copyright © 2002 by thomson learning, inc. efficiency markets and government chapter 2 copyright ©...

Copyright © 2002 by Thomson Learning, Inc.

Efficiency Markets and Government

Chapter 2

Copyright © 2002 Thomson Learning, Inc. Thomson Learning™ is a trademark used herein under license.

ALL RIGHTS RESERVED. Instructors of classes adopting PUBLIC FINANCE: A CONTEMPORARY APPLICATION OF THEORY TO POLICY, Seventh Edition by David N. Hyman as an assigned textbook may reproduce material from this publication for classroom

use or in a secure electronic network environment that prevents downloading or reproducing the copyrighted material. Otherwise, no part of this work covered by the copyright hereon may be reproduced or used in any form or by any means—graphic, electronic, or mechanical, including, but not limited to, photocopying, recording, taping, Web distribution, information networks, or information storage and retrieval

systems—without the written permission of the publisher. Printed in the United States of America

ISBN 0-03-033652-X


PLAN ÉCONOMIE NORMATIVE ET POSITIVE LE CRITÈRE D’EFFICACITÉ

LES CONDITIONS D’EFF. FF. DU MARCHÉ INEFF. DU MARCHÉ (CAS DU

MONOPOLE) INEFF. DE L’INTERVENTION DE L’ÉTAT

SUR LE MARCHÉ (IMPôTS ET SUBVENTIONS)

ÉQUITÉ ET EFFICACITÉ


Positive and Normative Economics

Positive Economics explains “what is” without making judgments about the appropriateness of “what is.”

Normative Economics: designed to formulate recommendations on what should be.


Normative Evaluation of Resource Use:

The Efficiency Criterion Pareto Optimality The efficiency criterion is satisfied

when resources are used over any given period of time in such a way as to make it impossible to increase the well-being of any one person without reducing the well-being of any other person.


Marginal Conditions for Efficiency

Total Social Benefit Total Social Cost Net Benefit = TSB – TSC Maximum Net Benefit occurs where

MSB = MSC


Figure 2.1 Efficient Output

Pri

ce,

Ben

efit

, an

d C

ost

(D

oll

ars)

Loaves of Bread per Month 0

A

B

To

tal

So

cial

Ben

efit

an

d C

ost

MSC

MSB

TSC TSB

2.00 = P

1.50 = P*

1.00 = P2

Q*

Q1 = 10,000 Q* = 15,000 Q2 = 20,000

B C E

A D

Z

TSB – TSC


Conditions under which the Market is Pareto Optimal

All productive resources are privately owned. All transactions take place in markets and in each

separate market many competing sellers offer a standardized product to many competing buyers.

Economic Power is dispersed in the sense that no buyers or sellers alone can influence prices.

All relevant information is freely available to buyers and sellers.

Resources are mobile and may be freely employed in any enterprise.


If These Conditions are Met

P = MPB = MSB

P = MPC = MSC

P = MSB = MSC

and

so


When Does the Market Interaction Fail to Achieve

Efficiency?

Monopoly

Taxes

Subsidies


Market Failure: A Preview of the Basis for Government Activity

Government intervention may be warranted if there is:

Monopoly power. Effects of market transactions on third parties. Lack of a market for a good where MSB>MSC

(i.e. a public good). Incomplete information about goods being sold. An unstable market.


Figure 2.2 Loss in Net Benefits Due to MonopoliesP

ric

e, B

en

efi

t, a

nd

C

os

t (D

olla

rs)

Loss in Net Benefits

Output per Month 0 QM

MSB = P

MSCM

D = MSB

MSC

MR

A

E B

Q*

F

D

G


Figure 2.3 Taxes and EfficiencyP

ric

e (

Ce

nts

pe

r M

es

sa

ge

Un

it)

Billions of Message Units per Month

6

5

4

E'

E

B

Demand = MSB

New Supply = MPC + T > MSC

Supply = MSC = MPC

0 3 4


Figure 2.4 Subsidies and EfficiencyP

ric

e (

Do

llars

pe

r B

us

he

l)

Bushels of Wheat per Year 0

5

4

3

A E

C

Demand = MSB

Q*

Supply = MSC

QS


Equity vs. Efficiency

Equity: perceived fairness of an outcome.

Horizontal equity is achieved when equal people are treated equally.

Vertical equity is achieved when people are treated fairly along a socio-economic continuum.


Figure 2.5 Utility Possibility Curve

An

nu

al W

ell-

Be

ing

of

A

0

UA

UA2

UA1

Annual Well-Being of B

Z

X

UB

E1

E2

E3

UB1 UB2


Positive Analysis Trade-off Between Equity and Efficiency When making choices about public policy

issues we are usually faced with the inevitable situation that you make one person worse off while making another better off. (Taxes must be paid by some in order that public goods can be purchased and these benefits accrue to others.) Some economists attempt to overcome this with the Compensation Criteria.


Compensation Criteria

An attempt is made to compare the dollar value of the gain to the gainers and the dollar value of the loss to the losers.

If the gainers gain more than the losers lose then the gainers can pay the losers enough to compensate the losers for their loss.

Everyone can be made at least as well off as they were without the change as long as there is compensation.


International View: Agricultural Subsidies, International Trade

Restrictions and Global Efficiency

Many nations subsidize farmers with Production subsidies Export subsidies Import constraints

This results in reduced agricultural efficiency Since WTO agreements, such subsidies and

import constraints have been reduced

copyright © 2002 by thomson learning, inc. efficiency markets and government chapter 2 copyright ©...

Documents