Textbook Notes (380,752)
CA (168,206)
UTSC (19,296)
MGEA02H3 (28)
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Week 9 study guide

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Department
Economics for Management Studies
Course Code
MGEA02H3
Professor
Gordon Cleveland

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Chapter 12 Economic Efficiency and Public Policy Notes
12.1 Productive and Allocative Efficiency
x efficiency requires that factors of production are fully employed, however, full employment is not enough to prevent the waste
x even when resources are fully employed, they may be used inefficiently
x 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, economy’s resources are being used inefficiently
Productive Efficiency
x 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
x productive efficiency for the firm requires the firm to be producing its output at the lowest possible cost
x 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
x productive efficiency for the industry requires that the marginal cost of production must be the same for each firm
x if firms and industries are productively efficient, the economy will go on, rather than inside, production possibilities boundary
Allocative Efficiency
x allocative efficiency : a situation in which the market price for each good is equal to that good’s marginal cost
x 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?
x perfectly competitive industries are productively efficient; if an economy could be made up entirely of perfectly competitive
industries, the economy would be allocatively efficient
x monopoly is not allocatively efficient because the monopolist’s price always exceeds its marginal cost
Allocative Efficiency and Total Surplus
x producer surplus : the price of a good minus the marginal cost of producing it, summed over the quantity produced
x for each unit sold, producer surplus is the difference between price and marginal cost
x allocative efficiency occurs where the sum of consumer and producer surplus is maximized
x the sum of producer and consumer surplus is maximized only at the perfectly competitive level of output; this is the only level of
output that is allocatively efficient
Allocative Efficiency and Market Failure
x one of the most important issues in public policy is whether, and under what circumstances, government action can increase the
allocative efficiency of market outcomes
12.2 Economic Regulation to Promote Efficiency
Regulation of Natural Monopolies
x natural monopoly : an industry characterized by economies of scale sufficiently large that one firm can most efficiently supply
the entire market demand
x Crown corporations : in Canada, business concerns owned by the federal or provincial government
x marginal-cost pricing : setting price equal to marginal cost so that buyers for the last unit are just willing to pay the amount that
it costs to make that unit
x when a natural monopoly with falling average costs sets price equal to marginal cost, it will suffer losses
x two-part tariff : a method of charging for a good or a service in which the consumer pays a flat access fee and a specified
amount per unit purchased
x for a natural monopoly with falling average costs, a policy of average-cost pricing will not result in allocative efficiency because
price will not equal marginal cost
x in the long run, allocative efficiency requires that capacity be chosen so that the expected market price is equal to the long-run
marginal cost of production
x average-cost pricing generally leads to inefficient long-run investment decisions
12.3 Canadian Competition Policy
x competition policy : policy designed to prohibit the acquisition and exercise of monopoly power by business firms
The Evolution of Canadian Policy
x by the 1950s, the following three broad classes of activity were illegal:
1. price-fixing agreements that unduly lessen competition
2. mergers or monopolies that operate to the detriment of the public interest
3. unfair” trade practices
Summary
12.1 Productive and Allocative Efficiency
x Economists distinguish two main kinds of efficiency: productive and allocative.
x Productive efficiency for the firm requires that the firm be producing its output at the lowest possible cost. Productive efficiency
for the industry requires that all firms in the industry have the same marginal cost.
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Description
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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