case econ08 ab.az.ppt 12
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7/30/2019 Case Econ08 Ab.az.Ppt 12
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© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair
Prepared by:
Fernando & Yvonn Quijano
12
Chapter
General Equilibriumand the Efficiencyof Perfect Competition
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Chapter Outline12General Equilibriumand the Efficiency
of Perfect CompetitionGeneral Equilibrium Analysis
A Technological Advance: The Electronic
Calculator
Market Adjustment to Changes in
Demand
Formal Proof of a General Competitive
Equilibrium
Allocative Efficiency and Competitive
Equilibrium
Pareto Efficiency
The Efficiency of Perfect CompetitionPerfect Competition versus Real Markets
The Sources of Market Failure
Imperfect Markets
Public Goods
Externalities
Imperfect Information
Evaluating the Market Mechanism
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GENERAL EQUILIBRIUM ANDTHE EFFICIENCY OF PERFECT COMPETITION
FIGURE 12.1 Firm and Household Decisions
Input and output markets
cannot be considered
separately or as if they
operated independently. While
it is important to understandthe decisions of individual
firms and households and the
functioning of individual
markets, we now need to add it
all up, to look at the operation
of the system as a whole.
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GENERAL EQUILIBRIUM ANDTHE EFFICIENCY OF PERFECT COMPETITION
partial equilibrium analysis The processof examining the equilibrium conditions inindividual markets and for households andfirms separately.
general equilibrium The condition thatexists when all markets in an economy arein simultaneous equilibrium.
efficiency The condition in which theeconomy is producing what people want atleast possible cost.
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GENERAL EQUILIBRIUM ANALYSIS
AN EARLY TECHNOLOGICAL ADVANCE:
THE ELECTRONIC CALCULATOR
FIGURE 12.2 Cost Saving Technological Change in the Calculator Industry
A significant—if not sweeping—technological change in a single industry affects many
markets. Households face a different structure of prices and must adjust their consumption
of many products. Labor reacts to new skill requirements and is reallocated across markets.
Capital is also reallocated.
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GENERAL EQUILIBRIUM ANALYSIS
MARKET ADJUSTMENT TO CHANGES IN DEMAND
FIGURE 12.3 Adjustment in an Economy with Two Sectors
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GENERAL EQUILIBRIUM ANALYSIS
FORMAL PROOF OF A GENERAL COMPETITIVEEQUILIBRIUM
Economic theorists have struggled with the question ofwhether a set of prices that equates supply and
demand in all markets simultaneously can actually existwhen there are literally thousands and thousands ofmarkets. If such a set of prices were not possible, theresult could be continuous cycles of expansion,contraction, and instability.
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ALLOCATIVE EFFICIENCYAND COMPETITIVE EQUILIBRIUM
PARETO EFFICIENCY
Pareto efficiency or Pareto optimality A condition in which no change is
possible that will make some members ofsociety better off without making someother members of society worse off.
OC C C
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ALLOCATIVE EFFICIENCYAND COMPETITIVE EQUILIBRIUM
THE EFFICIENCY OF PERFECT COMPETITIONThe three basic questions discussed previously included:
1. What gets produced? What determines the final mix of output?
2. How is it produced? How do capital, labor, and land get divided up
among firms? In other words, what is the allocation of resources
among producers?
3. Who gets what is produced? What determines which households get
how much? What is the distribution of output among consuming
households?
To demonstrate that the perfectly competitive system leads to anefficient, or Pareto optimal, allocation of resources, we need toshow that no changes are possible that will make some peoplebetter off without making others worse off.
ALLOCATIVE EFFICIENCY
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ALLOCATIVE EFFICIENCYAND COMPETITIVE EQUILIBRIUM
Efficient Allocation of Resources among Firms
To determine whether it is efficientto hire additional clerks at theRegistry of Motor Vehicles, thecost must be weighed against thevalue of people’s time spent
waiting in lines.
The assumptions that factor markets are competitive and open, that all firms pay the
same prices for inputs, and that all firms maximize profits lead to the conclusion that
the allocation of resources among firms is efficient.
ALLOCATIVE EFFICIENCY
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ALLOCATIVE EFFICIENCYAND COMPETITIVE EQUILIBRIUM
Efficient Distribution of Outputs amongHouseholds
We all know that people have different tastes and preferences, and that they will
buy very different things in very different combinations. As long as everyoneshops freely in the same markets, no redistribution of final outputs among
people will make them better off. If you and I buy in the same markets and pay
the same prices, and I buy what I want and you buy what you want, we cannot
possibly end up with the wrong combination of things. Free and open markets
are essential to this result.
ALLOCATIVE EFFICIENCY
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ALLOCATIVE EFFICIENCYAND COMPETITIVE EQUILIBRIUM
Producing What People Want: The EfficientMix of Output
The condition that ensures that the right things areproduced is P = MC .
Society will produce the efficient mix of output if all firms equate price and
marginal cost.
FIGURE 12.4 The Key Efficiency Condition: Price Equals Marginal Cost
ALLOCATIVE EFFICIENCY
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ALLOCATIVE EFFICIENCYAND COMPETITIVE EQUILIBRIUM
FIGURE 12.5 Efficiency in Perfect Competition Follows from a Weighing of
Values by Both Households and Firms
ALLOCATIVE EFFICIENCY
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ALLOCATIVE EFFICIENCYAND COMPETITIVE EQUILIBRIUM
PERFECT COMPETITION VERSUS REAL MARKETS
We have built a model of a perfectly competitivemarket system that produces an efficient allocationof resources, an efficient mix of output, and an
efficient distribution of output. The perfectlycompetitive model is built on a set of assumptions,all of which must hold for our conclusions to be fullyvalid.
These assumptions do not always hold in real-world markets.
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THE SOURCES OF MARKET FAILURE
market failure Occurs when resources aremisallocated, or allocated inefficiently. Theresult is waste or lost value.
There are four important sources of market failure:
(1) imperfect market structure, or noncompetitivebehavior,
(2) the existence of public goods,
(3) the presence of external costs and benefits, and(4) imperfect information.
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THE SOURCES OF MARKET FAILURE
IMPERFECT MARKETS
imperfect condition An industry in which singlefirms have some control over price andcompetition. Imperfectly competitive industriesgive rise to an inefficient allocation of resources.
monopoly An industry composed of only onefirm that produces a product for which there areno close substitutes and in which significant
barriers exist to prevent new firms from enteringthe industry.
In all imperfectly competitive industries, output is lower —the product is
underproduced—and price is higher than it would be under perfect competition.
The equilibrium condition P = MC does not hold, and the system does not
produce the most efficient product mix.
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THE SOURCES OF MARKET FAILURE
PUBLIC GOODS
public goods, or social goods Goods orservices that bestow collective benefits on
members of society. Generally, no one can beexcluded from enjoying their benefits. Theclassic example is national defense.
private goods Products produced by firms for
sale to individual households.
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THE SOURCES OF MARKET FAILURE
Private provision of public goods fails. A completely laissez-faire market system
will not produce everything that all members of a society might want. Citizens
must band together to ensure that desired public goods are produced, and this is
generally accomplished through government spending financed by taxes.
A classic example of a public
good is a park such as
Central Park in Manhattanproducing collective benefitsfor New Yorkers and tourists.
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THE SOURCES OF MARKET FAILURE
The market does not always force consideration of all the costs and benefits of
decisions. Yet for an economy to achieve an efficient allocation of resources, all
costs and benefits must be weighed.
EXTERNALITIES
externality A cost or benefit resulting fromsome activity or transaction that is imposed
or bestowed on parties outside the activityor transaction.
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THE SOURCES OF MARKET FAILURE
The conclusion that markets work efficiently rests heavily on the assumption that
consumers and producers have full knowledge of product characteristics,
available prices, and so forth. The absence of full information can lead to
transactions that are ultimately disadvantageous.
IMPERFECT INFORMATION
imperfect information The absence of fullknowledge concerning product characteristics,
available prices, and so forth.
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EVALUATING THE MARKET MECHANISM
Freely functioning markets in the real world donot always produce an efficient allocation ofresources, and this result provides a potentialrole for government in the economy
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C H
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efficiency
externality
general equilibrium
imperfect competition
imperfect information
market failure
monopoly
REVIEW TERMS AND CONCEPTS
Pareto efficiency, or Paretooptimality
partial equilibrium analysis
private goods
public goods, or socialgoods
Key efficiency condition inperfect competition:P X = MC X