1. Efficient Markets and Government
Chapter 2
Efficient Markets and Government

2. 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.”

3. 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 person’s well-being without reducing any other person’s well-being.

4. Figure 2.1 Efficient Output
Price, Benefit, and
Cost (Dollars)
Loaves of Bread per Month A B
Total Social Benefit
and Cost
MSC
Q1 = 10,000
2.00 = P
1.00 = P2 B A
MSB
Q2 = 20,000 C D
1.50 = P* Q*
Q* = 15,000 E
TSC Z
TSB
TSB – TSC

5. 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.

6. If These Conditions are Met
P = MPB = MSB
and
P = MPC = MSC so
P = MSB = MSC

7. Figure 2.2 Loss in Net Benefits Due to Monopolies
Price, Benefit, and
Cost (Dollars)
Output per Month MR
D = MSB
MSC QM
MSB = P
MSCM A B
Loss in Net Benefits E Q*

8. Figure 2.3 Taxes and Efficiency
New Supply =
MPC + T > MSC
Price (Cents per
Message Unit)
Billions of Message Units per Month 5 E
Demand =
MSB
Supply =
MSC = MPC 4 E' B 6 4 3

9. Figure 2.4 Subsidies and Efficiency
Price (Dollars per Bushel)
Bushels of Wheat per Year 4 E
Demand =
MSB Q*
Supply =
MSC 5 3 A C QS

10. 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 MSB>MSC (i.e. a public good)
Incomplete information about goods being sold
An unstable market

11. Figure 2.5 Utility Possibility CurveUA Z E1
UA2
Annual Well-Being of A X E2
UA1 E3
UB1
UB2 UB
Annual Well-Being of B

12. 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.

13. 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.