economic efficieny and markets

LECTURE NOTES 2: ECONOMIC EFFICIENY AND MARKETS Markets may bring about efficient allocations of resources.. Alper 1993: If resources are priced to reflect their true and complete cost

LECTURE NOTES 2:

ECONOMIC EFFICIENY AND MARKETS

Markets may bring about efficient allocations of resources Alper 1993:

If resources are priced to reflect their true and complete cost to society

….market will ensure that those resources are used in an optimally efficient ways

Efficiency is the primary criterion used as a measure of

market performance

Basic assumptions:

Consumers: maximizing the level of satisfaction (utility) Producers: maximizing their profit

A set of "ideal" conditions are satisfied

Perfectly competitive market

• Freedom of choice based on self interest and rational

behavior

• the absence of external effects;

• the absence of public goods/clear ownership rights

• all households and firms have complete information;

• all households and firms act as price takers.

We will explain what these concepts mean shortly.

But first, why might a competitive market economy

“automatically” generate efficient outcomes?

Essential ideas:

For some good or service X

Market demand curve = marginal benefit curve Market supply curve = marginal cost curve

Quantity per period

S

D P*

Q*

Quantity per period

D = MB

Quantity per period

D = MB = Marginal willingness to pay

q

One person’s demand

q1 q2 P2

P1

Quantity per period

D1+D2 =D = Social MB

Adding up individual demands to get market demand

The value consumers obtain

P

Q D

Pm

qm 0

Consumers obtain more value if they have more of the good

P

Q qm2

Market demand curve: negatively sloped

A ship in market demand curve:

• Income

• Prices of related goods

• Consumer preferences for the product considered

• Number of relevant consumers

Quantity per period

S = MC

D = MB P*

Q*

Quantity per period

S = MC

Quantity per period

Si = MC

p3

p2

p1

One firm only

Quantity per period

Market Supply (=S1+S2)

P

Adding up individual firm’s supplies to get market supply

The value obtained by producers

P

Q

S

qm P1

0

Producers may be able to obtain more value if they sell more goods

P

Q

S

qm2

Market supply curve: positive sloped

A ship in market demand curve:

• Prices of resources

• productivity of factors of production

• Number of relevant firms

Q

S

D P*

Q*

Consumer Surplus

Producer Surplus

Q

MC

MB

P3

A

B

D

C E

P1

P2

P4

Pareto optimality:

MB =MC