Economic Efficiency in Markets and Introduc4on to Market Failure Edexcel Economics 1.3.1 Economic Efficiency How well are scarce resources used? This is what is discussed when economists talk about 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 Alloca:ve Produc:ve Dynamic Social Alloca4ve Efficiency using a Price Theory Diagram Economic efficiency means making op:mum use of scarce resources Price R Consumer surplus P Producer surplus Supply S Alloca:ve efficiency is at an output which maximizes total consumer welfare Demand At the market equilibrium price, consumer and producer surplus is maximized – at this output, economic welfare is maximized. Q O T Quan:ty Alloca4ve Efficiency All points that lie on the PPF are alloca:vely •  Alloca:ve efficiency is reached when no one can be made beAer efficient because we cannot produce more of one product without affec:ng the amount of off without making someone all other products available. else worse off. This is also known Output
as Pareto efficiency of Beer •  Alloca:ve efficiency occurs when A the value that consumers place X1 on a good or service (reflected in B the price they are willing and able X2 to pay) equals the cost of the C factor resources used up in produc:on. X3 •  The main condi:on required for alloca:ve efficiency in a given market is that market price = Y1 Y2 Y3 marginal cost of supply Output of Cheese Produc4ve Efficiency 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 •  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. Cost Per Unit Produc:ve efficiency is achieved when the long run unit cost of produc:on is at a minimum Average Cost Output 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 Costs, Benefits Social op:mum output is where MSC = MSB MSC P2 MPC P1 MSB MPB Q1 Q2 Output 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! 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 Economic Efficiency in Markets and Introduc4on to Market Failure EdExcel Economics 1.3.1