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Economic Efficiency in Markets and Introduc4on to Market Failure Edexcel Economics 1.3.1

Economic’Efficiency’in’Markets’and’ …...Introduc4on’to’Market’Failure’ EdExcelEconomics1.3.1 ’ Created Date 9/23/2015 8:55:41 AM

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Page 1: Economic’Efficiency’in’Markets’and’ …...Introduc4on’to’Market’Failure’ EdExcelEconomics1.3.1 ’ Created Date 9/23/2015 8:55:41 AM

Economic  Efficiency  in  Markets  and  Introduc4on  to  Market  Failure  

Edexcel  Economics  1.3.1  

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Economic  Efficiency  

•  Efficiency  is  about  a  society  making  op4mal  use  of  scarce  resources  to  help  sa:sfy  changing  wants  &  needs  

•  There  are  several  meanings  of  efficiency  but  they  all  link  to  how  well  a  market  system  allocates  our  scarce  resources  to  sa:sfy  consumers  

•  Normally  the  market  mechanism  is  good  at  alloca:ng  these  inputs,  but  there  are  occasions  when  the  market  can  fail  

How  well  are  scarce  resources  used?  This  is  what  is  discussed  when  economists  talk  about  economic  efficiency  

Alloca:ve   Produc:ve  

Dynamic   Social  

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Alloca4ve  Efficiency  using  a  Price  Theory  Diagram  

Economic  efficiency  means  making  op:mum  use  of  scarce  resources  

Price  

Quan:ty  

Demand  

Supply  

P  

Q  

R  

S  

T  O  

Producer  surplus  

Consumer  surplus  

Alloca:ve  efficiency  is  at  an  output  which  maximizes  total  consumer  welfare  

At  the  market  equilibrium  price,  consumer  and  producer  surplus  is  maximized  –  at  this  output,  economic  welfare  is  maximized.  

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Alloca4ve  Efficiency  •  Alloca:ve  efficiency  is  reached  

when  no  one  can  be  made  beAer  off  without  making  someone  else  worse  off.  This  is  also  known  as  Pareto  efficiency  

•  Alloca:ve  efficiency  occurs  when  the  value  that  consumers  place  on  a  good  or  service  (reflected  in  the  price  they  are  willing  and  able  to  pay)  equals  the  cost  of  the  factor  resources  used  up  in  produc:on.    

•  The  main  condi:on  required  for  alloca:ve  efficiency  in  a  given  market  is  that  market  price  =  marginal  cost  of  supply  

A  

B  

C  

Outputof  Beer  

Output  of  Cheese  

X1  

X2  

X3  

Y1   Y2   Y3  

All  points  that  lie  on  the  PPF  are  alloca:vely  efficient  because  we  cannot  produce  more  of  one  product  without  affec:ng  the  amount  of  all  other  products  available.  

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Produc4ve  Efficiency  

•  Produc:ve  efficiency  exists  when  producers  minimize  the  wastage  of  resources  

•  Produc:ve  efficiency  also  relates  to  when  an  economy  is  on  their  produc4on  possibility  fron4er  

•  An  economy  is  produc:vely  efficient  if  it  can  produce  more  of  one  good  only  by  producing  less  of  another.  

A  firm  is  produc:vely  efficient  when  it  is  opera:ng  at  the  lowest  point  on  its  average  cost  curve  i.e.  unit  costs  have  been  minimised  

Cost  Per  Unit  

Output  

Produc:ve  efficiency  is  achieved  when  the  long  run  unit  cost  of  produc:on  is  at  a  minimum  

Average  Cost  

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Social  Efficiency  

•  The  socially  efficient  level  of  output  and/or  consump:on  occurs  when  marginal  social  benefit  (MSB)  =  marginal  social  cost  (MSC)  

•  The  existence  of  nega4ve  and  posi4ve  externali4es  means  that  the  private  level  of  consump:on  or  produc:on  differs  from  social  op:mum    

•  The  free  market  price  mechanism  does  not  always  take  into  account  social  costs  and  benefits  

Output  

P1  

Q1  

MPC  

MSC  

MPB  

MSB  

P2  

Q2  

Costs,  Benefits  

Social  op:mum  output  is  where  MSC  =  MSB  

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Dynamic  Efficiency  in  Markets:  Innova4on  

Innova:on  is  pu_ng  a  new  idea  or  approach  into  ac:on.  Innova:on  is  'the  commercially  successful  exploita:on  of  ideas'  

•  Product  innova4on  •  Small-­‐scale  and  frequent  

subtle  changes  to  the  characteris:cs  and  performance  of  a  good  or  a  service  

•  Process  innova4on  •  Changes  to  the  way  in  which  

produc:on  takes  place  or  is  organised  

•  Changes  in  business  models  and  pricing  strategies  

•  Innova:on  has  demand  and  supply-­‐side  effects  in  markets  and  the  economy  as  a  whole  

Austrian  economist  Joseph  Schumpeter  (pictured)  coined  the  term  crea4ve  destruc4on    which  refers  to  the  upheaval  of  the  established  order  in  the  pursuit  of  innova:on.  Smaller  disrup:ve  businesses  ocen  challenge  exis:ng  firms!  

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What  is  Market  Failure?  

Market  failure  is  when  the  price  mechanism  leads  to  an  inefficient  alloca:on  of  resources  and  a  deadweight  loss  of  economic  welfare  

Nega:ve  externali:es  

Posi:ve  externali:es  

Public  goods   Merit  goods  

De-­‐merit  goods   Informa:on  failures  

Monopolies   Immobility  of  factor  inputs  

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Economic  Efficiency  in  Markets  and  Introduc4on  to  Market  Failure  

EdExcel  Economics  1.3.1