Economic Efficiency
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Transcript of Economic Efficiency
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ECONOMIC EFFICIENCYManagerial EconomicsJack Wu
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ECON EFFICIENCY: CONDITIONS
for all users, same marginal benefit for all suppliers, same marginal cost marginal benefit = marginal cost
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EQUAL MARGINAL BENEFITif not equal provide more to user with higher marginal
benefit take away from user with lower marginal
benefit
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EQUAL MARGINAL COSTif not equal supplier with lower marginal cost should
produce more supplier with higher marginal cost should
produce less
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MARGINAL BENEFIT/COST if marginal benefit > marginal cost, produce
more of the item if marginal benefit > marginal cost, produce
less of the item
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ECONOMIC EFFICIENCY V.S. TECHNICAL EFFICIENCY Contrast economic efficiency vis-à-vis
technical efficiency Technical efficiency
producing at lowest possible cost doesn’t consider how much benefit the item
provides
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ADAM SMITH’S INVISIBLE HAND: PRICE Competitive market achieves three sufficient
condition for economic efficiency: buyers and sellers in a market system act
independently and selfishly, yet the overall outcome is efficient
i) users buy until marginal benefit equals price; ii) producers supply until marginal cost equals prices; iii) users and producers face same price.
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INVISIBLE HANDOutcome of price
competition in market Marginal benefit =
price Marginal cost = price Single price in market
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EXAMPLE OF INVISIBLE HAND Major policy issue: how to allocate licenses for
3G wireless telecommunications; “beauty contest” -- France auction – Germany, UK, US
pioneer: in early 1990s, US Federal Communications Commission showed that spectrum licenses were worth billions;
created pressure on other governments to allocate by auction and not favoritism.
Auction ensures that item goes to user with highest marginal benefit.
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INVISIBLE HAND Market system (price system): Economic
system in which resources are allocated through the independent decisions of buyers and sellers, guided by freely moving prices.
Successes of market system West/East Germany North/South Korea China after Deng Xiaoping’s reforms
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DE-CENTRALIZATION create internal market if there is a competitive market for an item,
set transfer price equal to market price consuming units should be allowed to
outsource
Note: Transfer price: price charged for the sale of
an item within an organization; Outsourcing: purchase of services or supplies
from external sources
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DECENTRALIZATION Within organization
For all users, marginal benefit = transfer price For all producers, marginal cost = transfer price Marginal benefit = transfer price = marginal cost
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UCLA ANDERSON SCHOOL, 1989
Half an invisible hand is worse than none priced photocopying paper free bond paper
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PRICE CEILINGUpper limit that sellers can charge and buyers can pay rent control regulated price for electricity
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0
1100
290 300 310
supply
demand
b
equilibriumexcess demand
Quantity (Thousand units a month)
Price
($ p
er
mon
th)
RENT CONTROL: EQUILIBRIUM
1000 900
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0
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290 300 310
supply
demand
b
Quantity (Thousand units a month)
Price
($ p
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th)
RENT CONTROL: SURPLUSES
1000 900
d
g
e
buyer surplus gain = cfeg buyer surplus loss = dgbseller surplus loss = cfeg + geb
c
f
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RENT CONTROL: LOSSES deadweight losses -- sellers willing to provide
item at price that buyers willing to pay, but provision doesn’t occur
price elasticities of demand and supply _demand more inelastic --> larger loss _ supply more elastic --> larger loss
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PRICE FLOORLower limit that sellers can charge and buyers can pay minimum wage agricultural price supports
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supply
demand
a
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equilibrium
excess supply
Quantity (Billion worker-hours a week)
Wag
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MINIMUM WAGE: EQUILIBRIUM
4.00
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supply
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Wag
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hou
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MINIMUM WAGE: SURPLUSES
4.00
f
d
e
g
seller surplus gain = fdgeseller surplus loss = ghb buyer surplus loss = fdge + egb
h
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MINIMUM WAGE: LOSSES deadweight losses -- sellers willing to provide
item at price that buyers willing to pay, but provision doesn’t occur
price elasticities of demand and supply _supply more inelastic --> larger loss _demand more elastic --> larger loss
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TAX: COMMODITY TAX“the only two sure things in life are death and taxes” buyer’s price - tax = seller’s price payment vis-à-vis incidence
US: airlines pay tax Asia: passengers pay
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Quantity (Thousand tickets a year)
Price
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TAX: EQUILIBRIUM
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h
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0
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Quantity (Thousand tickets a year)
Price
($ p
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)
supply
demand
$10
TAX: SURPLUSES
b
h
804
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920
f
d
j
buyer surplus loss = fdge + egb seller surplus loss = djhg + ghb revenue gain = fdge + djhg
g
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INCIDENCE incidence and deadweight loss depend on
price elasticities of demand and supply ideal tax (no deadweight loss): inelastic
demand/supply who pays the tax not relevant
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RETAILING: HOW SHOULD MANUFACTURER CUT PRICE? Wholesale price cut: Will retailers pass on the
price cut? Coupons: Will this provide consumers with
more effective price cut?
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INCIDENCE: REDUCING RETAIL PRICES
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DISCUSSION QUESTION Consider a company that manages a network
of hospitals across several counties in one state. Household incomes and the cost of living are higher in urban than rural areas. The company, however, has set the same prices for pharmaceuticals and services in all of its hospitals. It has also paid the same salaries for doctors, nurses, and other professional staff throughout the state.
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DISCUSSION QUESTION:CONTINUED Management has noticed that there are long
waiting lists for treatment at its urban hospitals. Can you explain this problem?
The company has had great difficulty in recruiting professional staff for its urban hospitals. Can you explain this problem?
What advice would you give to management?