MICROECONOMICS: Theory & Applications Chapter 19 General Equilibrium Analysis and Economic...

MICROECONOMICS: Theory & Applications

Chapter 19 General Equilibrium Analysis and Economic Efficiency

By Edgar K. Browning & Mark A. ZupanJohn Wiley & Sons, Inc.9th Edition, copyright 2006PowerPoint prepared by Della L. Sue, Marist College

Copyright 2006John Wiley & Sons, Inc.19-2

Learning Objectives

Delineate the difference between partial and general equilibrium analysis.

Explain the concept of economic efficiency. Outline the three conditions necessary for the

attainment of economic efficiency. Examine efficiency in production and what this implies

about input usage across difference industries.

(Continued)


Learning Objectives (continued)

Show how efficiency in output is related to the production possibility frontier.

Demonstrate how perfect competition satisfies all three conditions for economic efficiency.

Spell out the reasons why economic efficiency may not be achieved.


Partial and General Equilibrium Analysis Compared

General equilibrium analysis – the study of how equilibrium is determined in all markets simultaneously

Partial equilibrium analysis – the study of the determination of an equilibrium price and quantity in a given product or input market viewed as self-contained and independent of other markets; assumes that some things that conceivably could, but do not, change (“other things equal”)


The Mutual Interdependence of Markets Illustrated

Spillover effect – a change in equilibrium in one market that affect other markets

Feedback effect – a change in equilibrium in a market that is caused by events in other markets that, in turn, are the result of an initial change in equilibrium in the market under consideration


Interdependence Between Markets [Figure

19.1]


When Should General Equilibrium Analysis Be Used?

Guideline:– Partial analysis is usually accurate in cases involving a

change in conditions primarily affecting one market among many, with repercussions on other markets dissipated throughout the economy

– General equilibrium analysis tends to be more appropriate when a change in conditions affects many, or all, markets are the same time and to the same degree

Pareto optimal – the condition in which it is not possible, through any feasible change in resource allocation, to benefit one person without making some other person or persons worse off


Economic Efficiency

Efficient – Pareto optimal; an allocation of resources when it is not possible, through any feasible change in resource allocation, to benefit one person without making any other person worse off

Inefficient – the condition in which it is possible, through some feasible reallocation of resources, to benefit at least one person without making any other person worse off


Welfare Frontier

A curve that separates welfare levels that are attainable from those that cannot be reached given the available resources

Every point lying on the curve satisfies the definition of economic efficiency

Every point lying inside the curve represents an inefficient allocation of resources

Figure 19.2


Efficiency as a Goal for Economic Performance

The notions of efficient and inefficient resource allocations emphasize the factors that affect the level and distribution of well-being.

BUT, given the premise that each person is the best judge of their own welfare,

we cannot conclude that any efficient position is better than any inefficient position.


Fundamental Economic Problem and Economic Efficiency

Any economy must solve 3 fundamental economic problems:

– how much of each good to produce– how much of each input to use in the production of

each good– how to distribute goods among consumers

Condition for efficiency in the distribution of goods:

MRS1 = MRS2 = … = MRSi


Efficiency in Production

Edgeworth production box – a diagram that identifies all the ways two inputs such as labor and land can be allocated between industries in a simplified economy

Figure 19.3


Production Contract Curve and Efficiency in Production

Efficient resource allocations in input markets lies on the contract curve which connects points of tangency between isoquants.

Where the equilibrium lies on the contract curve depends on the input prices.

A general equilibrium in competitive input markets will occur at the point in which the slopes of the isoquants are equal to one another, as well as the input price ratio.

Figure 19.4


The Production Possibility Frontier and Efficiency in Output

The PPF shows the alternative combinations of two goods that can be produced with fixed supplies of inputs; it can be derived from the contract curve by plotting various possible output combinations directly

Marginal rate of transformation – the rate at which one product can be “transformed” into another

Figure 19.5


Efficiency in Output

Efficiency in output is attained when the rate at which consumers are willing to exchange one good for another (MRS) equals the rate at which one good can be transformed into another (MRT):

MRS1 = MRS2 = … = MRSi = MRT

Figure 19.6


An Economy’s PPF and the Gains from International Trade [Figure 19.7]


Competitive Markets and Economic Efficiency

Perfectly competitive markets satisfy the 3 conditions for economic efficiency:

– an efficient distribution of products among consumers

– efficiency in production– efficiency in output

Adam Smith’s “invisible hand” theorem


The Causes of Economic Inefficiency

Market power– Monopoly (output market)– Monopsony (input market)

Imperfect information Externalities/Public goods

– Side effects borne by people not directly involved in the market activities

– May be harmful or beneficial


Copyright 2006 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in section 117 of the 1976 United States Copyright Act without express permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information herein.

MICROECONOMICS: Theory & Applications Chapter 19 General Equilibrium Analysis and Economic...

Documents

Transcript of MICROECONOMICS: Theory & Applications Chapter 19 General Equilibrium Analysis and Economic...