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It’s All About Efficiency…

It’s All About Efficiency…. And so we begin again…. Public policy encourages, discourages, prohibits, or prescribes private actions We base everything on the idea of a perfectly competitive economy Market failures are private choices that violate the perfect economy. The Benchmark. Utility

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It’s All About Efficiency…

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  1. It’s All About Efficiency…

  2. And so we begin again… • Public policy encourages, discourages, prohibits, or prescribes private actions • We base everything on the idea of a perfectly competitive economy • Market failures are private choices that violate the perfect economy

  3. The Benchmark • Utility • Assumptions of consumption: • More we have, the more utility we have • Declining marginal utility • Assumptions of production: • Buy factor inputs to produce goods for sale • Additional unit of output requires same units of input as predecessor • Leads to Pareto Efficiency • Can’t find an allocation that makes one person better without making at least one worse

  4. How Do We Measure Changes in Efficiency? • Social Surplus • Net benefits from competing in markets

  5. Caveats • General equilibrium model is static rather than dynamic • Can never be complete • Assumptions are often violated in reality

  6. What if the Invisible Hand Gets Confused??? • Market failures are private choices that violate the perfect economy • Market failures constitute the most commonly advanced rationales for public policy • Collective action can allow us to improve efficiency • Social surplus is larger under alternative than under market equilibrium

  7. 1) Public Goods • Nonrivalrous, nonexcludable, congestable • Shoe example

  8. Public Goods Follow-Up • P. 87-88 example • Prisoner’s dilemmas and Nash equilibriums

  9. 2) Externalities • Positive or negative • Examples?

  10. 3) Natural Monopoly • Single firm can produce at lowers cost than any other arrangement • If you force it to price efficiently, it leaves. If you allow it to price where it wants, you take a deadweight loss. • X-Inefficiency • Natural monopoly that doesn’t reach minimum costs

  11. 4) Information Assymetry • Amount of information about the characteristics of a good varies in relevant ways across persons • Search v. experience v. post-experience • Examples?

  12. So Those Are the Big Four… • But there are many other limitations of the competitive framework…

  13. Thin Markets • Few buyers or sellers • Monopsony • Oligarchy

  14. Preference Problems • Endogenous • Self-regarding • Other-regarding • Process-regarding

  15. Uncertainty Problems • Two-period worlds lead to more complex decisions • Ski example • Insurance • Risk v. uncertainty • Law of large numbers • Moral hazards • Subjective perception of risk (flood/earthquake)

  16. Uncertainty Problems • Prospect Theory

  17. Intertemporal Allocation Problems • Contracts in present for future production and delivery • What about future generations? • How do we know their wants/needs?

  18. Adjustment Costs • Economy is never static like we wish to assume • Epidemic on eggs… • Oil embargo and Iranian revolution…

  19. Macroeconomic Dynamics • Business cycle • Fiscal v. monetary policies

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