6355 Lecture Notes - Lecture 9: Allocative Efficiency, Marginal Utility, Marginal Cost
5 Jun 2018
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Equilibrium in a competitive market results in the economically efficient level of output, where
marginal benefit equals marginal cost.
Equilibrium in a competitive market results in the greatest amount of economic surplus, or total net
benefit to society, from the production of a good or service.
Market failure occurs when the market does not result in economic efficiency - allocative
inefficiency arises.
The market fails to produce the efficient level of output - too many or too few goods and services
consumed or produced.
A lack of competition in the market is a form of market failure, as it leads to allocative inefficiency -
too little is produced at a price greater than marginal costs.
Measures to increase competition:
• Deregulation
• Trade reform
A contestable market is one in which the potential for competition exists due to minimal entry and
exit costs.
Externality is a benefit or cost that affect someone who is not directly involved in the production or
consumption of a good or service.
Negative externalities occurs when a production or consumption activity imposes costs on other
who are not directly associated with that activity, and no compensation is paid.
Consumption example: cigarette smoke
Production example: pollution
Positive externalities in consumption or production occur when an activity benefits others who are
not directly involved and who do not pay for it
Examples: education, public transport, private gardens, research
Private costs: the cost borne by the producer of a good or service
Social cost: the total cost of producing a good, including both the private cost and any external cost.
Private benefit: the benefit received by the consumer of a good or service.
Social benefit: the total benefit from consuming a good, including both the private benefit and any
external benefit.
Solutions to negative externalities
1. Taxes
2. Private bargaining between affected parties
3. Regulation
4. Vouchers, permits or licences
Common resources are an extreme case of externalities where no one can be denied access to the
resource by one person's use of the resource reduces the possible use by others.
Without government intervention people will use too much of a common resource because:
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Document Summary
Equilibrium in a competitive market results in the economically efficient level of output, where marginal benefit equals marginal cost. Equilibrium in a competitive market results in the greatest amount of economic surplus, or total net benefit to society, from the production of a good or service. Market failure occurs when the market does not result in economic efficiency - allocative inefficiency arises. The market fails to produce the efficient level of output - too many or too few goods and services consumed or produced. A lack of competition in the market is a form of market failure, as it leads to allocative inefficiency - too little is produced at a price greater than marginal costs. Measures to increase competition: deregulation, trade reform. A contestable market is one in which the potential for competition exists due to minimal entry and exit costs.
