Chapter 4: Microeconomic objectives

Question 1

What is allocative efficiency?

Answer 1

Allocative efficiency is achieved when society produces a combination of goods and services that maximises its welfare. Occurs when MSB=MSC or when P=MC.

Question 2

What happens when there is a case of underconsumption/ underproduction?

Answer 2

For any output level lower than Qs (MSB=MSC) where MSB>MSC or P>MC, society values each additional unit of the good more than the additional cost of consuming/ producing it. Thus there is under-allocation of resources to the consumption/ production of the good, resulting in a DWL (mkt failure)

Question 3

What happens when there is a case of overconsumption/ overproduction?

Answer 3

For any output level higher than Qs (MSB=MSC) where MSB<MSC or P<MC, society values each additional unit of the good less than the additional cost of consuming/ producing it. Thus there is an over-allocation of resources to the consumption/ production of the good, resulting in a DWL (mkt failure)

Question 4

What is productive efficiency?

Answer 4

Productive efficiency is achieved when the output is produced at the lowest average cost in the long run, at the given state of technology (min. point of LRAC curve)

Question 5

What is equity?

Answer 5

Equity is a normative issue on how resources should be distributed amongst various groups of people and requires a value judgement to be made.

Question 6

What is market failure?

Answer 6

Market failure occurs when the free market is unable to allocate resources efficiently

Question 7

What are the types of market failure?

Answer 7

1. Partial market failure
   - externalities
   - information failure
   - factor immobility
   - market dominance
2. Complete market failure
   - public goods

Question 8

What are public goods?

Answer 8

Public goods are non-excludable, non-rivalrous and non-rejectable in consumption.

Question 9

Define non-excludability

Answer 9

Non-excludability means that it is technically impossible or extremely costly to prevent non-payers from consuming the good once it is provided

Question 10

Define non-rivalry

Answer 10

Consumption of the good by one person does not reduce the amount of the good available for others.

Question 11

Define non-rejectability

Answer 11

The inability of consumers to refuse the consumption of the good once it has been provided

Question 12

What are the implications of non-excludability?

Answer 12

Non-excludability gives rise to a free rider problem where people would hope to free ride on the provision made by others. If those who don’t pay cannot be prevented from consuming the good, people will not be willing to reveal their preferences for the good. This will result in a concealed demand. Thus producers cannot change the prices of their goods and therefore will not be motivated to produce the good.

Question 13

What are the implications of non-rivalry?

Answer 13

Once the good is produced, the marginal cost of providing the good to an additional person is 0. Since allocative efficiency is achieved when P=MC, since the MC=0, the efficient P is also 0. Producers should not change the price. However if left to the free market, the producers will not be willing to charge at 0 price.

Question 14

What are negative externalities?

Answer 14

Negative externalities arising from an economic activity are the costs to third parties who are not involved in the production or consumption of a good and these third parties are not compensated for the costs incurred.

Question 15

What are the 6 steps to explain why market failure occurs due to negative externalities? (Production)

Answer 15

1. Explain MPC and identify free mkt eqm
   - Self interested producers only consider their MPC (give eg). Hence the equilibrium in the free market will lie at Qe where MPC=MPB
2. Explain -ve externality
   - However the production of (give eg) generates negative externalities (give eg), identify 3rd party + cost to 3rd party
3. Divergence between cost curves
   - The existence of negative externalities results in a divergence between MPC and MSC
4. Identify Qs where MSB=MSC
   - The socially optimal level of output Qs is where MSB=MSC
5. Compare Qe and Qs
   -Between Qe and Qs, society values an additional unit of the good less than what it costs to produce it
6. Explain DWL
   - Therefore there is an overproduction of Qs-Qe, resulting in a DWL to society as shown by the shaded area on the diagram

Question 16

What are positive externalities?

Answer 16

Positive externalities arising from an economic activity are the benefits to third parties who are not involved in the production or consumption of a good and these third parties do not pay for the benefits they receive.

Question 16

What are the 6 steps to explain why market failure occurs due to positive externalities?

Answer 16

1. Explain MPB, identify free mkt eqm Qe
2. Explain the +ve externality
3. Divergence between benefit curves
4. Identify Qs where MSB=MSC
5. Compare Qe and Qs
6. Explain DWL

Question 17

What are the 6 steps to explain why market failure occurs due to imperfect info?

Answer 17

1. Explain perceived MPB (consumers) and perceived MPC (producers) + identify Qe where perceived MPB=MPC
2. Explain imperfect info
3. Divergence between perceived MPB and actual MPB
4. Identify Qo where actual MPB=MPC
5. Compare between Qe and Qo
6. Explain DWL

Question 18

What are examples of factor immobility?

Answer 18

1. Occupational mobility (inability of FOPs to move from one sector to another)
2. Geographical immobility ( inability or lack of willingness of FOPs to change locations)