Lecture10-ECO100 - Introduction to Introduction to...

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Unformatted text preview: Introduction to Introduction to Economics Economics Lecture 10: 10 Efficiency and Efficiency and Government Government Intervention © Gustavo Indart Slide 1 ECO 100Y ECO 100Y Productive Productive and Allocative Effi Efficiency Efficiency implies both productive efficiency and allocative efficiency Productive efficiency requires that all resources are efficiency that all resources are used productively to maximize output That is, it requires resources not be wasted Allocative efficiency requires that the proper outputmix be produced That is, it requires a proper allocation of resources among different industries © Gustavo Indart Slide 2 Productive Productive Efficiency Productive efficiency has two aspects: production within each firm allocation of production among firms in an industry Productive efficiency for the firm requires that the firm produces Productive efficiency for the firm requires that the firm produces any level of output at the lowest possible cost In the long-run, this implies that the firm must choose the least costl combination of the factors of prod least costly combination of the factors of production Productive efficiency for the industry requires that marginal cost be the same for all firms be the same for all firms This implies that each additional unit of output must be supplied by the firm with the lowest marginal cost © Gustavo Indart Slide 3 Productive Productive Efficiency for the Firm Fi K A firm is productively efficient when it minimizes the cost of when it minimizes the cost of producing any level of output. Cost-minimization implies that MRTS = w/r. A profit-maximizing firm must be, therefore, productively efficient in any and all market structures. Y1 TC1 L* L Slide 4 K* © Gustavo Indart Productive Productive Efficiency for the Industry $ 80 Firm A MC $ 80 Firm B MC 60 60 40 40 20 20 (qA − 1) © Gustavo Indart qA q qB (qB + 1) q Slide 5 Productive Productive Efficiency for Firms and the Industry Y If firms and industries are productively efficient, then the economy is on the production possibility curve. A YA B YB At point B there is inefficiency in production since more of and more of X and Y can be produced with the same resources. XB © Gustavo Indart XA X Slide 6 Allocative Allocative Efficiency Allocative efficiency relates to the product mix, that is, to the quantities of the various commodities being produced Th The economy achieves allocative efficiency when MC = P for MC each good produced The demand curve shows the value that consumers assign to The demand curve shows the value that consumers assign to each unit of the commodity That is, P is equal to the marginal value (or marginal benefit to consumers of obtaining one additional unit of the benefit) to consumers of obtaining one additional unit of the commodity When P = MC, the marginal benefit of consuming one additional unit is equal to the marginal cost of producing that dditi th th additional unit It is in this sense that we say that there is allocative efficiency in the economy th © Gustavo Indart Slide 7 Allocative Efficiency Allocative Efficiency (continued) Alternatively, there is allocative efficiency in the y, economy when the total surplus is being maximized in each market That is, where the summation of consumer surplus and producer surplus is being maximized If all markets are perfectly competitive, then there is allocative efficiency since total surplus is being maximized in each market © Gustavo Indart Slide 8 P Perfect Perfect Competition: Total Surplus Maximization S Consumer Surplus PE Producer Surplus E Perfectly competitive industries are allocative efficient Indeed efficient. Indeed, P = MC MC and thus total surplus is maximized. D QE © Gustavo Indart Q Slide 9 Perfect Perfect Competition vs. Monopoly P Monopolies are allocative inefficient since P > MC and thus total surplus is not MC th maximized. The deadweight loss measures the allocative inefficiency of the monopoly. B S A Consumer Surplus Producer Surplus Deadweight Loss PB PA MR QB © Gustavo Indart D Q Slide 10 QA Perfect Perfect Competition vs. Monopoly (continued) Productive Efficiency Perfect Competition Monopoly Allocative Efficiency Yes Yes All firms produce at P = MC in all the minimum of LAC in industries the minimum of LAC in industries the long-run Same MC for all firms Yes No Will operate on the P > MC LAC Slide 11 © Gustavo Indart Government Government Intervention and Price Setting To replicate perfect competition conditions: Allocative efficiency (P = MC) All firms making zero economic profit in the longrun We’ll consider 2 policy options: consider policy options: Marginal cost pricing Average cost pricing We’ll consider the effects of each of these policies under two different cost schedules under two different cost schedules © Gustavo Indart Slide 12 Marginal Cost Pricing (I) Marginal Cost Pricing (I) P MC AC PA A It achieves allocative efficiency Monopolist suffers economic losses MR QA © Gustavo Indart D Q Slide 13 Marginal Cost Pricing (II) Marginal Cost Pricing (II) P MC AC PA A It achieves allocative efficiency Monopolist makes economic profits MR QA © Gustavo Indart D Q Slide 14 Average Cost Pricing (I) Average Cost Pricing (I) P AC MC PA A It doesn’t achieve allocative efficiency Monopolist makes Monopolist makes zero economic profits Deadweight Loss MR QA © Gustavo Indart D Q Slide 15 Average Cost Pricing (II) Average Cost Pricing (II) P MC AC B A It doesn’t achieve allocative efficiency Monopolist makes economic profits PA Deadweight Loss MR QB © Gustavo Indart D Q Slide 16 QA Allocative Allocative Efficiency and Zero Economic Profits P MC AC’ Introduction of a lumpsum tax Introduction of marginal cost or average cost pricing cost or average cost pricing It achieves allocative It achieves allocative efficiency Monopolist makes zero economic profits zero economic profits D Q Slide 17 AC PA A MR QA © Gustavo Indart Externalities Externalities and Allocative Inefficiency Inefficiency An economy achieves allocative efficiency when marginal cost cost (MC) is equal to marginal benefit (MB = P) for each is equal to marginal benefit for each good produced This is so in the absence of externalities, that is, assuming that Private marginal cost (MCP) is equal to social marginal cost (MCS) Private marginal benefit (MBP) is equal to social marginal benefit (MBS) If MCP ≠ MCS and/or MBP ≠ MBS then there is market MC MC MB MB there is market failure and allocative efficiency is not achieved Too much is produced if there is a negative externality Too little is produced if there is a positive externality li if © Gustavo Indart Slide 18 P Negative Negative Externalities and All Allocative Inefficiency MCS S = MCP P1 PE When there is a negative externality, MCS > MCP D = MBP = MBS Q1 © Gustavo Indart QE Q Slide 19 P Government Government Intervention and All Allocative Efficiency Effi S’ = MCS = MCP When there is a negative there is negative externality, MCS > MCP S = MCP P1 PE P2 Tax To achieve allocative efficiency the government could introduce unit introduce a unit-tax that would that would increase private marginal cost and shift the S curve to S’. D = MB Q1 QE Q Slide 20 © Gustavo Indart P Positive Positive Externalities and All Allocative Inefficiency When there is a positive there is positive externality, MBS > MBP S = MCP = MCS P1 PE MBS D = MBP QE © Gustavo Indart Q1 Q Slide 21 Government Government Intervention and Allocative Efficiency Allocative Efficiency P To achieve allocative efficiency the government could introduce a uni -subsidy that would ld it decrease MCP and shift the S curve to S’. S = MCP = MCS P1 PE PC Subsidy S’ = MCP MBS D = MBP QE Q1 When there is a positive externality, MB MB MBS > MBP Q Slide 22 © Gustavo Indart ...
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