Market Efficiency and Inefficiency

Question 1

Pareto efficiency

Answer 1

in an efficient market, there are no possible trades that will make one party better without making the other worse

to increase the level of the minimum income or to reduce the inequality of income it is necessary that wealth increase more rapidly than population

Question 2

Pareto efficient market requires:

Answer 2

1. every producer of good should have same marginal costs
2. marginal cost should equal marginal benefit
3. all consumers should receive same marginal benefit from good

In competitive market, it is assumed that mkt. eq. = Pareto efficient

Question 3

Negative externalities

Answer 3

Occur when the costs of producing or consuming a good affect those who are not involved

1) Production level is higher than efficient because the marginal private cost, which the firm uses to make production decision, is lower than marginal social cost

2) Firms produce too much and create a deadweight loss for society

Question 4

Positive externalities

Answer 4

Occur when the benefits of producing or consuming a good affect those who are not involved (e.g: neighbourhood benefiting from one house’s CCTV system)

1) Consumption is lower than efficient because marginal private benefit is lower than marginal social benefit

2) Consumers buy too little and create deadweight loss