Efficiencies of Markets Flashcards
Introduction to Efficiency in Markets I
Markets operating optimally will produced the most efficient solutions to the economic problem. This involves allocating the available resources to their most productive use and producing goods and services most valued by consumers in the least costly ways.
The finished products should then be distributed to best satisfy the wants and needs of consumers. It is generally the case that the most competitive markets provide the best outcomes.
Introduction to Efficiency in Markets II: Price Mechanism
In market economies, the price mechanism is central to solving the economic problem. It determines who receives the products and factors of production that are offered for sale. The price mechanism determines the level of output, the price and who is the successful buyer.
Price Signals
- match output from producers with consumer demand and ration scarce resources and the products made from them
- through changes in demand and supply, prices tell producers and consumers that they need to adjust their economic behaviour in response to changing market conditions
Costs of the Firm
Profit is the difference between the total cost of producing any output and the total revenue obtained from selling any outpit. Therefore, the equilibrium position for the firm will be at the point where the difference between total cost and total revenue is the greatest. There is no incentive to decrease of increase output.
Total costs
Total costs include all the costs involved in producing a given volume of output, including a normal profit. Normal profit is the minimum return that a firm is prepared to accept to remain in business and is therefore a necessary cost to be met by the business.
Fixed and Variable Costs
Costs are either fixed of variable: fixed and variable.
Fixed costs are all those payments that continue as a constant total amount, regardless of where production levels are at eg. rent on buildings, insurance, electricity.
Variable costs are those that increase or decrease in total amount as production levels rise and fall. Examples are supplies, commissions, delivery costs, packaging supplies.
Average total costs (AC)
Average total costs (AC) at any level of output will equal average fixed costs (AFC) plus average variable costs (AVC) at that level of output.
AC = AVC + AFC
Marginal Cost
Marginal cost is defined as the increase or decrease in the cost of producing onemore unit or serving one more customer.
Allocative Efficiency
Allocative efficiency occurs when all goods and services within an economy are distributed to consumer preferences. In this scenario, price always equal marginal cost of production. The reason for this is that the price consumers are willing to pay for a product reflects the marginal utility they get from consuming the product.
Therefore, the optimal outcome is achieved when marginal cost = marginal benefit
Allocative Efficiency II
Allocative efficiency can be found in perfectly competitive markets because firms in those markets don’t have enough power to increase prices. To survive commercially, they have to produce what society values most, at the prices consumers are willing to pay.
By contrast, monopolies are said to be productively inefficient levels of output, simply because they have enough market to affect prices and reduce consumer surplus by engaging in price discrimination.
Equilibrum/Consumer Surplus/Producer Surplus
The area where the demand and supply meet is the equilibrium price. The area above the supply level and below the equilibrium price is called producer surplus and the area under the demand level and above equilibrium price is called consumer surplus.
What is consumer surplus?
Consumer surplus is a measure of the economic welfare that people gain from purchasing and then consuming goods and services.
Consumer Surplus is the difference between the total amount that consumers are willing and able to pay for a good or service (shown by demand curve) and the total amount they actually do pay (market price). It is indicated by the area under the demand curve and above the market price.
What is producer surplus?
Producer surplus is a measure of producer welfare. Producer surplus is the difference between what producers are willing and able to supply a good for and the price they actually receive. Producer surplus is shown by area above the supply curve and below the market price. Higher prices provide an incentive to supply more to the market (profit motive).
Productive Efficiency
Productive Efficiency occurs when the optimal combination of inputs results in the maximum amount of outputs at minimal costs. This is the case when firms operate at the lowest point of their average total cost curve (where marginal costs equal average costs). A productively efficient economy always produces on the PPC.
It requires firms to use the least costly factors of production, the best processes and the most advanced technology available. In addition, wastage during production has to be reduced to a minimum and possible economies of scale have to be realised.
If those conditions are met, it won’t be possible for firms to produce more goods or services without more inputs.
Technical Efficiency
Closely related to technical efficiency but a more narrow and specialised definition. Technical efficiency is the effectiveness which a given set of inputs is used to produce an output. A firm is said to be technically efficient if a firm is producing the maximum output from minimum quantity of inputs, such as labour, capital and technology. Technical efficiency requires no unemployment of resources.
The simplest way to differentiate productive and technical efficiency is to think of productive efficiency in terms of cost minimisation by adjusting the mix of inputs, whereas technical efficiency is output maximisation from a given mix of inputs.
