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Economics for Management Studies
Gordon Cleveland

Chapter 12 Economic Efficiency and Public Policy Notes 12.1 Productive and Allocative Efficiency N efficiency requires that factors of production are fully employed, however, full employment is not enough to prevent the waste N even when resources are fully employed, they may be used inefficiently N here are three examples of inefficiency in the use of fully-employed resources: 1. if firms do not use the least-cost method of producing their chosen outputs, they are being insufficient 2. if the marginal cost of production is not the same for every firm in an industry, the industry is being inefficient 3. if too much of one product and too little of another product are produced, economys resources are being used inefficiently Productive Efficiency N 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 N productive efficiency for the firm requires the firm to be producing its output at the lowest possible cost N productive efficiency for the industry : when the industry is producing a given level of output at the lowest possible cost; this requires that marginal cost be equated across all firms in the industry N productive efficiency for the industry requires that the marginal cost of production must be the same for each firm N if firms and industries are productively efficient, the economy will go on, rather than inside, production possibilities boundary Allocative Efficiency N allocative efficiency : a situation in which the market price for each good is equal to that goods marginal cost N the economy is allocatively efficient when, for each good produced, its marginal cost of production is equal to its price Which Market Structures are Efficient? N perfectly competitive industries are productively efficient; if an economy could be made up entirely of perfectly competitive industries, the economy would be allocatively efficient N monopoly is not allocatively efficient because the monopolists price always exceeds its marginal cost Allocative Efficiency and Total Surplus N producer surplus : the price of a good minus the marginal cost of producing it, summed over the quantity produced N for each unit sold, producer surplus is the difference between price and marginal cost N allocative efficiency occurs where the sum of consumer and producer surplus is maximized
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