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ECONOMIC EFFICIENCY
ECONOMIC EFFICIENCY
ECON EFFICIENCY: CONDITIONS
for all users, same marginal benefit for all suppliers, same marginal costmarginal benefit = marginal cost
EQUAL MARGINAL BENEFIT
if not equalprovide more to user with higher marginal benefittake away from user with lower marginal benefit
EQUAL MARGINAL COSTif not equalsupplier with lower marginal cost should produce moresupplier with higher marginal cost should produce less
MARGINAL BENEFIT/COSTif marginal benefit > marginal cost, produce more of the itemif marginal benefit > marginal cost, produce less of the item
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
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 efficienti) users buy until marginal benefit equals price; ii) producers supply until marginal cost equals prices; iii) users and producers face same price.
INVISIBLE HANDOutcome of price
competition in market Marginal benefit =
price Marginal cost = price Single price in market
EXAMPLE OF INVISIBLE HAND
Major policy issue: how to allocate licenses for 3G wireless telecommunications;“beauty contest” -- Franceauction – 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.
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
DE-CENTRALIZATIONcreate internal marketif there is a competitive market for an item, set transfer price equal to market priceconsuming 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
DECENTRALIZATION Within organization
For all users, marginal benefit = transfer price
For all producers, marginal cost = transfer price
Marginal benefit = transfer price = marginal cost
UCLA ANDERSON SCHOOL, 1989
Half an invisible hand is worse than nonepriced photocopying paperfree bond paper
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 incidenceUS: airlines pay tax Asia: passengers pay
0
800
900
e
Quantity (Thousand tickets a year)
Price
($ p
er ti
cket
)
supply
demand
$10
TAX: EQUILIBRIUM
b
h
804
794
920
0
800
900
e
Quantity (Thousand tickets a year)
Price
($ 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
INCIDENCEincidence and deadweight loss depend on price elasticities of demand and supplyideal tax (no deadweight loss): inelastic demand/supplywho pays the tax not relevant
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?
INCIDENCE: REDUCING RETAIL PRICES