Economic Efficiency means creating as much value as possible from a given set of resources. As a goal, it gives us a standard by which we can compare various economic institutions and policies.
Economic Efficiency Criterion: An economic action is efficient if it makes at least one person better off without making anyone worse off. Economic Efficiency is possible under either of the following two rules:
Example: Consider the following policy which will cost $40 to fund. A tax will be levied to pay for the policy. Each person will pay 1/2 of the tax. The table summarizes the effects of the policy.
|Individual A||Individual B||Total|
Is the Policy Economically Efficient?
What will have to happen in order to satisfy the economic efficiency criterion?
Economic Efficiency Continued:
In the context of Supply and Demand Economic Efficiency occurs as a result of competitive equilibrium. Under certain circumstances, market forces (the Invisible Hand) work to maximize economic efficiency and welfare.
Demand Curve represents the value of a good in the eyes of consumers. Remember, it is the maximum people will pay for various quantities of the good.
Supply Curve represents the opportunity cost of producing various quantities of a good.
It stands to reason, that when value (Demand) equals cost (Supply) economic efficiency will be met.
Lowering prices will result cause cost to exceed benefits.
Raising prices will result in a cause potential benefits to be foregone.
Definition: Consumer Surplus--the difference between the selling price and the value a person places on a good. Graphically, it is the area below the demand curve and above the selling price.
Example: Suppose that I buy a beer for $1. If I had been willing to pay $1.50 for the beer, then I will actually be receiving consumer surplus of $.50.
Definition: Producer Surplus--the difference between the selling price and the opportunity cost of producing the good. Graphically, it is the area above the supply curve and below the equilibrium price.
There are four basic reasons why the invisible hand may not be economically efficient.
Competition among sellers drives prices down. This benefits consumers. If sellers can limit competition then they can charge higher prices than would be economically efficient.
An externality is a side effect of an action that influences the well-being of non consenting parties. Sometimes an externality is called a spillover.
A pure public good is one which is consumed jointly by everyone. With public goods, there is no effective way to exclude nonpaying consumers and consumption by one person does not diminish the amount available for others.
A near public good is one which is consumed jointly by everyone even though nonpaying consumers can be excluded. Until congestion sets in, the marginal cost of providing additional units is virtually zero.
trial and error purchasing may be unsatisfactory in determining product quality.
III. Property Rights
Definition: Property Right: The right to use, control and obtain the benefits associated with a particular good.
Private Property Right: Exists when the property right is:
This page was last modified Tuesday, April 8, 1997.