Market Efficiency

Question 1

Define the concept of market efficiency in a perfectly competitive market.

Answer 1

Market efficiency occurs at market equilibrium, and is achieved through the characteristics of a perfectly competitive market:

1. Large numbers of producers and consumers - competition of price.
2. Limited product differentiation - minimal difference between products ensures that buyers cannot differentiate between the products.
3. Free entry and exit into the market - easy for producers to enter and exit the market.

Question 2

Define consumer surplus.

Answer 2

Consumer surplus is the difference between the price a consumer pays for a product, and the price they are willing to pay.

Question 3

Define producer surplus.

Answer 3

Producer surplus is the difference between the price a producer sells their product at, and the price they are wiling to sell at.

Question 4

Define total surplus.

Answer 4

Total surplus is the measure of economic welfare (wellbeing of an economy e.g. living standards) that a market creates for consumers and producers.

It is formulated by:
consumer surplus + producer surplus, or;
total benefits - total costs (producer and consumer)

Question 5

Define deadweight loss (DWL).

Answer 5

The term Deadweight loss refers to a reduction of total surplus, as a result of either underproduction, or overproduction.

Question 6

How is DWL created, and how can they be eliminated to achieve market efficiency?

Answer 6

Through government intervention, DWL is created with:

1. Price ceilings - maximum price that sellers are allowed to charge.
   By keeping price below market equilibrium, quantity demanded exceeds quantity supplied to the extent that it may create a shortage - DWL is formed as it reduces total surplus (increasing consumer surplus, reducing producer surplus).
2. Price floors - minimum price that sellers are to charge. By keeping price above market equilibrium, quantity supplied exceeds quantity demanded to the extent that it may create a surplus - DWL is formed as it reduces total surplus (increase producer surplus, reducing consumer surplus).