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Chapter 12

Chapter 12 Economic Efficiency and Public Policy.docx

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Department
Economics (Arts)
Course
ECON 208
Professor
Mayssun El- Attar Vilalta
Semester
Fall

Description
Chapter 12 Economic Efficiency and Public Policy 12.1 Productive and Allocative Efficiency (TABLE p. 280)  Efficiency requires factors of production to be fully employed; however, there may still be waste of resources since factors of production may be used inefficiently: o If firms don’t use the least-cost method of producing their chosen outputs = firms inefficient (cost for a single firm producing some level of output) o If the MC of production isn’t the same for every firm in an industry = industry inefficient (total cost for all the firms in an industry) o If too much of one product and too little of another product are produced = economy’s resources used inefficiently (level of output of one product compared with another) Product Efficiency  Productive efficiency for the firm: when the firm chooses among all available production methods to produce a given level of output at the lowest possible cost  SR – only 1 variable factor – firm uses enough of the variable factor to produce the desired level of output LR – more than one method of production available – firms are locate on rather than above LRAC curve  Productive efficiency for the firm requires the firm to be producing its output at the lowest possible cost; if not efficient – producing at higher costs, reducing profits  Incentive of firms to produce efficiently regardless of market structure (monopoly, perfect competition, oligopoly, or monopolistic competition)  Productive efficiency for the industry: when the industry is producing a given level of total output at the lowest possible/minimum cost.  If industry is productively inefficient, it’s possible to reduce the industry’s total cost of producing any given output by reallocating production among the industry’s firms  Productive efficiency for the industry requires that the marginal cost of production be the same for each firm  Once MC equated btwn 2 firms, there are no further cost savings to be obtained by reallocating output = productively efficient industry Productive Efficiency and the PPB  At productive efficiency, the industry cant increase its output without using more resources  PPB shows the combinations of output of two products that are possible when the economy is using its resources efficiently. At a point inside the PPB, inefficiency – can produce more of one good without producing less of the other – due to individual firms not minimizing their costs or b/c within an industry, MC are not equalized across the various firms.  If firms and industries are productively efficient, the economy will be on, rather than inside, the PPB Allocative Efficiency  Allocative efficiency: a situation in which the market price (marginal value) for each good is equal to that good’s MC; concerns the quantities of the various products to be produced – Pareto efficient  The economy is allocatively efficient when, for each good produced, its MC of production = price  When consumers face the market price for some good, they adjust their consumption of the good until their marginal value is just =price; market price reflects consumer’s marginal value 1  If the level of output of some product is such that MC to produces exceeds marginal value to consumers, too much of that product is being produced; b/c the cost to society of the last uni produced exceeds the benefits of consuming it. BUT if MC is < marginal value, too little being produced, cost to society of producing the next unit is MC) to achieve AE = marginal value (price)>MC – competition preference over monopoly  Monopoly is not allocatively efficient because the monopolist’s price always exceeds its MC Other Market Structures  Imperfectly competitive markets, oligopoly and monopolistic competition (both of which still may produce more satisfactory results that monopoly), are allocatively inefficient.  When firm has market power (-ve sloping D curve), marginal revenue the price of a good minus the MC of producing it, summed over the quantity produced –> area above the MC curve and below price line; the diff between actual price received for it and the lowest price would accept  Produce one more unit; producer’s cost ^ by MC = lowest amount that producer will accept for product. If accepts less than MC, reduces firms profits  For each unit sold, producer surplus is the difference between price and MC  For whole industry, we need to know industry supply curve = overall PS  For perfect competition, the industry supply curve is horizontal sum of all firms’ MC curves = PS is the area above the S curve and below price line The Allocative Efficiency of Perfect Competition Revisited (288)  Market/Allocative efficiency exists in a market if the total economic surplus is maximized  Allocative efficiency occurs where the sum of consumer and producer surplus is maximized  AE under perfect competition since maximizes the sum of consumer and produce surplus at eq.; lower than eq Q, consumer values it more than cost to produce, but then there is no CS or PS between demanded Q and eq Q – loss to economy; total surplus is lower at demanded Q than Q*  If above Q*, consumers value it less than the cost of producing it; better for society to produce less than Q2 since total surplus is < at Q*; producers earn –ve PS on units above Q* since MC>p* and consumers earn – ve CS on units above Q* since marginal valueMC Allocative Efficiency and Market Failure  perfect competition only actually exists in a small # of industries – theoretical ideal  market failure – when market transactions – production and consumption – impose costs or confer benefits on economic agents who aren’t involved in the transaction – externalities – raise the possibility that market outcomes will be allocatively inefficient  when production of good/service causes pollution, the Q produced in a perfectly competitive industry will exceed the efficient amount 3  One of the most important issues in public policy is whether, and under what circumstances, govt action can increase the allocative efficiency of market outcomes  Economic regulation and competition policy – promote AE 12.2 Economic Regulation to Promote Efficiency  Non-competitive/monopoly practices: monopolies/cartels/price-fixing agreements among oligopolists, either explicit or tacit  Competition policy: the laws and other instruments that are used to encourage competitive behaviour and discourage monopoly practices; used to promote AE by ^competition in market  Economic regulations: employed by federal/provincial/local govts, which prescribe the rules under which firms can do business and in some cases determine the prices that businesses can charge for their output o CRTC: federal agency that regulates many aspects of radio/tv/telecommunications industries o OSFI: oversees the regulation of Canada’s bank and insurance companies  When competitive behaviour not possible (natural monopolies: electricity), public ownership or economic regulation of privately owned firms can be used as a substitute for competition; consumers protected from restricted output and high prices from monopoly power Regulation of Natural Monopolies  Natural monopoly: an industry characterized by economies of scale sufficiently large that one firm can most efficiently supply the entire market demand (electricity, local telephone)  Requires establishment of large+expensive distribution networks (transmission lines, pipelines) and the size of the market is such that only a single firm can ach
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