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chapter 12

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University of Toronto St. George
Michael Ho

Chapter 12 12.1 productive and allocated efficiency  Efficiency requires that factors of reductions are fully employed. However, will implement of resources is not enough to prevent their waste of resources. 1. If firms do not use the least cost method of producing their chosen output their pink inefficient 2. If the marginal cost of production is not the same for every firm in the industry, the industry is being inefficient. 3. Is too much of one product and too little of another product are produced; the economy’s resources are being used inefficiently. Productive efficiency  Productive efficiency has two aspects one concerning production with being each firm and one concerning the allocation of production among the firms in an industry.  Productive efficiency for firm: when the firms choose is among all the available production markets to produce a given level of output at lowest possible cost  In a short run with the only one variable factor in the firm merely uses a map of the variable factor to produce the desired level of output however it in long-run there are more thean one methods of production is available therefore productive efficiency requires that a firm uses that least costly of the available methods of producing any given output, that is firms are located on, rather than about their long run average cost curves.  It follows that any product maximizing firms will seek to be productive and efficient no matter the market structure within it operates, perfect competition, monopoly, oligopoly or monopolistic competition.  Productive efficiency for the industry: when the industry is producing any given level of output at the lowest possible cost. This requires that marginal cost be equated across all firms in the industry  In an industry is productively inefficient it is possible to reduce the industry’s total cost of producing an output by reallocating production among the industry’s firms. Productive sufficiency and the production possibilities from the:  If firms and industries are productive and efficient, the economy will be on, rather than insight, the production possibilities boundary. Allocative efficiency  Allocative efficiency: a situation in which the market price for each good is equal to the good’s marginal cost  When the combination of goods produced is allocatively efficient, economists say that, the economy is Pareto efficient.  The economy allocatively efficient when, for each good produced, its marginal cost of production is equal to its price  When consumers face the market price for some good, but just to their consumptions of that good until the marginal value is equal to the price, therefore , since price reflects the marginal value of the rights to consumers we can restate the condition for Allocative efficiency to be that for each of which produced marginal costs must be equal to marginal value.  If the level of output of some products is such that marginal cost to producers exceeding marginal value to consumers too much of that product is being produced because the cost to society for the last unit produce exceeds the benefits of consuming it.  On the other hand, if the level of output of some good is such that the marginal cost is less than the marginal value, too little of that good is being produced, because if the cost to society of producing them next unit is less than the benefits that would be gains from consuming it.  Allocative efficiency and the production possibilities boundary: This diagram illustrates how the allocation of resources in the economy changes as we move along the production possibilities boundary, for example as the economy moves from point A to point B to point C along the PPB resources are being transferred from the steel sector to the wheat sector. Therefore, steel output is falling and wheat output is rising. Which market structures are efficient  Perfect competition:  In perfect competition, all firms in the industry faces the same prices of their products and they equate marginal cost to the price. It follows immediately that marginal cost will be the same for all firms.  When the marginal cost is equal to price for all the firms, therefore in perfectly competitive industries, the industry as a whole is productively inefficient.  Perfectly competitive industries are productively efficient. If an economy could be made up entirely of perfectly competitive industries, the economy would be allocatively efficient.  Monopoly:  Monopolists have an incentive to be productive and efficient because their profits will be maximized when they adopt the lowest cost production method.  Therefore, profit-maximizing monopolists will operate on their long run average cost curves and therefore can be productively efficient.  Although a monopolist will be productive and efficient, it will choose a level of output that is too low to achieve allocated efficiency. The monopolist chooses and output at which the price charged is greater than marginal cost, which violates the condition for allocative efficiency because the price, and therefore the marginal value to consumer, exceeds the marginal cost of production. From this result follows the classic efficiency based preference for competition over monopoly: monopoly is not allocatively efficient because the monopolist’s price always exceeds its marginal cost.  Other market structures:  Whenever a firm has any market power, in the sense that it faces and negatively sloped demand curve, its marginal revenue will be less than its price. When it equates marginal cost and marginal revenue, as all profit- maximizing firms do, marginal cost will also be less than price. This inequality implies allocative inefficiency. Thus, oligopoly and monopolistic competition are also allocatively inefficient.  Although neither oligopoly nor monopolistic competition achieves the conditions for allocative efficiency, they may nevertheless produce more satisfactory results than monopoly.  Oligopoly is more favorable because, competition between oligopoly used encourages innovation and new alternative products, it also challenges public policy to keep oligopolist competing in using their competitive energies to improve products and to reduce cost rather than to restrict inter firm competition and to erect entry barriers. Allocated efficiency and total surplus  Consumer and product surplus  Consumer surplus is the difference between the value that consumer place on a product and the payment in that they actually make to buy the product.  Product surplus is an analogous concept to consumer surplus. Product surplus is the price of a good minus the marginal cost of producing it, summed over the quantity produced.  It is also the difference that if actual price that the producer receives for product and the lowest price that the producer would be willing to accept for the sale to other product  To accept any amount to less than the marginal cost would reduce the firms profit  For each unit sold, producer surplus is the difference between price and marginal cost. The allocated efficiency of perfect competition revisited  Allocated efficiency occurs when the sum of the consumer and producer surplus is maximized  The allocatively efficient output occurs under perfect competition where the demand curve intersects the supply curve, that is the point of the equilibrium of a competitive market.  The sum of producer and consumer surplus is maximized only at the perfectly competitive level of output. T
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