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Theanalysisisthenusedtoevaluateresourceallocationincompetitivemarketsoperatingunderconditionsofperfectcompetitionwithnoexternalities.Thisisfollowedbyexamplesshowinghowmonopolypowerandgovernmentinterventioncanresultinlossesinefficiencyinmarkets.Theobjectivehereistoshowhowwelfaretrianglescanbeusedtomeasurelossesinwell-beingwhenefficiencyisnotachieved.
Theequity-efficiencytradeoffisalsointroducedinthechapter.Theutilitypossibilitycurveisusedtoshowstudentshowcitizensoftenrationallyopposemovementstoefficientresourceusewhencompensationforlossesinwell-beingisnotactuallypaid.Positiveanalysisoftheequity-efficiencytradeoffisalsoprovided,therebyclosingthechapterwithanillustrationofhowthepositiveapproachisusefultonormativeanalysis.
ChangesinThisEdition
Thischapterhasbeenupdatedwhereneeded.Otherwise,therehavebeennochangesinthiscoretheorychapter.Anewproblemwasaddedtotheendofthechapter.
ChapterOutline
PositiveandNormativeEconomics
NormativeEvaluationofResourceUse:
TheEfficiencyCriterion
MarginalConditionsforEfficiency
Markets,Prices,andEfficiencyConditions
WhenDoesMarketInteractionFailtoAchieveEfficiency
MonopolisticPower
HowTaxesCanCauseLossesinEfficiencyinCompetitiveMarkets
PublicPolicyPerspective:
TheTaxSystemandtheBirthRate—AnExampleofPositiveEconomicAnalysis
HowGovernmentSubsidiesCanCauseLossesinEfficiency
MarketFailure:
APreviewoftheBasisforGovernmentActivity
EquityversusEfficiency
TheTradeoffbetweenEfficiencyandEquity:
AGraphicAnalysis
TheTradeoffbetweenEquityandEfficiencyinaSystemofCompetitiveMarkets
PositiveAnalysisTradeoffBetweenEquityandEfficiency
InternationalView:
AgriculturalSubsidies,InternationalTradeRestrictions,andGlobalEfficiency
MajorPointsandLectureSuggestions
1.Instructorsmaywishtoemphasizethedifferencebetweenthenormativeandpositiveapproaches.Thenormativeapproachisbasedonunderlyingvaluesthatembodyanindividualisticethic.Thepositiveapproachissimplyascientificmethodusedtoformulatehypothesessubjecttoempiricalverification.Ipointouttomystudentsthatthenormativeapproachinpublicfinancesetsupbenchmarksagainstwhichtheimpactofgovernmentregulations,expenditures,andtaxescanbeevaluated.
2.Therearetwoaspectsofefficiencythatareusefultoemphasizeinlectures:
a.Efficiency,asthetermiscommonlyusedbythelayperson,simplymeansavoidanceofwasteinachievinganyusefulobjective.Studentsaremostlikelyalreadyfamiliarwiththisaspectofefficiency.
b.Thesecondaspectofefficiencydealswithexchange.Evenwhenproductionisaccomplishedwithoutwaste,additionalnetgainsareusuallypossiblethroughmutuallyagreeableexchanges.
Indiscussingthesecondaspectofefficiency,withwhichstudentsarelessfamiliar,youcanpointoutthatfreedomtotradeisanimportantaspectofefficiency.Constraintsonmutuallyagreeabletradetherebypreventattainmentofefficiencywhennothirdpartiesareaffectedbythosetransactions.
3.Thederivationofthemarginalconditionsforefficiencyprovidesagoodopportunitytoreviewmarginalanalysisforstudents.Makesuretoconfineyourdiscussiontoaparticulargood.Theexampleinthetextusesbread.IfindthatstudentsarequitereceptivetothenotionthatnetsocialgainsaremaximizedwheneachpossiblegoodorserviceismadeavailableuptothepointatwhichMSB=MSC.TheinclusionofthetotalsocialbenefitandtotalsocialcostcurvesinFigure2.1inthetexthelpsstudentsseehowadditionalproductionofgoodsisinefficientbeyondthepointatwhichMSB=MSC,eventhoughTSB>
TSCforadditionaloutput.
4.Noticehowthemarginalnetbenefitisdefinedasthedifferencebetweenthemarginalsocialbenefitandthemarginalsocialcostofanygivenquantityofagood.
5.Afterderivingtheefficiencyconditions,Iliketoreinforcethetheorybyimmediatelyshowingstudentshowthemarginalconditionsaresatisfiedunderidealconditionsinperfectlycompetitivemarkets.Indoingso,Iintroducetheconceptsofmarginalprivatebenefitandmarginalprivatecost.IshowhowP=MPB=MPCincompetitivemarkets.Finally,IsetthestageforfutureanalysisinChapter3bypointingoutthat,providednothirdparties(otherthanbuyersandsellers)areaffectedbymarketexchanges,P=MSB=MSC.Becausetheseconditionsareusedthroughoutthetext,itisimportantforstudentstounderstandthederivation.Ifindthatstudentshavelittledifficultywiththeexposition.Ifyougetthesignificanceofthesepointsacrossearlyinthecourse,itiseasytoshowhowtaxesandsubsidiespreventpricesfromsimultaneouslyreflectingmarginalsocialcostsandbenefits.
Thenumericalexampleinthetexthasbeenhelpfultomystudents.NotethatIusethesamenumberswhendiscussingcompetitivemarketsforbread.
6.Theobviousnextstepistoprovideyourstudentswithexamplesofcasesforwhichmarketsdonotachieveefficiency.Theexerciseofmonopolypowerisagoodexampleofhowlackofcompetitioninmarketscancauselossesinefficiency.Thisexamplecanthenbesupplementedwithanalysisoftheeffectsoftaxesandsubsidiesonprivatechoicesinmarkets.TheexampleoftargetpricesforagricultureintheUnitedStatesshowshowsubsidiestoagricultureresultinmorethantheefficientamountofresourcesallocatedtoagriculturaluses.
Youmightwishtosupplementtheseexampleswithsomeofyourown.Inanycase,themaininstructionalobjectiveistoshowstudentshowlossesinwell-beingresultingfrominefficientoutputlevelscanbemeasuredastriangularareasinthegraphs.
ThePublicPolicyPerspectiveshowsstudentshowthepersonalexemptionintheU.S.incometaxcanbeviewedasasubsidytoraisingchildren.
7.Ibelievethatitisimportanttoemphasizetheequity-efficiencytradeoffearlyinthecourse.Thisprovidesanopportunitytoshowhowthepositiveapproachcanbeusedtopredictthenetgainsandlossestocitizens.Theutilitypossibilitycurveisagoodtooltoillustratepoliticalconflict.Firstmakesurethatstudentsseethesimilaritybetweentheutilitypossibilitycurveandtheproductionpossibilitycurve.Inparticular,pointoutthatthemaximumpossiblelevelofwell-beingofanyoneperson,giventhewell-beingofothers,dependsonresourcesavailableandtechnology.Thecurvealsoshowshowthereisnooneuniqueefficientallocationofresources.Itcanbeusedtoshowhowtheefficientoutcomesofcompetitiveinteractioncanresultinadistributionofwell-beingforwhichmanypersonsliveinpoverty.
8.Iliketousetheutilitypossibilitycurvetoshowhowchangesinresourceallocationcanresultinbothgainersandlosersevenwhenthereismovementfrominefficienttoefficientresourceuse.Unlesscompensationisactuallypaid,thelosersacttopreventtheresourcechangethatmakesthemworseoff.
ANoteontheAppendixtoChapter2
TheappendixtoChapter2setsupatwo-dimensionalmodelofefficientresource.Thisappendixcaneasilybeskippedbecausethebasicnotionsaredevelopedintuitivelywithinthechapter.If,however,youhavegoodstudents,youcanassigntheappendixandderivetheconditionsinclass.ThestandardwelfaremodelisdevelopedintheappendixandEdgeworth-Bowleyboxesareusedtoderivetheefficiencyconditions.
OutlineoftheAppendixtoChapter2
AModelofEfficientResourceUse
ProductionandTechnology
ProductiveEfficiency
TheProductionPossibilityCurve
TastesandUtility
AttainmentofEfficiency
AnInterpretationofEfficiencyConditions
RankingEfficientOutcomes:
SocialWelfareFunctions
EfficiencyandEconomicInstitutions
PureMarketEconomyandProductiveEfficiency
APureMarketEconomyandParetoEfficiency
IncomeDistribution
AlternativeEconomicInstitutionsandEfficiency
MarketImperfections
True/FalseQuestions
1.Thenormativeapproachtopublicfinanceprescribescertainactionstoachievepredeterminedcriteria.(T)
2.Positiveeconomicanalysisisbasedonunderlyingvaluejudgments.(F)
3.“Thegovernmentshouldabolishtariffstoachieveefficiency”isanormativestatement.(T)
4.Itispossibleforefficiencynottobeattainedevenifallproductioniscarriedonwithoutwaste.(T)
5.Efficiencyisattainedwhenresourcesareusedeachyearinsuchawaythatnofurthernetgainispossible.(T)
6.Theefficientannualoutputofanygivengoodisattainedifthatgoodismadeavailableinamountsuptothepointatwhichthetotalsocialbenefitofthegoodequalsthetotalsocialcost.(F)