
Components of CBA
1- Identify costs and benefits
- Examples of costs: Construction expense, labour, Maintenance, ENVIRONMENTAL IMACT
- Examples of benefits: Reduced time travel, job opportunities, economic development
2 - Assign monetary values
Makes it easier to compare multiple projects
3 - If applicable, some have projects have a long-term impact (DISCOUNTING)
Must use statistical forecasting techniques as future benefits and costs are uncertain, so discounting is applied to take them into consideration. Like inflation.
4 - Compare net benefits and costs.
Decide whether to proceed or not
Advantages of CBA
- Resources are allocated efficiency
- Transparency with costs and benefits
- Future oriented - taking into consideration long-term impacts through discounting
- Can be used to compare against other multiple projects to ensure resources are allocated for maximized profits
Disadvantages of CBA
- Assigning a monetary value can subjective and difficult. Like it’s hard to assign a value for environmental damage.
- Time-consuming
- Risk of bias - stakeholders may manipulate data to favour their interests.
- Long-term uncertainty.
Define market failure
Absence of government intervention and presence of externalities
Characteristics of market failure
- Absence of public goods and merit goods
- Presence of demerit goods
- Information Failure
- Resource depletion
- Presence of monopoly
- Social costs > social benefits
Define information failure/asymmetric informaiton
A situation in which some participants in the market have better information about market conditions than others
Markets ONLY operate efficiently if everyone has perfect knowledge
Define adverse selection
When it comes to insurance, people who are more prone to diseases and accidents are more likely to have insurance.
Define moral hazard
An individual who has insurance would be more likely to take risks as they know they’re covered by insurance.
Define externalities
An external cost or benefit that is not reflected into market price, which distorts price mechanism.
It affects 3rd party in consumption and production.
Define negative externality in production
Harming third party due to production process, like the fumes from plastic factories causing lung-diseases to citizens.
Define negative externality in consumption
Harming third party due to consumption process, like people smoking cigarettes affect those around them with lung diseases.
