Chapter 5: Efficiency CBA Part 1: Market failure and shadow-pricing Flashcards Preview

ECON3220 Final Exam > Chapter 5: Efficiency CBA Part 1: Market failure and shadow-pricing > Flashcards

Flashcards in Chapter 5: Efficiency CBA Part 1: Market failure and shadow-pricing Deck (32):
1

In a perfectly competitive market economy, the allocation of factors will be...

Pareto Optimal

2

Some conditions for a perfectly competitive market economy

- no monopoly or monopsony
- no distorting taxes or regulations
- profit maximising producers and utility maximising consumers
- a complete set of private property rights

3

Pareto optimality

A situation where no reallocation of factors of production can make one person better off without making someone else worse off

4

If we lived in a perfectly competitive market economy, the private sector would...

- Choose to undertake all projects that are efficient from an economic point of view (contribute to Pareto optimality)
- Never choose to undertake an inefficient project

5

If we lived in a perfectly competitive market economy, would would the role of government be in promoting economic efficiency?

- There would be no role for government in promoting economic efficiency
- Public projects wouldn't be required because all efficient projects are already being undertaken by the private sector
- Private projects would not require government approval because they always contribute to economic efficiency

6

Would there by any role for government in a perfectly competitive market economy?

The government might want to redistribute income in a way that did not alter the efficiency of private resource allocation decisions

7

Would there be any role for benefit-cost anlaysts in a perfectly competitive market economy?

No. There would be no public projects aimed at improving resource allocation, and private projects would not have to be appraised and approved by government regulators

8

How do models of perfectly competitive market economies help?

They provide a standard of efficiency against which the performance of real-world economies can be assessed

9

Is there an alternative to the theoretical model of the perfectly competitive economy?

- In principle: Yes. Resource allocation decisions could be made by economic planners rather than the market
- In theory: If planners had access to all relevant information, they could allocate resources efficiently

10

The free market economy and the centrally planned economy are...

Theoretical extremes

11

Efficiency CBA

- Deals with overall net benefits of a project, irrespective of who the gainers and losers are
- Measures the economic efficiency of the project
- Ignores distribution of net benefits

12

If Efficiency CBA net benefit is positive...

The project brings about a more efficient allocation of resources than the alternative (the world "without" the project)

13

Which groups will the net benefit of the project under the efficiency cba flow to?

- Private sector (profits)
- Public sector (taxes/charges)
- General public (employment benefits, rent, pollution costs, etc.)
- Residents of foreign countries

14

Kaldor-Hicks Criterion

If the project is a potential Pareto improvement, it represents an increase in economic welfare

15

Two problems we face when conducting efficiency cba

- Missing markets (e.g. pollution, recreational fishing)
- Markets in which market price does not measure the value to the economy (e.g. non-competitive markets, markets distorted by taxes/regulations)

16

How do we deal with the problems we face when conducting efficiency CBA?

- Non-market valuation techniques
- Shadow-pricing techniques (adjusting observed market prices to make them reflect marginal benefit/cost to the economy)

17

For what elements of a CBA do we create shadow prices?

- Material inputs/outputs (taxes, subsidies, regulations, market imperfections)
- Factor inputs (labour, land, capital, taxes, regulations)
- Cost of public funds
- Corrective taxes and subsidies

18

Prices when markets are distorted

- When markets are distorted, there are two prices at Q*:
- Pb (reflecting demand conditions)
- Ps (reflecting supply conditions)

19

Taxes and subsidies: Pb for ad velorem/specific taxes/subsidies?

Ad velorem tax: Pb = Ps(1+t)
Specific tax: Pb=Ps+t
Ad velorem subsidy: Pb=Ps(1-s)
Specific subsidy: Pb=Ps-s

20

After tax/before tax prices

After tax price: Pb (the price the buyer payers)
Before tax price: Ps (the price the seller receives)

21

After subsidy/before subsidy prices

Before subsidy price: Ps (the price the seller receives)
After subsidy price: Pb (the price the buyer pays)

22

Shadow pricing: material inputs with indirect tax (e.g. GST)

- If input is sourced through additional supply, use Ps
- If input is diverted from other users, use Pb
- If output is replacing other suppliers, use Ps
- If output is satisfying additional demand, use Pb

23

Shadow pricing: material imported input with tariff

- If input is sourced through additional imports, use Pw
- If input is diverted from other users, use Pb
- If output is replacing imports, use Pw
- If output is satisfying additional demand, use Pb

24

Shadow pricing: material inputs with subsidy

With subsidy, buyers pay less than what sellers receive
- If input is sourced through additional supply, use Ps
- If input is diverted from other resources, use Pb
- If output is replacing other suppliers, use Ps
- If output is satisfying additional demand, use Pb

25

Material inputs with Price > MC (e.g. economies of scale)

- If input is sourced through additional supply, use Pm (mc)
- If input is diverted from other users, use P
- If output replacing other suppliers, use Pm
- If output satisfying additional demand, use P

26

Labour input: distortion? two prices at Q*?

- Distortion: minimum wage, results in excess supply of labour (unemployment)
- At Q*: two prices of labour:
- Price indicated by the demand curve (Wm, the minimum wage)
- Price indicated by the supply curve (Ws, the reservation wage - the wage required to induce an extra unit of supply)

27

Shadow pricing: labour input with minimum wage

- If labour is diverted from other employers, use Wm (=VMPl)
- If labour is sourced from unemployed, use Ws (additional supply)

28

Shadow pricing: labour input drawn from monopolist

- If labour is diverted from other employer/monopolist, use Wp (=VMPL), not market wage W

29

Shadow pricing: labour input drawn from monopsonist

- If labour is diverted from other employer/monopsonist, use Wp = (VMPL), not market wage W

30

What does the efficiency cba shadow pricing rule tell us?

Tells us which is the appropriate price to use to value project outputs/inputs in the cba (demand curve or supply curve price?)

31

Efficiency cba shadow pricing rule

VALUED AT EQUILIBRIUM ON DEMAND CURVE (Pb):
- OUTPUT: satisfies additional demand (after tax; after subsidy)
- INPUT: sourced from an alternative market use (after tax; after subsidy)

VALUED AT EQUILIUBRIUM ON SUPPLY CURVE (Ps):
- OUTPUT: satisfies existing demand from an alternative source (before tax; before subsidy)
INPUT: sourced from additional supply (before tax; before subsidy)

32

Logic of the pricing rule

- Sourced from an alternative market use (e.g. otherwise employed elsewhere) -> opp. cost is the value of output foregone in that use. If alternative use is in a competitive undistorted market, labour's VMP in that use equals wage, measured by a point on the demand curve for labour
- Sourced from additional supply (e.g. otherwise unemployed) -> opp. cost is the value of leisure time (the reservation wage) measured by a point on the supply curve