ch11-110131004038-phpapp01

8/6/2019 ch11-110131004038-phpapp01

1/33

2002 Prentice Hall Business Publishing 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair

C

H

A

P

T

E

R

C

H

A

P

T

E

R

1111

Prepared by: FernandoPrepared by: Fernando

Quijano and Yvonn QuijanoQuijano and Yvonn Quijano

General Equilibrium and theGeneral Equilibrium and theEfficiency of PerfectEfficiency of Perfect

CompetitionCompetition

8/6/2019 ch11-110131004038-phpapp01

2/33


Firm and Household DecisionsFirm and Household Decisions

Input and outputInput and output

markets cannot bemarkets cannot be

considered separatelyconsidered separately

or as if they operatedor as if they operated

independently.independently.

8/6/2019 ch11-110131004038-phpapp01

3/33


Partial Equilibrium AnalysisPartial Equilibrium Analysis

Partial equilibrium analysisPartial equilibrium analysis isis

the process of examining thethe process of examining the

equilibrium conditions inequilibrium conditions inindividual markets, and forindividual markets, and for

households and firms,households and firms,

separately.separately.

8/6/2019 ch11-110131004038-phpapp01

4/33


General EquilibriumGeneral Equilibrium

General equilibriumGeneral equilibrium is theis the

condition that exists when allcondition that exists when all

markets in an economy are inmarkets in an economy are insimultaneous equilibrium.simultaneous equilibrium.

8/6/2019 ch11-110131004038-phpapp01

5/33


EfficiencyEfficiency

In judging the performance of anIn judging the performance of an

economic system, two criteria usedeconomic system, two criteria used

are efficiency and equity (fairness).are efficiency and equity (fairness).

EfficiencyEfficiencyis the condition inis the condition in

which the economy is producingwhich the economy is producing

what people want at the leastwhat people want at the leastpossible cost.possible cost.

8/6/2019 ch11-110131004038-phpapp01

6/33


General Equilibrium AnalysisGeneral Equilibrium Analysis

To examine the move from partial toTo examine the move from partial to

general equilibrium analysis we willgeneral equilibrium analysis we will

consider the impact of:consider the impact of:

a major technological advance, anda major technological advance, and

a shift in consumer preferences.a shift in consumer preferences.

8/6/2019 ch11-110131004038-phpapp01

7/33 2002 Prentice Hall Business Publishing 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair

Cost-Saving Technological ChangeCost-Saving Technological Change

Technology improvements made it possible toTechnology improvements made it possible to

produce at lower costs in the calculator industry.produce at lower costs in the calculator industry.

8/6/2019 ch11-110131004038-phpapp01



As new firms entered the industry and existing firmsAs new firms entered the industry and existing firms

expanded, output rose and market prices dropped.expanded, output rose and market prices dropped.

8/6/2019 ch11-110131004038-phpapp01



A significant technological change inA significant technological change in

a single market affects manya single market affects many

markets:markets:

Households must adjust to changingHouseholds must adjust to changing

pricesprices

Labor reacts to new skill requirementsLabor reacts to new skill requirements

and is reallocated across marketsand is reallocated across markets

Capital is also reallocatedCapital is also reallocated

8/6/2019 ch11-110131004038-phpapp01


A Shift in Consumer PreferencesA Shift in Consumer Preferences

To examine the effects of a change in one market on otherTo examine the effects of a change in one market on other

markets, we will consider the wine industry in the 1970s.markets, we will consider the wine industry in the 1970s.

Production and Consumption of Wine in the United States, 19651980

YEAR

U.S.PRODUCTION(MILLIONS OF

GALLONS)

IMPORTS(MILLIONS OF

GALLONS)

TOTAL(MILLIONS OF

GALLONS)

CONSUMPTIONPER CAPITA(GALLONS)

1965 565 10 575 1.32

1970 713 22 735 1.52

1975 782 40 822 1.96

1980 983 91 1073 2.02

Percent change,19651980

+ 74.0 +810.0 + 86.6 +53.0

Source: U.S. Department of Commerce, Bureau of the Census, Statistical Abstract of the United States, 1985, Table 1364, p. 765.

8/6/2019 ch11-110131004038-phpapp01


Adjustment in an EconomyAdjustment in an Economy

with Two Sectorswith Two Sectors

This graph shows theThis graph shows the

initial equilibrium in aninitial equilibrium in an

economy with twoeconomy with two

sectorswine (sectorswine (XX) and) andother goods (other goods (YY)prior)prior

to a change into a change in

consumer preferences.consumer preferences.

8/6/2019 ch11-110131004038-phpapp01




A change in consumerA change in consumer

preferences causes anpreferences causes an

increase in the demandincrease in the demand

for wine, and,for wine, and,consequently, aconsequently, a

decrease in the demanddecrease in the demand

for other goods.for other goods.

8/6/2019 ch11-110131004038-phpapp01




A higher price creates aA higher price creates a

profit opportunity inprofit opportunity in

sectorsectorXX..

Simultaneously, lowerSimultaneously, lowerprices result in losses inprices result in losses in

industryindustry YY..

8/6/2019 ch11-110131004038-phpapp01




As new firms enterAs new firms enter

industryindustryXXand existingand existing

firms expand, outputfirms expand, output

rises and market pricesrises and market pricesdrop. Excess profitsdrop. Excess profits

are eliminated.are eliminated.

8/6/2019 ch11-110131004038-phpapp01




As new firms exitAs new firms exit

industryindustry Y,Y, market pricemarket price

rises and losses arerises and losses are

eliminated.eliminated.

8/6/2019 ch11-110131004038-phpapp01


Wine Production is anWine Production is an

Increasing-Cost IndustryIncreasing-Cost Industry

Land in Grape Production in the United States and in California Alone, 1974and 1982

NUMBER OF VINEYARDS NUMBER OF ACRES

United States

1974 14,208 712,8041982 24,982 874,996

Percent change +75.8 +22.8

California

1974 8,333 607,011

1982 10,481 756,720

Percent change +25.8 +24.7

Source: U.S. Department of Commerce, Bureau of the Census, Census of Agriculture (1974 and 1982), 1, part 51.

8/6/2019 ch11-110131004038-phpapp01


Formal Proof of aFormal Proof of a

General Competitive EquilibriumGeneral Competitive Equilibrium

This section explains why perfectThis section explains why perfect

competition is efficient in dividingcompetition is efficient in dividing

scarce resources among alternativescarce resources among alternative

uses.uses.

If the assumptions of a perfectlyIf the assumptions of a perfectly

competitive economic system hold, thecompetitive economic system hold, the

economy will produce an efficienteconomy will produce an efficientallocation of resources.allocation of resources.

8/6/2019 ch11-110131004038-phpapp01


The Efficiency of Perfect CompetitionThe Efficiency of Perfect Competition

The three basic questions in aThe three basic questions in a

competitive economy are:competitive economy are:

1.1. What will be produced?What will be produced? WhatWhatdetermines the final mix of output?determines the final mix of output?

2.2. How will it be produced?How will it be produced? How doHow do

capital, labor, and land get divided upcapital, labor, and land get divided up

among firms?among firms?

3.3. Who will get what is produced?Who will get what is produced? WhatWhat

is the distribution of output amongis the distribution of output among

consuming households?consuming households?

8/6/2019 ch11-110131004038-phpapp01



As we will see, in a perfectlyAs we will see, in a perfectly

competitive economic system:competitive economic system:

1.1. resources are allocated among firmsresources are allocated among firmsefficiently,efficiently,

2.2. final products are distributed amongfinal products are distributed among

households efficiently, andhouseholds efficiently, and

3.3. the system produces the things thatthe system produces the things that

people want.people want.

8/6/2019 ch11-110131004038-phpapp01

20/33


Pareto EfficiencyPareto Efficiency

Pareto efficiency,Pareto efficiency, ororParetoPareto

optimality,optimality, is a condition in which nois a condition in which no

change is possible that will make somechange is possible that will make some

members of society better off withoutmembers of society better off withoutmaking some other members of societymaking some other members of society

worse off.worse off.

This very precise concept of efficiencyThis very precise concept of efficiencyis known asis known as allocative efficiency.allocative efficiency.

8/6/2019 ch11-110131004038-phpapp01

21/33



Efficient Allocation of Resources:Efficient Allocation of Resources:

Perfectly competitive firms have incentives toPerfectly competitive firms have incentives to

use the best available technology.use the best available technology.

With a full knowledge of existing technologies,With a full knowledge of existing technologies,

firms will choose the technology that producesfirms will choose the technology that produces

the output they want at the least cost.the output they want at the least cost.

Each firm uses inputs such thatEach firm uses inputs such that MRPMRPLL== PPLL..

The marginal value of each input to each firmThe marginal value of each input to each firm

is just equal to its market price.is just equal to its market price.

8/6/2019 ch11-110131004038-phpapp01

22/33



Within the constraints imposed by incomeWithin the constraints imposed by income

and wealth, households are free to chooseand wealth, households are free to chooseamong all the goods and services availableamong all the goods and services available

in output markets. Utility value is revealed inin output markets. Utility value is revealed in

market behavior.market behavior.

As long as everyone shops freely in theAs long as everyone shops freely in the

same markets, no redistribution of finalsame markets, no redistribution of final

outputs among people will make them betteroutputs among people will make them better

off.off.

Efficient Distribution of Outputs AmongEfficient Distribution of Outputs AmongHouseholds:Households:

8/6/2019 ch11-110131004038-phpapp01

23/33



Society will produce theSociety will produce the

efficient mix of output if allefficient mix of output if all

firms equate price andfirms equate price andmarginal cost.marginal cost.

Producing What People WantProducing What People Want

the Efficient Mix of Output:the Efficient Mix of Output:

8/6/2019 ch11-110131004038-phpapp01

24/33


The Key Efficiency Condition: PriceThe Key Efficiency Condition: Price

Equals Marginal CostEquals Marginal Cost

IfIfPPXX

>> MCMCXX, society gains value by producing more, society gains value by producing more XX

IfIfPPXX

8/6/2019 ch11-110131004038-phpapp01

25/33


Efficiency in Perfect CompetitionEfficiency in Perfect Competition

Efficiency in perfect competition follows from a weighing of values byEfficiency in perfect competition follows from a weighing of values byboth households and firms.both households and firms.

8/6/2019 ch11-110131004038-phpapp01

26/33


The Sources of Market FailureThe Sources of Market Failure

Market failureMarket failure occurs when resourcesoccurs when resources

are misallocated, or allocatedare misallocated, or allocated

inefficiently. The result is waste or lostinefficiently. The result is waste or lost

value. Evidence of market failure isvalue. Evidence of market failure isrevealed by the existence of:revealed by the existence of:

Imperfect marketsImperfect markets

Public goodsPublic goods

ExternalitiesExternalities

Imperfect informationImperfect information

8/6/2019 ch11-110131004038-phpapp01

27/33


Imperfect MarketsImperfect Markets

Imperfect competitionImperfect competition is an industry inis an industry in

which single firms have some controlwhich single firms have some control

over price and competition.over price and competition.

Imperfectly competitive industries giveImperfectly competitive industries give

rise to an inefficient allocation ofrise to an inefficient allocation of

resources.resources.

8/6/2019 ch11-110131004038-phpapp01

28/33



MonopolyMonopolyis an industry composedis an industry composed

of only one firm that produces aof only one firm that produces a

product for which there are no closeproduct for which there are no close

substitutes and in which significantsubstitutes and in which significantbarriers exist to prevent new firmsbarriers exist to prevent new firms

from entering the industry.from entering the industry.

8/6/2019 ch11-110131004038-phpapp01

29/33



In all imperfectly competitive industries,In all imperfectly competitive industries,

output is lowerthe product isoutput is lowerthe product is

underproducedand price is higherunderproducedand price is higher

than it would be under perfectthan it would be under perfectcompetition.competition.

The equilibrium conditionThe equilibrium condition P = MCP = MCdoes notdoes not

hold, and the system does not produce thehold, and the system does not produce themost efficient product mix.most efficient product mix.

8/6/2019 ch11-110131004038-phpapp01

30/33


Public GoodsPublic Goods

Public goodsPublic goods, or, orsocial goodssocial goods areare

goods and services that bestowgoods and services that bestow

collective benefits on members ofcollective benefits on members of

society.society.

Generally, no one can be excluded fromGenerally, no one can be excluded from

enjoying their benefits. The classicenjoying their benefits. The classic

example is national defense.example is national defense.

8/6/2019 ch11-110131004038-phpapp01

31/33


Public GoodsPublic Goods

Private goodsPrivate goods are products producedare products produced

by firms for sale to individualby firms for sale to individual

households.households.

Private provision of public goods fails. APrivate provision of public goods fails. A

completely laissez-faire market will notcompletely laissez-faire market will not

produce everything that all members of aproduce everything that all members of a

society might want. Citizens must bandsociety might want. Citizens must band

together to ensure that desired publictogether to ensure that desired public

goods are produced, and this is generallygoods are produced, and this is generally

accomplished through governmentaccomplished through government

spending financed by taxes.spending financed by taxes.

8/6/2019 ch11-110131004038-phpapp01

32/33


ExternalitiesExternalities

AnAn externalityexternalityis a cost or benefitis a cost or benefit

resulting from some activity orresulting from some activity or

transaction that is imposed or bestowedtransaction that is imposed or bestowed

on parties outside the activity oron parties outside the activity ortransaction.transaction.

The market does not always forceThe market does not always force

consideration of all the costs and benefits ofconsideration of all the costs and benefits ofdecisions. Yet for an economy to achievedecisions. Yet for an economy to achieve

an efficient allocation of resources, all costsan efficient allocation of resources, all costs

and benefits must be weighed.and benefits must be weighed.

8/6/2019 ch11-110131004038-phpapp01

33/33

Imperfect InformationImperfect Information

Imperfect informationImperfect information is the absenceis the absence

of full knowledge concerning productof full knowledge concerning product

characteristics, available prices, and socharacteristics, available prices, and so

forth.forth.

The absence of full information can lead toThe absence of full information can lead to

transactions that are ultimatelytransactions that are ultimately

disadvantageous.disadvantageous.

ch11-110131004038-phpapp01

Documents

Transcript of ch11-110131004038-phpapp01