1.4 Market efficiency, consumer surplus and producer surplus

market efficiency

1. allocative efficiency

2. The sum of consumer & producer surplus

market efficiency definition

occurs when resources are allocated in the most optimal way, so the total surplus is maximised and no one can be made better off without making someone else worse off (because resources are allocated so well)

market efficiency happens when

1. market is in equilibrium (d=s)

2. there is allocative efficiency (MB=MC) - no externalities, (MSB=MSC)- accounts for externalities

3. there are no market failures

allocative efficiency definition

resources are allocated in a way that maximises total social welfare, meaning marginal benefits = marginal costs

Consumer surplus definition

extra satisfaction (utility) Gaines by consumers from paying a lower price than they were initially willing to pay

Producer surplus

extra satisfaction/benefit gained by a producer when they receive a higher price for a good then the minimum amount they were willing to accept to produce and sell it

Total surplus (total welfare)

• consumer + producer surplus

• at the equilibrium community surplus is maximised, efficient outcome no wasted resources, and unmet demand

does a free market lead to allocative efficiency ?

yes, in theory, a free market (no gov intervention, no market failure) leads to:

• market equilibrium

• allocate efficiency because: (resources are used to produce what society most wants in the right quantity)

• total surplus is maximised

why does the supply curve = marginal social cost (MSC) ?

because it shows the cost to society of producing one more unit (MSC), assuming no external costs

why does the demand curve - marginal social benefit (MSB) ?

because it shows the benefit of society from consuming one more unit (MSB), assuming no external benefits