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Lecture Six: Economic Efficiency. IPEM Tohoku University Managerial Economics Lecturer: Jack Wu Period 3/ February 16. Econ Efficiency: Conditions. for all users, same marginal benefit for all suppliers, same marginal cost marginal benefit = marginal cost. Equal Marginal Benefit. - PowerPoint PPT Presentation
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LECTURE SIX:ECONOMIC EFFICIENCY
IPEM Tohoku University
Managerial Economics
Lecturer: Jack Wu
Period 3/ February 16
ECON EFFICIENCY: CONDITIONS
for all users, same marginal benefit for all suppliers, same marginal cost marginal benefit = marginal cost
EQUAL MARGINAL BENEFIT
if not equal provide more to user with higher marginal
benefit take away from user with lower marginal
benefit
EQUAL MARGINAL COST
if not equal supplier with lower marginal cost should
produce more supplier with higher marginal cost should
produce less
MARGINAL BENEFIT/COST
if marginal benefit > marginal cost, produce more of the item
if marginal benefit > marginal cost, produce less of the item
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
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.
INVISIBLE HANDOutcome of price
competition in market Marginal benefit =
price Marginal cost = price Single price in market
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.
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
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
DECENTRALIZATION
Within organization For all users, marginal benefit = transfer price For all producers, marginal cost = transfer price Marginal benefit = transfer price = marginal cost
UCLA ANDERSON SCHOOL, 1989
Half an invisible hand is worse than none priced photocopying paper free bond paper
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
0
800
900
e
Quantity (Thousand tickets a year)
Pri
ce (
$ p
er
tick
et)
supply
demand
$10
TAX: EQUILIBRIUM
b
h
804
794
920
0
800
900
e
Quantity (Thousand tickets a year)
Pri
ce (
$ p
er
tick
et)
supply
demand
$10
TAX: SURPLUSES
b
h
804
794
920
f
d
j
buyer surplus loss = fdge + egb seller surplus loss = djhg + ghb revenue gain = fdge + djhg
g
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
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?
INCIDENCE: REDUCING RETAIL PRICES