Download It`s All About Efficiency…

It’s All About Efficiency…
And so we begin again…
• Public policy encourages, discourages,
prohibits, or prescribes private actions
• We base everything on the idea of a perfectly
competitive economy
• Market failures are private choices that violate
the perfect economy
The Benchmark
• Utility
• Assumptions of consumption:
– More we have, the more utility we have
– Declining marginal utility
• Assumptions of production:
– Buy factor inputs to produce goods for sale
– Additional unit of output requires same units of input
as predecessor
• Leads to Pareto Efficiency
– Can’t find an allocation that makes one person better
without making at least one worse
How Do We Measure Changes in
Efficiency?
• Social Surplus
– Net benefits from competing in markets
Caveats
• General equilibrium model is static rather
than dynamic
• Can never be complete
• Assumptions are often violated in reality
What if the Invisible Hand Gets
Confused???
• Market failures are private choices that violate
the perfect economy
• Market failures constitute the most
commonly advanced rationales for public
policy
– Collective action can allow us to improve
efficiency
• Social surplus is larger under alternative than
under market equilibrium
1) Public Goods
• Nonrivalrous, nonexcludable, congestable
– Shoe example
Public Goods Follow-Up
• P. 87-88 example
• Prisoner’s dilemmas and Nash equilibriums
2) Externalities
• Positive or negative
– Examples?
3) Natural Monopoly
• Single firm can produce at lowers cost than
any other arrangement
• If you force it to price efficiently, it leaves. If
you allow it to price where it wants, you take a
deadweight loss.
• X-Inefficiency
– Natural monopoly that doesn’t reach minimum
costs
4) Information Assymetry
• Amount of information about the
characteristics of a good varies in relevant
ways across persons
• Search v. experience v. post-experience
– Examples?
So Those Are the Big Four…
• But there are many other limitations of the
competitive framework…
Thin Markets
• Few buyers or sellers
• Monopsony
• Oligarchy
Preference Problems
•
•
•
•
Endogenous
Self-regarding
Other-regarding
Process-regarding
Uncertainty Problems
• Two-period worlds lead to more complex
decisions
– Ski example
• Insurance
– Risk v. uncertainty
– Law of large numbers
– Moral hazards
– Subjective perception of risk (flood/earthquake)
Uncertainty Problems
• Prospect Theory
Intertemporal Allocation Problems
• Contracts in present for future production and
delivery
• What about future generations?
– How do we know their wants/needs?
Adjustment Costs
• Economy is never static like we wish to
assume
• Epidemic on eggs…
• Oil embargo and Iranian revolution…
Macroeconomic Dynamics
• Business cycle
• Fiscal v. monetary policies