Efficient Markets and Government

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Efficient Markets and Government
Chapter 2
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Positive and Normative Economics

• Positive Economics explains what is, without
  making judgments about the appropriateness of
  what is.
• Normative Economics designed to formulate
  recommendations about what should be.

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Normative Evaluation of Resource Use The
Efficiency Criterion

• Pareto Optimality
• The efficiency criterion is satisfied when
  resources are used over any given period of time
  in such a way as to make it impossible to
  increase any one persons well-being without
  reducing any other persons well-being.

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Figure 2.1 Efficient Output
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Conditions under which a Perfectly Competitive
Market System Exists

• All productive resources are privately owned.
• All transactions take place in markets, and in
  each separate market many competing sellers offer
  a standardized product to many competing buyers.
• Economic power is dispersed in the sense that no
  buyers or sellers alone can influence prices.
• All relevant information is freely available to
  buyers and sellers.
• Resources are mobile and may be freely employed
  in any enterprise.

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If These Conditions are Met
P MPB MSB
and
P MPC MSC
so
P MSB MSC
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Figure 2.2 Loss in Net Benefits Due to Monopolies
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Figure 2.3 Taxes and Efficiency
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Figure 2.4 Subsidies and Efficiency
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Market Failure A Preview of the Basis for
Government Activity

• Government intervention may be warranted if a
  market exhibits
• Monopoly power by one supplier
• Effects of market transactions on third parties
• Lack of a market for a good where MSBMSC (i.e. a
  public good)
• Incomplete information about goods being sold
• An unstable market

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Figure 2.5 Utility Possibility Curve
UA
Z
E1
UA2
Annual Well-Being of A
X
E2
UA1
E3
UB
UB1
UB2
0
Annual Well-Being of B
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Positive Analysis Trade-off Between Equity and
Efficiency

• When making choices about public policy issues,
  we are usually faced with the inevitable
  situation that you make one person worse off
  while making another better off.

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Compensation Criteria

• An attempt is made to compare the dollar value of
  the gain to the gainers and the dollar value of
  the loss to the losers.
• If the gainers gain more than the losers lose,
  then the gainers can pay the losers enough to
  compensate the losers for their loss.
• Everyone can be made at least as well off as they
  were without the change as long as compensation
  is paid.