Farid Abolhassani Markets and Efficiency 10

Learning Objectives After working through this chapter, you will be able to: List and describe the assumptions of the perfectly competitive market Give examples of markets which are highly competitive and those which are less so Explain why perfectly competitive markets are efficient Compare health care markets with the model of perfect competition

Key Terms Consumer efficiency Consumer efficiency A situation where consumers cannot increase their satisfaction by reallocating their budget. Exchange efficiency Exchange efficiency Is achieved when the price at which a good or service is exchanged is equal to both the marginal social cost and the marginal social benefit of that good or service. Market failure Market failure The failure of an unregulated market to achieve an efficient allocation of resources. Perfect competition Perfect competition A market in which there are many suppliers, each selling an identical product and many buyers who are completely informed about the price of each supplier’s product, and there are no restrictions on entry into the market. Price taker Price taker A supplier that cannot influence the price of the good or service they supply.

Perfect Competition Many producers selling the same product to many purchasers; No restrictions on potential producers entering the market; Existing producers have no advantage over the new producers; Producers and purchasers are well informed about prices.

How perfect competition arises Minimum efficient scale Minimum efficient scale of a single producer is small relative to the demand for a good or service Consumers don’t care which firm they buy from The minimum efficient scale is the smallest quantity of output at which long-run average cost reaches its lowest level. The minimum efficient scale is the smallest quantity of output at which long-run average cost reaches its lowest level.

Price Taker A price taker is a firm that cannot influence the price of a good or service. The reason why a perfectly competitive firm is a price taker is that: It produces a tiny fraction of the total output of a particular good or service and; Buyers are well informed about the prices of other firms A price taking firm faces a demand curve that is perfectly elastic.

Effectiveness Effectiveness simply means that production or consumption of something will yield satisfaction (or utility)

Different Types of Efficiency

Operational Efficiency ‘Given that some activity is worth doing, what is the best way of providing it Operational efficiency asks the question, ‘Given that some activity is worth doing, what is the best way of providing it? selection between alternative means of achieving the same ends Operational efficiency involves the selection between alternative means of achieving the same ends and may, therefore, be interpreted as the pursuit of maximum output for a given level of resources or minimum cost for a given level of output.

The rules of achieving operational efficiency If one means of achieving a given end is less (more) costly and produces the same amount of output then this option should (should not) be preferred; If one means of achieving a given end is less costly and produces more output then this should be preferred; If one means of achieving a given end is less costly and produces less output then cost-effectiveness ratios should be computed, the lower ratio indicating greater efficiency

Allocative Efficiency Allocative efficiency judges whether an activity is worthwhile doing Just as operational efficiency infers effective health care, so allocative efficiency infers operational efficiency. The social perspective is fundamental to allocative efficiency. This perspective ensures that due account is taken of all costs and benefits of interventions, regardless of whether they fall within or outside the health care sector

Externality Production externality Production externality Social cost = Private cost + E Consumption externality Consumption externality Social benefit = Private benefit ± E If E = 0 then Social cost = Private cost Social benefit = Private benefit

Efficiency of the Market Consumers ’ surplus: Consumers ’ value – Price Producers ’ surplus: Price – Actual production cost Efficiency = Maximizing Surplus

Surplus a b c Surplus = (a + c) + (b – c) = a + b S = MSC D = MSB Q P

Surplus a b c d e Surplus = (a + c - e) + (b – c - d) = (a + b) – (d + e) S = MSC D = MSB Q P

Efficiency of the Market a b Surplus = a + b S = MSC D = MSB QEQE PEPE

Efficiency of the Market MSC=Marginal Social Cost MPC=Marginal Private Cost P=Price MPB= Marginal Private Benefit MSB=Marginal Social Benefit MSC = MPC = P = MPB = MSB

Efficiency-equity Relationship Individual ability and willingness to pay Market-based resource allocation Income and wealth distribution

Are health services competitive? For some areas of health care there may be many suppliers but for others not. Generally, primary care is provided by a large number of individual doctors and small group practices whereas specialist services often have few providers. There are barriers to entry into the health care system. Doctors, nurses and other health professionals (quite rightly) need qualifications and a license before they can provide health care. Different providers are not selling an identical product. The quality (or at least the reputation for quality) of care and service is known to vary between providers. For a lot of health care, consumers are not fully informed about what services they need and they cannot be sure about differences in quality between providers.