Chapter 4: Economic Efficiency and Markets

Question 1

Economic efficiency

Answer 1

• achieved when the marginal benefits from production equal the marginal costs, an index for examining how an economy functions (demand = supply) (MWTP = MC or Aggregate supply)
• Does not demand equity in distribution
• If a project creates more benefits than it does costs, then it is good, no matter who pays the costs and who receives the benefits

Question 2

Social efficiency

Answer 2

• requires that all market and non-market values be incorporated into the marginal benefits and marginal costs of production

Question 3

socially efficient equilibrium

Answer 3

where MWTP=MC

Question 4

Static efficiency

Answer 4

• at a specific point in time

Question 5

dynamic efficiency

Answer 5

allocation of resources over time

Question 6

Alternatives to markets

Answer 6

Distribution based on need
Equal distribution 
First come first served
Lottery
Survival of the fittest

Question 7

Market equilibrium

Answer 7

• The price level where Qs = Qd
• Markets always try to move towards their equilibrium level
• Stores do not have lots of items they cant sell (or else they lower the price)
• Stores are usually not short of items they can sell (or else they raise the price)
• Stores adjust price to reach equilibrium

Question 8

Market failures

Answer 8

Cause a divergence between market and social values and can prevent a decentralized competitive market from reaching the socially efficient equilibrium

Question 9

Negative externalities

Answer 9

• Producers don’t pay the full costs of production
• such as when the production of a good produces pollution that affects other people
• The price of the good in the market is below the true price
• Producers produce more than the socially optimal amount of the good

Question 10

Positive externalities

Answer 10

• Producers cant capture the full benefits of production

- Make less than the socially optimal amount of the good

Question 11

social costs

Answer 11

private costs + external costs

Question 12

private costs

Answer 12

costs that the firm pays for directly

Question 13

external costs

Answer 13

costs that firms do not pay for
society pays for them in different ways
environmental damage

Question 14

Free riders

Answer 14

• people who pay less than their MWTP for a public good
  o Many public goods suffer from free riders because they are non- excludable from benefits even though they do not pay for the good

Question 15

Public goods and market failures

Answer 15

o People try to avoid paying even with a positive MWTP because they figure someone else will pay and provide the good
o Often use taxes to address the issue, which may be efficient for society but not individuals