A Simple Marker Model Chap7

Question 1

Market equilibrium

Answer 1

A situation where the price in a given market is such that the quantity demanded is equal to the quantity supplied.

Question 2

Pareto efficiency

Answer 2

A situation in which there is no way of making any person better off without making someone else worse off (a point on the production possibilities frontier).

Question 3

Perfect competition

Answer 3

A market in which there are many suppliers, each selling an identical product and many buyers who are completely informed about the price of each supplier’s product, and there are no restrictions on entry into the market.

Question 4

Price taker

Answer 4

A supplier that cannot infl uence the price of the good or service they supply.

Question 5

Perfectly competitive market and a controlled market.

Answer 5

A perfectly competitive market is also called a free market.
a market in which there is no intervention or regulation by the state, except to enforce private contracts and the ownership of property. A perfectly competitive market is the opposite of a controlled market, in which the state directly regulates how goods, services and labour may be used, priced or distributed.

free markets will automatically produce an equilibrium price and quantity. This was fi rst postulated by Adam Smith in his seminal work, The Wealth of Nations in 1776.

Question 6

Equilibrium

Answer 6

When that system is a market, equilibrium occurs when all participants are satisfi ed. They have no reason to change their behaviour and therefore there is a tendency for production or prices in that market to remain unchanged. At any other price, either consumers or producers are dissatisfi ed and will seek to change their behaviour (demand or supply more or less), which will alter the price until equilibrium is found and no more change occurs.

Question 7

What does the supply curve reflect?

Answer 7

It reflects the sellers marginal cost. The cost of producing one extra unit)

Question 8

What does the demand curve reflect?

Answer 8

the marginal utility (extra benefi t) (MB) that consumers receive from consuming each unit.

Question 9

Social welfare

Answer 9

Social welfare is total social benefi t minus total social cost. For a particular market, social welfare is represented by the area below the marginal social benefi t curve and above the marginal social cost curve. Social welfare is maximized at the point where marginal social benefi t (MSB) equals marginal social cost (MSC).

If MSB is greater than MSC then you can increase social welfare by increasing quantity because the extra benefi t is greater than the extra cost and vice versa: if MSB is less than MSC then you can increase social welfare by decreasing quantity because the benefi t lost is less than the cost saved.

Question 10

Productive efficiency

Answer 10

The concept of productive effi ciency refers to the maximisation of health outcome for a given cost, or the minimisation of cost for a given outcome.

Productive effi ciency is also referred to as economic efficiency.

Question 11

Comparing technical, productive and allocative efficiency.

Answer 11

Thus technical effi ciency addresses the issue of using given resources to maximum advantage; productive effi ciency of choosing different combinations of resources to achieve the maximum health benefi t for a given cost; and allocative effi ciency of achieving the right mixture of healthcare programmes to maximise the health of society

Question 12

Allocative efficiency

Answer 12

A situation in which the factors of production have been allocated so as to reflect what people demand (i.e. demand matches supply). Social welfare is maximized as MB = MC in all markets and there can be no substitution between markets to increase welfare beyond its current level.

Allocative efficiency describes a situation where resources are allocated and commodities distributed in a way that maximizes social welfare.

The concept of allocative effi ciency takes account not only of the productive effi ciency with which healthcare resources are used to produce health outcomes but also the effi ciency with which these outcomes are distributed among the community. Such a societal perspective is rooted in welfare economics and has implications for the defi nition of opportunity costs. In theory, the effi cient pattern of resource use is such that any alternative pattern makes at least one person worse off. In practice, strict adherence to this criterion has proved impossible. Further, this criterion would eliminate as ineffi cient changes that resulted in many people becoming much better off at the expense of a few being made slightly worse off. Consequently, the following decision rule has been adapted: allocative effi ciency is achieved when resources are allocated so as to maximise the welfare of the community.

allocative effi ciency is sometimes used interchangeably with Pareto effi ciency.

In reality, Pareto effi ciency is rarely possible as generally there are winners and losers from most transactions. It is only valid if the world can be seen to be the outcome of a perfectly competitive market where demand and supply curves are as described above and there is technical and economic effi ciency. Importantly, when looking at Pareto effi ciency, economists are only assessing the effi ciency of resource distribution; it cannot tell us anything about how equitable that distribution is, as you will discover in the next activity.

Question 13

Technical efficiency

Answer 13

technical’ effi ciency is sometimes referred to as ‘operational’, ‘technological’, ‘scale’ or ‘producer’ effi ciency.

Question 14

What is the ‘invisible hand’ theory in economics?

Answer 14

This is an economic principle fi rst postulated by Adam Smith in the eighteenth century. It describes a situation where perfectly competitive markets will automatically produce an equilibrium price and quantity. According to the invisible hand theory, each of us, acting in our own self-interests, generates a demand for goods and services that compels others to deliver those goods and services in the most effi cient manner.

Question 15

Would you expect a Pareto effi cient allocation to be equitable?

Answer 15

It is a good thing for a market to be Pareto effi cient because it means that total benefi t to society is maximized. This means that the sum of the utilities of every person is maximized. However, this might mean that some people have a very large amount of utility but others have a relatively small amount. An example might help you to understand this. Let’s say you had a million oranges and everybody else had one each. This could still be Pareto effi cient provided there is no way for you to obtain a million and one oranges without making anyone else worse off. This is why Pareto effi cient allocation is not related to equity. In this case there is scope for government intervention even though there is effi ciency – i.e. on equity grounds.

Question 16

What are the necessary conditions for a perfectly competitive market?

Answer 16

A free or perfectly competitive market can only operate effi ciently if a number of important conditions are met, including these four: • producers selling the same product (homogeneity);
• many sellers and buyers;
• no restrictions on potential sellers entering the market;
• buyers and sellers well informed about prices.

Question 17

Why should health care be considered as a market? (Benefits)

Answer 17

Effi ciency. In a market environment people can demonstrate their preferences for different goods and services by exercising choice. This both generates highly precise information about their preferences, so providers are motivated to supply the services people want (allocative effi ciency), and provides the incentive for providers to be as effi cient as possible in order to undercut competitors (technical effi ciency).

I I. Customer service and innovation. In markets there is always the opportunity for people to come forward with new ideas to meet an unmet need: a powerful incentive to experiment, innovate and focus squarely on service users.

iii. Resiliency. A major criticism of government action in the fi eld of public policy is that it has followed ‘utopian social engineering’, resulting in any wrong decision being felt hard and universally. In markets, where there are so many participants, it would be remarkable if all made the same mistakes.
iv. Voluntary co-operation. Markets form part of a sphere that is based on voluntary co-operation, in that the decisions of businesses, individuals and researchers are not forced on anyone else. This contrasts with monopoly where there are few alternative options.
v. Equity. In centrally-planned systems, where there is no formal choice, middle and upper class people typically are better at creating choices and negotiating a better deal. With an appropriate redistribution of resources, markets give everyone this opportunity.

Question 18

What are the advantages of markets in the allocation of resources?

Answer 18

Markets are a useful resource allocation mechanism for the following reasons.

1 In theory at least, markets automatically tend towards a situation of equilibrium where the output produced is exactly equal to the output used. You looked at this in the last activity.

2 Given a few specifi c requirements, markets will produce an output that is allocatively effi cient – that is, each unit of output is produced when the additional benefi t it brings exceeds its cost.

3 The market is dynamic: it is a ‘powerful and effi cient information system’. Changes in people’s preferences are quickly passed on to and acted on by producers. Likewise, changes in the availability of and cost of resources are refl ected in prices. Cheaper substitute resources are quickly opted for instead.