CHAPTER SEVEN –PERFECT COMPETITION AND THE INVISIBLE HAND Flashcards
Whats the social surplus?
In an perfectly competitive market, the social surplus – the sum of the consumer surplus and producer
surplus, which as a reminder are the difference between one’s reservation value and the actual value of
the trade – is maximized.
Whats the Pareto efficiency?
In a competitive market equilibrium there are no unexploited gains to trade. However, no individual can
have a better outcome without making someone else’s worse. This is called a pareto efficient outcome.
Whats the deadweight loss?
The deadweight loss refers to the decrease in social surplus from a market distortion. Panel (a) shows that
the market can operate freely as the Q2 has a price of P2 which is the equilibrium. Thus, the social surplus
is the triangle A + triangle B. However, panel (b) shows a market in which a price control is put into place.
How do you calculate the buyer surplus?
Surplus buyer: res. value – price
How do you calculate the seller surplus?
Surplus seller: price – res. value
How do you calculate the total surplus? (social surplus)
consumer surplus + producer surplus
What is referred to as Pareto Efficiency?
Pareto-Efficiency (or Allocative Efficiency):
Allocation X is Pareto-efficient if nobody in the
economy can be made better off without making
someone else worse off (in terms of utility).
What is referred to as a Pareto Improvement?
If some people are better off after the change, but no
one is worse off.
Name the two types of disequilibria
– The market price may exceed the equilibrium price leading to excess
supply.
– The market price may be smaller than the equilibrium price leading to
excess demand.
„Under perfect competition and with no market failures,
markets…
„Under perfect competition and with no market failures,
markets squeeze as many useful goods and services out of
the available resources as possible.“
What is deadweight loss?
The reduction in social surplus
resulting from a market
intervention
Name an example for deadweight loss
Excess demand:
Shelves of a market empty
Demand high
Name the two problems of the invisible hand
1. Coordination problem = bringing together self-interested economic agents to form markets 2. Incentive problem = how to motivate agents to participate in markets
Name the two possible solutions of the problems of the invisible hand
1. Command economy = central agency directs resources, provides incentives 2. Market economy = prices direct flow of resources, provide incentives for participants
