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Efficient Markets and Government

Efficient Markets and Government. Chapter 2. Positive and Normative Economics. Positive Economics explains “what is,” without making judgments about the appropriateness of “what is.” Normative Economics: designed to formulate recommendations about what “should be.”.

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Efficient Markets and Government

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  1. Efficient Markets and Government Chapter 2

  2. Positive and Normative Economics • Positive Economics explains “what is,” without making judgments about the appropriateness of “what is.” • Normative Economics: designed to formulate recommendations about what “should be.”

  3. Normative Evaluation of Resource Use: The Efficiency Criterion • Pareto Optimality • The efficiency criterion is satisfied when resources are used over any given period of time in such a way as to make it impossible to increase any one person’s well-being without reducing any other person’s well-being.

  4. Figure 2.1 Efficient Output A MSC B 2.00 = P C E Price, Benefit, and Cost (Dollars) 1.50 = P* 1.00 = P2 D A MSB Q1 = 10,000 Q2 = 20,000 TSC Q* = 15,000 B TSB Z Total Social Benefit and Cost TSB – TSC 0 Q* Loaves of Bread per Month

  5. Conditions under which a Perfectly Competitive Market System Exists • All productive resources are privately owned. • All transactions take place in markets, and in each separate market many competing sellers offer a standardized product to many competing buyers. • Economic power is dispersed in the sense that no buyers or sellers alone can influence prices. • All relevant information is freely available to buyers and sellers. • Resources are mobile and may be freely employed in any enterprise.

  6. If These Conditions are Met P = MPB = MSB and P = MPC = MSC so P = MSB = MSC

  7. Figure 2.2 Loss in Net Benefits Due to Monopolies B MSB = P MSC E Price, Benefit, and Cost (Dollars) Loss in Net Benefits MSCM A D = MSB MR QM Q* 0 Output per Month

  8. Figure 2.3 Taxes and Efficiency MPC + T > MSC New Supply = MSC = MPC Supply = E' 6 E 5 Price (Cents per Message Unit) 4 B MSB Demand = 0 3 4 Billions of Message Units per Month

  9. Figure 2.4 Subsidies and Efficiency MSC Supply = 5 A E 4 Price (Dollars per Bushel) C 3 MSB Demand = Q* QS 0 Bushels of Wheat per Year

  10. Market Failure: A Preview of the Basis for Government Activity Government intervention may be warranted if a market exhibits: • Monopoly power by one supplier • Effects of market transactions on third parties • Lack of a market for a good where MSB>MSC (i.e. a public good) • Incomplete information about goods being sold • An unstable market

  11. Figure 2.5 Utility Possibility Curve UA Z E1 UA2 Annual Well-Being of A X E2 UA1 E3 UB1 UB2 UB 0 Annual Well-Being of B

  12. Positive Analysis Trade-off Between Equity and Efficiency • When making choices about public policy issues, we are usually faced with the inevitable situation that you make one person worse off while making another better off.

  13. Compensation Criteria • An attempt is made to compare the dollar value of the gain to the gainers and the dollar value of the loss to the losers. • If the gainers gain more than the losers lose, then the gainers can pay the losers enough to compensate the losers for their loss. • Everyone can be made at least as well off as they were without the change as long as compensation is paid.

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