Unit 7 & 8: Part 3 Efficiency and fairness

Question 1

What is competitive equilibrium

Answer 1

Competitive equilibrium is achieved when profit-maximizing producers and utility-maximizing consumers settle on a price that suits all parties.

At this equilibrium price, the quantity supplied by producers is equal to the quantity demanded by consumers

Question 2

Pareto efficiency vs fairness at the competitive equilibrium

Answer 2

Pareto Efficiency
➢At the competitive equilibrium allocation in the bread market, it is not possible to make any of the consumers or firms better off without making at least one of them worse off
➢The equilibrium allocation in the competitive market is pareto efficient

Fairness
➢Although the allocation is Pareto efficient, it does not necessarily mean that it is fair (i,.e. distribution of surplus between rich and poor, we may want to take individual standard of living into account)

Question 3

PRICE-SETTING FIRM OR MONOPOLY

Answer 3

Sets price and quantity to maximise profits (“price-maker”)

Chooses an output level at which marginal cost is less than price

Deadweight losses (Pareto inefficient)

Owners receive economic rents (profits greater than normal profits)

Incentive for innovation and to prevent copying

Spend on influencing elections, legislation or on advertising

Question 4

FIRM IN A PERFECTLY COMPETITIVE MARKET

Answer 4

Takes market determined price as given and chooses quantity to maximise profits (“price-taker”)

Chooses an output level at which marginal cost equals price

No deadweight losses for consumers and firms (can be Pareto efficient if no-one else in the economy is affected)

If the owners receive any economic rents, the rents are likely to disappear as more firms enter the market

Hardly spend on influencing elections, legislation or on advertising

Little incentive for innovation (others would copy)