Topic 2 Objectives

1. Topic 2 Objectives Develop concept of efficiency to evaluate economic performance. distinction between positive and normative economics Link between resource allocation and economic transactions Marginal conditions for efficiency – maximization of net social benefit at the pt where MSB = MSC

2. Topic 2 Objectives • Resource allocation in competitive markets (no externalities) • monopoly power and govt invention leads to losses in efficiency • Welfare triangles to measure losses in well being when efficiency is not achieved • Equity-efficiency trade off • Utility possibility curve- explains why citizens rationally oppose movements to efficient resource use when compensation for losses in well-being is not actually paid • Positive analysis of equity-efficiency tradeoff

3. TOPIC 2 OUTLINE • Positive and Normative Economics • Normative evaluation of resource use: the efficiency criterion • Marginal conditions for Efficiency • Markets, Prices and Efficiency Conditions • When does market interaction fail to achieve efficiency? • Monopolistic Power • How Taxes can cause losses in efficiency in Competitive Markets

4. TOPIC 2 OUTLINE • How govt subsidies can cause losses in efficiency • Mkt failure : a preview of basis for govt activities • Equity vs efficiency • The trade off between efficiency and equity: graphic analysis • The trade off between efficiency and equity in a system competitive markets • Positive analysis tradeoff between equity and efficiency

5. Major points on topic 2 • Difference between positive and normative approaches • Positive – a scientific method used to formulate hypotheses subject to empirical verification • Normative – based on underlying values that embody an individualistic ethic. • 2 aspects of efficiency: • Avoidance of waste in achieving any useful objective • Exchange- even if prod is accomplished without waste, additional net gains are usually possible through mutually agreeable exchanges

6. Major points on topic 2 • Marginal conditions for efficiency: • Nt social gains are maximised when each possible g & s is made availale up to the pt where MSB= MSC • Additional prod is inefficient beyond the point eventhough TSB>TSC (fig 2.1) • Marginal Net benefit= MSB-MSC • Marginal conditions under perfectly competitive markets: • P =MPB=MPC in competitive mkt • Provided there is no 3rd party, P=MSB=MSC

7. Major points on topic 2 • Example of cases where mkt do not achieve efficiency • Exercise of monopoly power – lack of competition causes losses in efficiency • Effect of taxes and subsidies on private choices in mkts • Losses in well-being from inefficient output levels is measured as triangular areas in the graphs. • Equity efficiency approach show how positive approach can be used to predict net gains and losses to citizens

8. Major points on topic 2 • Utility possibility curve – a good tool to illustrate political conflict: • Max level of well –being of any one person, given the well-being of others depends on the resources available and technology. • There is no unique efficient alloc of resources • Efficient outcomes of comptv interaction can result in a distribution of well-being for which many persons live in poverty • UPC show how changes in resource alloc can result in both gainers and losers even when there is movement from inefficient to efficient resource use • Unless compensation is actually paid, the losers act to prevent the resource change that makes them worse off.