7.3 Efficiency and Market Failure Flashcards

Flashcards covering efficiency, market failure, Pareto optimality, and dynamic efficiency in economics, suitable for A-Level students.

What does productive efficiency represent?

A state where an economy or firm is producing at its minimum cost and maximum possible output.

How is productive efficiency depicted on a PPF diagram?

By points lying on the frontier curve, illustrating that resources are used to produce maximum output.

What is allocative efficiency?

Allocating resources in a way that maximizes the satisfaction of society’s wants and needs.

When is allocative efficiency achieved?

When the marginal cost of producing an additional unit of a good equals its marginal benefit to consumers.

What is the primary focus of productive efficiency versus allocative efficiency?

Productive efficiency is concerned with producing goods at the lowest cost, while allocative efficiency focuses on producing the right mix of goods as per consumer preferences.

What is the main outcome of productive efficiency?

Cost-effectiveness in production.

What does allocative efficiency ensure?

That the production of goods and services maximizes societal welfare.

What is a key aspect of manufacturing sector?

Firms strive to minimize production costs through efficient use of technology and resources.

What is a key aspect of service industries?

Optimizing the deployment of human resources, technology, and processes to deliver services effectively.

What condition ensures all resources (labor, capital, raw materials) are used to their fullest, avoiding wastage?

Optimal Resource Utilization

What does employing the latest and most efficient technology lead to?

Increase output and reduce costs.

What happens to prices when firms reduce their costs and still maintain profit margins?

Leads to lower prices, as firms can reduce their costs and still maintain profit margins.

What happens when production aligns with the preferences and demands of consumers?

Maximised Consumer Welfare

What does the free market mechanism allow for?

Allows the forces of supply and demand to reach an equilibrium naturally.

What are the advantages of competition?

Innovation and Quality Enhancement & Efficient Pricing

What is the result of dominance by monopolies or oligopolies?

Price manipulation and inefficient resource allocation.

What can government regulations help to accomplish?

Correct market failures and promote efficiency.

What can taxation and subsidies be used for?

Correct market failures, such as externalities, influencing resource allocation.

Why is comprehending the conditions for productive and allocative efficiency vital?

Evaluating market performance, recognizing the limitations of real-world markets, and appreciating the role of government policies in addressing market failures.

What is Pareto Optimality?

A state where no individual's condition can be improved without worsening another's situation.

What does Pareto Optimality aim to maximize?

Economic welfare.

What is an ideal distribution of resources?

Where any reallocation would lead to decreased overall efficiency.

What do markets in perfect competition often reach?

A state close to Pareto Optimality, where goods are produced and consumed at their most efficient levels.

What does allocative efficiency involve in terms of Pareto Optimality?

Analysing whether goods and services are distributed in accordance with consumer preferences.

What is Pareto Optimality pivotal in?

Welfare economics for evaluating the desirability of different economic states and outcomes.

What do governments and policymakers often rely on Pareto Optimality for?

Gauge the effectiveness of their interventions, like subsidies, taxes, or regulations.

What is one of the biggest challenges in achieving Pareto Optimality?

Balancing it with equitable distribution of resources, a critical aspect in policy formulation.

What kind of government interventions must be carefully designed?

To move the market towards Pareto efficiency without creating additional inefficiencies.

What is dynamic efficiency in economics?

Focuses on the ability of an economy to optimally allocate resources over time, fostering growth and development.

What is the cornerstone of dynamic efficiency?

Innovation, driving economic growth through new and improved products and services.

What does dynamic efficiency require an emphasis on?

Long-term investments, particularly in research and development (R&D).

What advantages do economies that demonstrate dynamic efficiency experience?

Can outperform others in international markets leading to a constant cycle of innovation.

What is fundamental for innovation and the efficient adoption of new technologies?

A highly skilled workforce

What is dynamic efficiency also hindered by?

Many firms prioritize immediate profits over long-term investments, impeding the pursuit of dynamic efficiency.

Define Market Failure

Occurs when the free market fails to allocate resources in a manner that achieves the most favourable outcome for society.

What are externalities?

Occur when the production or consumption of goods or services imposes costs or benefits on others which are not reflected in market prices.

What are the societal benefits derived from education and healthcare?

Positive Externalities & contribute to a more informed and healthy workforce.

What are the costs imposed on third parties, like the environmental damage caused by pollution?

Negative Externalities

Market price in market failure

The market price does not reflect the true cost to society, leading to excessive production or consumption, results in welfare loss and inefficient resource allocation.

Why does the market underprovide services like education?

The societal benefit is greater than the individual benefit, leading to underconsumption and a suboptimal allocation of resources.

Define Public goods.

Those that are non-excludable (people cannot be prevented from using them) and non-rivalrous (use by one person does not reduce availability to others).

Why are public goods underprovided?

Due to the inability to exclude non-payers and the lack of rivalry in consumption, private firms find it unprofitable to provide public goods.

What does monopoly lead to?

Single seller dominates the market, often leading to higher prices and lower outputs compared to competitive markets.

What is adverse selection?

Occurs when products of different qualities are sold at a single price due to asymmetric information, leading to the average quality of goods in the market declining.

What is Moral hazard?

Arises when a party insulated from risk behaves differently than if it were fully exposed to the risk.

When do firms create barriers to entry?

Prevent new firms from entering the market and challenging their dominance; Monopolies and oligopolies can create barriers to entry.

What is the most influential correction governments use to intervene?

Regulations; Imposing regulations to control negative externalities (like pollution standards) and to prevent monopolistic abuses.

What intervention is the most useful for the free-rider problem?

Public Provision; Direct provision of public goods like national defense, to ensure their availability.

What methods can be implemented to improve resource allocation and enhance overall societal welfare.

Implement taxes to reduce negative externalities (like carbon taxes) and subsidies to encourage positive externalities (like subsidies for renewable energy).

What is the result in welfare and efficiency when market price does not reflect true cost to society?

Market Failure Analysis: The market price does not reflect the true cost to society, leading to excessive production or consumption. This results in a welfare loss and inefficient resource allocation.

What is the free-rider problem?

Free Rider Problem: The free-rider problem arises because people can benefit from these goods without paying for them, leading to underproduction or no production at all.