WHAT IS ALLOCATIVE EFFICIENCY Flashcards
@ free market equilibrium there is an
efficient allocation of scarce resources
draw a diagram w effieicnet allocaiton of scarcer reources
y axis = price/costs/benefits
x axis = quantity
s = mpc = msc
d= mpb = msb
demand and supply cross at perfection of p* q*
label cs & ps
title - efficient allocation of scarce resources
supply is equal to
marginal private cost
marginal social cost
what is private cost
cop for a producer
e.g gas and electricity
what does marginal mean in PRODUCTION CASE
**
extra cost of producing one extra unit
the supply curve here is upward sloping due to the
law of diminishing marginal returns
explain why the supply curve is upward sloping
if mc increase everytime and therefore the next unit is more expenisev
suppliers want a higher price each time to produce extra units to cover costs and make profit
how do we calculate social cost / what is it made of and means
private costs + external costs
what are external costs
check definition
impacts on 3rd parties not involved in the transaction
but effected by production of a good
if a 3rd party is impacted by external costs negatovley how does this effect the social cost equation
EC are real
they exist more
so it becomes a positive figure
sc are now higher than private COSTS
if a 3rd party is impacted by external costs positivley how does this effect the social cost equation
they exist less so are negative
and this brings down the social cost
WHY DOES S = MPC = MSC only
2 points
We assume in a free market that’s operating well and being allocativley efficient
that there’s no external costs at all
demand is equal to
Marginal Private benefit
Marginal Social Benefit
what are private bebenfits in consumption terms
individual consumer benefits/satisfaction achieved from consuming
what is marginal in the DEMand sense
extra benefit achieved from consuming one more unit of a good
why is MPB downward sloping
law of dimininshing marginal utility
whats the law of diminishing marginal utility
less satisfaction is gained form the previous unit as you increase consumption
social benefit =
private benefit + external benefit
what is an external beenfit of consumption
an imapct on a 3rd party due to consumption
if an EB/impact is +Ve on a 3rd party due to consumption what is the effect ont he SB equation
EB figure will be positive
meaning social benefits will be greater than private benefits
if an external benefit/ impact on 3rd party due to production is negative what is the effect on the SB equation
consumption harms the 3rd party so eb becomes -ve so brings down SB compared to pb
in a free market operating competitivley and allocating resources well what do we assume about consumption
no externalities in consumption at all
so
D= MPB= MSB
Allocative efficiency occurs when what 3 things gtake place
Maximisation of Society Surplus
Maximisation on Net Social Benefit
Where resources perfectly follow consumer demand
society surplus is the sumof
consumer surplus + producer surplus
MAX OF SOCIETY SURPLUS - basic eocn problemis
how ro allcoate scarce reosurces given unlimited wants
MAX OF SOCIETY SURPLUS - who ar ethe tw most improtant economic agents in a free market
consuers who have the wants and producers who can produce output to satisfy these wants
MAX OF SOCIETY SURPLUS - When can we not be doing any better w allocation of scarce resources
Hint agents
if in aosr both agents are as happy as possible
MAX OF SOCIETY SURPLUS - when do we have this
talkign about a certain section on the graph
triangles representing consumer and producer surplus are the greatest they canbe
MAX OF SOCIETY SURPLUS - when is consumer surplus maximised on the grapgh
d=s i.e equilibrium at p* and q*
cs+ ps = big triangle
MAX OF SOCIETY SURPLUS - the triangle of society surplus on our grpah is greatest size we cna obtia IN A FREE MKT
what happens if we move ht eprice above or below
There’ll be aloss of welfare compared to the size of the triangle
MAXIMISATION OF NET SOCIAL BENEFIT - where does this occur
in a free mkt htis is happening at
assuming we have
where MSB=MSC
in a free market this is happening at equilibrium
assuming we have no EC/EB S=MSC D=MSB are both equal to each other
MAXIMISATION OF NET SOCIAL BENEFIT - explain how were not maximing social beenfit when move beyond( to the right) of Q*
if we produce at any quanittiy beyond Q* our SC are higher than out SB therfore we are not maximising our net SB as this q causes it to reduce
MAXIMISATION OF NET SOCIAL BENEFIT - explain how were not maxing social beenfit when we move to the left of Q*
silly to stop there as social beenfit will always be greater than social cost up until Q
so stoping at any Q below q* means we loose out on potential net social benefit by not producing those units
so we keep producing to add more benfots than costs which keep happening up till Q*
therfore equilibrium is at MSC=MSB we’re maxing net SB as we cant gain anymore and not loosing any
WHERE RESOURCES PERFECTLY FOLLOWING CONSUMER DEMAND - What does this mean
no
no
no
this happens at …. in mkt
no excess supply
no excess demand
no shortages
This happens ar equilib price in mkt
WHERE RESOURCES PERFECTLY FOLLOWING CONSUMER DEMAND - in a free market at p* everything being produced by producers is being … and …
there are no …
demanded and able to be bought by consumers
there are no surpluses and shortagrs
WHERE RESOURCES PERFECTLY FOLLOWING CONSUMER DEMAND - we find thers a perf allocation of scarce resources @ p* explain what this means
at this price …
so
@ this price exactly what’s being produced is following consumer demand perfectly
so s= d
so we’re achieving point of this para
We solve the basoc econ problem w the three points made but onteh basis of 5 assumptions
state them
hint- similar to perfect competiton
many buyers and seller
perf info for C&P
no barriers to entry/exit - so firms can compete/leave if theu want to
firms are profit maxers
consumers are utility maximiser s
If any of assumption break down waht can this cause
it canbe a source of mkt failure whereby mkt equilib isnt at the allocativley efficient point
overall mkt equilib occurs at
MPC = MPB (S=D)
THIS IS THE PRIVATE OPTIMUM
If assumption breaks down there may be a difference between
private optimum and social optimum
what is the social optimum
MSC =MSB
Why is the social optimum/ msc=msb allocativley efficient
its maximisation of
where
as we assume
because its the maximisation of net social benefit
where msc - msb is where mpc = mpb
as we assume no external costs and no external beenfits
when one of our assumptions break down what do we drop
our other assumption that there are noe xternal costs and benefit
