economic efficiency
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Economic Efficiency. Managerial Economics Jack Wu. Econ Efficiency: Conditions. for all users, same marginal benefit for all suppliers, same marginal cost marginal benefit = marginal cost. Equal Marginal Benefit. if not equal provide more to user with higher marginal benefit - PowerPoint PPT PresentationTRANSCRIPT
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ECONOMIC EFFICIENCYManagerial EconomicsJack Wu
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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 BENEFITif not equal provide more to user with higher marginal
benefit take away from user with lower marginal
benefit
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EQUAL MARGINAL COSTif 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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PRICE CEILINGUpper limit that sellers can charge and buyers can pay rent control regulated price for electricity
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0
1100
290 300 310
supply
demand
b
equilibriumexcess demand
Quantity (Thousand units a month)
Price
($ p
er
mon
th)
RENT CONTROL: EQUILIBRIUM
1000 900
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0
1100
290 300 310
supply
demand
b
Quantity (Thousand units a month)
Price
($ p
er
mon
th)
RENT CONTROL: SURPLUSES
1000 900
d
g
e
buyer surplus gain = cfeg buyer surplus loss = dgbseller surplus loss = cfeg + geb
c
f
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RENT CONTROL: LOSSES deadweight losses -- sellers willing to provide
item at price that buyers willing to pay, but provision doesn’t occur
price elasticities of demand and supply _demand more inelastic --> larger loss _ supply more elastic --> larger loss
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PRICE FLOORLower limit that sellers can charge and buyers can pay minimum wage agricultural price supports
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0
4.20
8 10 11
supply
demand
a
b
c
equilibrium
excess supply
Quantity (Billion worker-hours a week)
Wag
e ($
per
hou
r)
MINIMUM WAGE: EQUILIBRIUM
4.00
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0
4.20
8 10 11
supply
demand
a
b
c
Quantity (Billion worker-hours a week)
Wag
e ($
per
hou
r)
MINIMUM WAGE: SURPLUSES
4.00
f
d
e
g
seller surplus gain = fdgeseller surplus loss = ghb buyer surplus loss = fdge + egb
h
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MINIMUM WAGE: LOSSES deadweight losses -- sellers willing to provide
item at price that buyers willing to pay, but provision doesn’t occur
price elasticities of demand and supply _supply more inelastic --> larger loss _demand more elastic --> larger loss
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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)
Price
($ p
er ti
cket
)
supply
demand
$10
TAX: EQUILIBRIUM
b
h
804
794
920
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0
800
900
e
Quantity (Thousand tickets a year)
Price
($ p
er ti
cket
)
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