Chapter 03 _Economic Efficiency_

Chapter 03 _Economic Efficiency_ - Chapter 3 Social Costs...

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1 Chapter 3 Social Costs and Benefits: Economic Efficiency Introduction and Review In the last chapter we developed a simple model of rational economic behavior. We observed that the existing resources couldn’t satisfy human material wants. We called this scarcity. Scarcity at the national level results in scarcity at the level of individual decision makers. Each decision maker, be it a consumer or a producer, has access only to a limited amount of land, labor, and capital. Time is also a constraining factor. We assumed that individual decision makers are rational in the sense that they compare the marginal private benefit (MB) of each activity to its marginal private cost (MC). They increase the level of the activity if MB > MC and they reduce it if MB < MC. They leave the level of activity unchanged if MB = MC. This last condition defines the optimal level of the activity because it results in maximum satisfaction. The government enters the picture whenever the activities carried out by decision makers are in conflict with public interest. In other words, the activities carried out by individuals based on their own private marginal costs and benefits yield an outcome that is not optimal from the society’s point of view. In this case government policies to change decision makers’ behavior by somehow changing the MB or MC of their activities may be justified. The last chapter concentrated on the first aspect of this issue; namely, the determination of the level of activity chosen by an individual. This chapter will discuss the second aspect, the definition of a socially optimal outcome. It should be realized that ultimately economics is a social science concerned with people’s decisions about production, exchange, and consumption. We analyze individual behavior in order to understand social issues. We like to know the social consequences of the decisions made by millions of individual producers and consumers who use the society’s scarce resources to achieve maximum satisfaction of material wants. Since human wants are unlimited while resources are limited, we like to know how to use these scarce resources in order to maximize the society’s wellbeing. Economics is concerned with just that. Economics is concerned with how to make the best use of the society’s scarce resources to achieve maximum satisfaction of material wants. Recall from Chapter 1 that all societies must answer three fundamental economic questions of what goods and services to produce, how to produce them, and how to distribute them among members of the society. If you think about it, we cannot answer these questions without having a social objective in mind. That social objective is the maximum satisfaction of material wants for the members of the society. The three questions should be answered with this social objective in mind. How do we guarantee that the kinds and quantities of different goods produced are what people want the most so that they derive maximum satisfaction from them, the production methods used to produce them are the efficient ones, and the distribution of the goods among people is
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This note was uploaded on 11/08/2010 for the course ECN ECN 001A taught by Professor Scottcarrell during the Spring '10 term at UC Davis.

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Chapter 03 _Economic Efficiency_ - Chapter 3 Social Costs...

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