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LECTURE SIX:ECONOMIC EFFICIENCY
IPEM Tohoku University
Managerial Economics
Lecturer: Jack Wu
Period 3/ February 16
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ECON EFFICIENCY: CONDITIONS
for all users, same marginal benefit for all suppliers, same marginal cost marginal benefit = marginal cost
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EQUAL MARGINAL BENEFIT
if not equal provide more to user with higher marginal
benefit take away from user with lower marginal
benefit
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EQUAL MARGINAL COST
if not equal supplier with lower marginal cost should
produce more supplier with higher marginal cost should
produce less
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MARGINAL BENEFIT/COST
if marginal benefit > marginal cost, produce more of the item
if marginal benefit > marginal cost, produce less of the item
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ECONOMIC EFFICIENCY V.S. TECHNICAL EFFICIENCY
Contrast economic efficiency vis-à-vis technical efficiency
Technical efficiency producing at lowest possible cost doesn’t consider how much benefit the item
provides
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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.
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INVISIBLE HANDOutcome of price
competition in market Marginal benefit =
price Marginal cost = price Single price in market
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EXAMPLE OF INVISIBLE HAND Major policy issue: how to allocate licenses for
3G wireless telecommunications; “beauty contest” -- France auction – Germany, UK, US
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.
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INVISIBLE HAND
Market system (price system): Economic system in which resources are allocated through the independent decisions of buyers and sellers, guided by freely moving prices.
Successes of market system West/East Germany North/South Korea China after Deng Xiaoping’s reforms
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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
Note: Transfer price: price charged for the sale of
an item within an organization; Outsourcing: purchase of services or supplies
from external sources
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DECENTRALIZATION
Within organization For all users, marginal benefit = transfer price For all producers, marginal cost = transfer price Marginal benefit = transfer price = marginal cost
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UCLA ANDERSON SCHOOL, 1989
Half an invisible hand is worse than none priced photocopying paper free bond paper
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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
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0
800
900
e
Quantity (Thousand tickets a year)
Pri
ce (
$ p
er
tick
et)
supply
demand
$10
TAX: EQUILIBRIUM
b
h
804
794
920
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0
800
900
e
Quantity (Thousand tickets a year)
Pri
ce (
$ p
er
tick
et)
supply
demand
$10
TAX: SURPLUSES
b
h
804
794
920
f
d
j
buyer surplus loss = fdge + egb seller surplus loss = djhg + ghb revenue gain = fdge + djhg
g
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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
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RETAILING: HOW SHOULD MANUFACTURER CUT PRICE?
Wholesale price cut: Will retailers pass on the price cut?
Coupons: Will this provide consumers with more effective price cut?
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INCIDENCE: REDUCING RETAIL PRICES