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06effy_sg - Chapter 6 Economic Efficiency Chapter 6...

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Chapter 6: Economic Efficiency Chapter 6 Economic Efficiency CHAPTER SUMMARY The central idea in this chapter is Adam Smith’s invisible hand. Free-market competition will ensure that the allocation of resources is economically efficient. Although the buyers and sellers act selfishly, the net outcome is at least as good as the best efforts of the most enlightened and well-informed central planner. This applies to markets for goods and services as well as capital. The same general principle applies within an organization. Through decentralization, management can achieve efficient use of scarce resources. This means charging a transfer price for items produced and consumed within the organization. Government policies such as price ceilings, price floors, and taxes cause deadweight losses and impede economic efficiency. The extent of these deadweight losses depends on the price elasticities of demand and supply. There will be no deadweight loss if either the demand or the supply is extremely inelastic. KEY CONCEPTS economic efficiency transfer price price ceiling technical efficiency outsourcing deadweight loss invisible hand capital market price floor market or price system bankruptcy tax incidence GENERAL CHAPTER OBJECTIVES 1. Define three sufficient conditions for economic efficiency. 2. Discuss how Adam Smith’s invisible hand, i.e., the market price, achieves economic efficiency in a perfectly competitive market. 3. Apply the three conditions for economic efficiency to a single organization and discuss the efficiency of de-centralization. 4. Discuss the role of capital markets and bankruptcy. 5. Analyze the economic consequences of price ceilings and price floors. © I.P.L. Png and C.W.J. Cheng 1
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Chapter 6: Economic Efficiency 6. Analyze the economic consequences of taxes. NOTES 1. Concept of economic efficiency . (a) An allocation of resources (quantity) is economically efficient where no reallocation can make one person (human being or business) better off without making another worse off. i. A guide to managing resources within an organization and across entire economies. ii. Identifies opportunities for profit (there is a way to make money by resolving an economic inefficiency). iii. A way to assess government intervention. iv. It assesses resource allocations in terms of each individual user’s evaluation of the benefit. (b) Three sufficient conditions for economic efficiency: i. All users achieve same marginal benefit; ii. All suppliers operate at same marginal cost; and iii. Every user’s marginal benefit = every supplier’s marginal cost. When marginal benefit is less than marginal cost, society overall could gain by reducing provision of that item, and vice versa. (c)
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06effy_sg - Chapter 6 Economic Efficiency Chapter 6...

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