Efficiency
Managerial Economics
Jack Wu
Econ Efficiency: Conditions



for all users, same marginal benefit
for all suppliers, same marginal cost
marginal benefit = marginal cost
Equal Marginal Benefit
if not equal
 provide more to user with higher
marginal benefit
 take away from user with lower
marginal benefit
Equal Marginal Cost
if not equal
 supplier with lower marginal cost
should produce more
 supplier with higher marginal cost
should produce less
Marginal Benefit/Cost


if marginal benefit > marginal cost,
produce more of the item
if marginal benefit > marginal cost,
produce less of the item
Adam Smith’s Invisible Hand:
Price


Competitive market achieves three sufficient
condition for economic efficiency:
buyers and sellers in a market system act
independently and selfishly, yet the overall
outcome is efficient



i) users buy until marginal benefit equals price;
ii) producers supply until marginal cost equals prices;
iii) users and producers face same price.
Example of Invisible Hand




Major policy issue: how to allocate licenses for
3G wireless telecommunications;
pioneer: in early 1990s, US Federal
Communications Commission showed that
spectrum licenses were worth billions;
created pressure on other governments to
allocate by auction and not favoritism.
Auction ensures that item goes to user with
highest marginal benefit.
De-centralization



create internal market
if there is a competitive market for an
item, set transfer price equal to market
price
consuming units should be allowed to
outsource
UCLA Anderson School, 1989
Half an invisible hand is worse than
none
 priced photocopying paper
 free bond paper
Price Ceiling
Upper limit that sellers can charge and
buyers can pay
 rent control
 regulated price for electricity
Price ($ per month)
Rent Control: Equilibrium
1100
b
1000
900
0
supply
equilibrium
excess demand
290
300
demand
310
Quantity (Thousand units a month)
Price ($ per month)
Rent Control: Surpluses
buyer surplus gain = cfeg
buyer surplus loss = dgb
seller surplus loss = cfeg + geb
d
1100
1000 c
900
f
b
g
supply
e
demand
0
290
300
310
Quantity (Thousand units a month)
Rent Control: Losses


deadweight losses -- sellers willing to
provide item at price that buyers willing
to pay, but provision doesn’t occur
price elasticities of demand and supply
_demand more inelastic --> larger loss
_ supply more elastic --> larger loss
Price Floor
Lower limit that sellers can charge and
buyers can pay
 minimum wage
 agricultural price supports
Wage ($ per hour)
Minimum Wage: Equilibrium
a
excess supply
supply
4.20
b
4.00
equilibrium
c
0
demand
8
10
11
Quantity (Billion worker-hours a week)
Wage ($ per hour)
Minimum Wage: Surpluses
seller surplus gain = fdge
seller surplus loss = ghb
buyer surplus loss = fdge + egb
a
4.20
4.00
f
d
supply
e
b
g
h
c
0
demand
8
10
11
Quantity (Billion worker-hours a week)
Minimum Wage: Losses


deadweight losses -- sellers willing to
provide item at price that buyers willing
to pay, but provision doesn’t occur
price elasticities of demand and supply
_supply more inelastic --> larger loss
_demand more elastic --> larger loss
Tax: Commodity Tax
“the only two sure things in life are death
and taxes”
 buyer’s price - tax = seller’s price
 payment vis-à-vis incidence


US: airlines pay tax
Asia: passengers pay
Price ($ per ticket)
Tax: Equilibrium
804
$10
e
800
794
0
supply
b
h
900
demand
920
Quantity (Thousand tickets a year)
Tax: Surpluses
Price ($ per ticket)
buyer surplus loss = fdge + egb
seller surplus loss = djhg + ghb
revenue gain = fdge + djhg
804 f
800 d
794
0
j
$10
e
g
b
h
900
supply
demand
920
Quantity (Thousand tickets a year)
Incidence



incidence and deadweight loss depend
on price elasticities of demand and
supply
ideal tax (no deadweight loss):
inelastic demand/supply
who pays the tax not relevant