Market Efficiency

Definition

Producing goods that society wants at the lowest cost.

Productive Efficiency

Concerned with the optimal method of producing goods and at the lowest cost.

Allocative Efficiency

Concerned with the optimal distribution of goods and services wanted by society, MB=MC.

Consumer Surplus

Difference between what a consumer is prepared to pay and what they actually pay. ½ quantity demanded x (price willing to pay - price payed)

Producer Surplus

Difference between what a producer is willing to receive and what they actually receive. ½ quantity supplied x (price received - price willing to receive)

Total Surplus

Combined area of consumer and producer surplus, can only be maximised at equilibrium.

Deadweight Loss

the avoidable decrease in surplus due to the market being prevented from producing at equilibrium.

Price Floor

A minimum price set above the equilibrium to benefit producers.

Price Floor Effects

• underproduction causes a surplus and deadweight loss - increase in producer surplus does not equal decrease in consumer surplus

• lead to inefficient allocation of sales - higher price set to help producers but consumers may not want the good

• wasted resources - sellers waste time, resources and effort on producing goods that aren’t demanded

• lead to inefficiently higher quality and quantity - buyers would prefer lower quantity at lower price

Price Ceiling

A maximum price set below the equilibrium to benefit consumers.

Price Ceiling Effects

• underproduction causes a shortage and a deadweight loss - increase in consumer surplus does not equal the decrease in producer surplus

• inefficient allocation of resources - people willing to pay a higher price don’t get it, people who don’t want to pay a higher price do get it (people get apartments through connections or luck)

• wasted resources - people spend money, time and extra effort in order to deal with shortages caused by price ceiling (waste time looking for an apartment when there isn’t one)

• inefficiently low quality - producers aren’t willing to supply quality goods due to the low price (landlords won’t improve/repair apartment conditions)

• black markets - a market where goods are sold illegally (people will bribe landlords with extra money to get the apartment)

Inefficiency of a Tax

• price paid by buyers rises and price received by sellers falls

• tax places a wedge between price buyers pay and sellers receive

• quantity sold falls because cost of production rises

• size of market for the good shrinks

• underproduction causes deadweight loss

Inefficiency of a Subsidy

• cost of subsidy is greater than producer and consumer surplus

• encourage inefficiency among producers

• overproduction creates a deadweight loss