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© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
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© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
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© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of...
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Ch11

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Transcript of "Ch11"

  1. 1. © 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 CHAPTERCHAPTER 1111 Prepared by: Fernando QuijanoPrepared by: Fernando Quijano and Yvonn Quijanoand Yvonn Quijano General Equilibrium and theGeneral Equilibrium and the Efficiency of PerfectEfficiency of Perfect CompetitionCompetition
  2. 2. © 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 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.
  3. 3. © 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 Partial Equilibrium AnalysisPartial Equilibrium Analysis • Partial equilibrium analysisPartial equilibrium analysis isis the process of examining thethe process of examining the equilibrium conditions inequilibrium conditions in individual markets, and forindividual markets, and for households and firms,households and firms, separately.separately.
  4. 4. © 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 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 in simultaneous equilibrium.simultaneous equilibrium.
  5. 5. © 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 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). • EfficiencyEfficiency is 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 least possible cost.possible cost.
  6. 6. © 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 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.
  7. 7. © 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. 8. © 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 • 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.
  9. 9. © 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 • 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
  10. 10. © 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 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, 1965–1980Production and Consumption of Wine in the United States, 1965–1980 YEARYEAR U.S.U.S. PRODUCTIONPRODUCTION (MILLIONS OF(MILLIONS OF GALLONS)GALLONS) IMPORTSIMPORTS (MILLIONS OF(MILLIONS OF GALLONS)GALLONS) TOTALTOTAL (MILLIONS OF(MILLIONS OF GALLONS)GALLONS) CONSUMPTIONCONSUMPTION PER CAPITAPER CAPITA (GALLONS)(GALLONS) 19651965 565565 1010 575575 1.321.32 19701970 713713 2222 735735 1.521.52 19751975 782782 4040 822822 1.961.96 19801980 983983 9191 10731073 2.022.02 Percent change,Percent change, 1965–19801965–1980 ++ 74.074.0 ++810.0810.0 ++ 86.686.6 ++53.053.0 SourceSource: U.S. Department of Commerce, Bureau of the Census,: U.S. Department of Commerce, Bureau of the Census, Statistical Abstract of the United StatesStatistical Abstract of the United States, 1985, Table 1364, p. 765., 1985, Table 1364, p. 765.
  11. 11. © 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 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 sectors—wine (sectors—wine (XX) and) and other goods (other goods (YY)—prior)—prior to a change into a change in consumer preferences.consumer preferences.
  12. 12. © 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 Adjustment in an EconomyAdjustment in an Economy with Two Sectorswith Two Sectors • 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.
  13. 13. © 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 Adjustment in an EconomyAdjustment in an Economy with Two Sectorswith Two Sectors • A higher price creates aA higher price creates a profit opportunity inprofit opportunity in sectorsector XX.. • Simultaneously, lowerSimultaneously, lower prices result in losses inprices result in losses in industryindustry YY..
  14. 14. © 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 Adjustment in an EconomyAdjustment in an Economy with Two Sectorswith Two Sectors • As new firms enterAs new firms enter industryindustry XX and existingand existing firms expand, outputfirms expand, output rises and market pricesrises and market prices drop. Excess profits aredrop. Excess profits are eliminated.eliminated.
  15. 15. © 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 Adjustment in an EconomyAdjustment in an Economy with Two Sectorswith Two Sectors • As new firms exitAs new firms exit industryindustry Y,Y, market pricemarket price rises and losses arerises and losses are eliminated.eliminated.
  16. 16. © 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 Wine Production is anWine Production is an Increasing-Cost IndustryIncreasing-Cost Industry Land in Grape Production in the United States and in California Alone,Land in Grape Production in the United States and in California Alone, 1974 and 19821974 and 1982 NUMBER OF VINEYARDSNUMBER OF VINEYARDS NUMBER OF ACRESNUMBER OF ACRES United StatesUnited States 19741974 14,20814,208 712,804712,804 19821982 24,98224,982 874,996874,996 Percent changePercent change +75.8+75.8 +22.8+22.8 CaliforniaCalifornia 19741974 8,3338,333 607,011607,011 19821982 10,48110,481 756,720756,720 Percent changePercent change +25.8+25.8 +24.7+24.7 SourceSource: U.S. Department of Commerce, Bureau of the Census,: U.S. Department of Commerce, Bureau of the Census, Census of AgricultureCensus of Agriculture (1974 and 1982), 1, part 51.(1974 and 1982), 1, part 51.
  17. 17. © 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 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 efficient allocation of resources.allocation of resources.
  18. 18. © 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 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? WhatWhat determines 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?
  19. 19. © 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 The Efficiency of Perfect CompetitionThe Efficiency of Perfect Competition • 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 firms efficiently,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.
  20. 20. © 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 Pareto EfficiencyPareto Efficiency • Pareto efficiency,Pareto efficiency, oror ParetoPareto 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 without making some other members of societymaking some other members of society worse off.worse off. • This very precise concept of efficiencyThis very precise concept of efficiency is known asis known as allocative efficiency.allocative efficiency.
  21. 21. © 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 The Efficiency of Perfect CompetitionThe Efficiency of Perfect Competition 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 existingWith a full knowledge of existing technologies, firms will choose thetechnologies, firms will choose the technology that produces the output theytechnology that produces the output they want at the least cost.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 eachThe marginal value of each input to each firm is just equal to its market price.firm is just equal to its market price.
  22. 22. © 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 The Efficiency of Perfect CompetitionThe Efficiency of Perfect Competition • Within the constraints imposed by incomeWithin the constraints imposed by income and wealth, households are free to chooseand wealth, households are free to choose among 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 Among Households:Households:
  23. 23. © 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 The Efficiency of Perfect CompetitionThe Efficiency of Perfect Competition • Society will produce theSociety will produce the efficient mix of output if allefficient mix of output if all firms equate price andfirms equate price and marginal cost.marginal cost. Producing What People WantProducing What People Want —the Efficient Mix of Output:—the Efficient Mix of Output:
  24. 24. © 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 The Key Efficiency Condition: PriceThe Key Efficiency Condition: Price Equals Marginal CostEquals Marginal Cost IfIf PPXX >> MCMCXX, society gains value by producing more, society gains value by producing more XX IfIf PPXX << MCMCXX, society gains value by producing less, society gains value by producing less XX The value placed on good X by society through the market, or the social value of a marginal unit of X. Market-determined value of resources needed to produce a marginal unit of X. MCX is equal to the opportunity cost of those resources: lost production of other goods or the value of the resources left unemployed (leisure, vacant land, etc).
  25. 25. © 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 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 by both households and firms.both households and firms.
  26. 26. © 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 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 is revealed by the existence of:revealed by the existence of: • Imperfect marketsImperfect markets • Public goodsPublic goods • ExternalitiesExternalities • Imperfect informationImperfect information
  27. 27. © 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 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.
  28. 28. © 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 Imperfect MarketsImperfect Markets • MonopolyMonopoly is 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 significant barriers exist to prevent new firmsbarriers exist to prevent new firms from entering the industry.from entering the industry.
  29. 29. © 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 Imperfect MarketsImperfect Markets • In all imperfectly competitive industries,In all imperfectly competitive industries, output is lower—the product isoutput is lower—the product is underproduced—and price is higherunderproduced—and price is higher than it would be under perfectthan it would be under perfect competition.competition. • The equilibrium conditionThe equilibrium condition P = MCP = MC does notdoes not hold, and the system does not produce thehold, and the system does not produce the most efficient product mix.most efficient product mix.
  30. 30. © 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 Public GoodsPublic Goods • Public goodsPublic goods, or, or social 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.
  31. 31. © 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 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.
  32. 32. © 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 ExternalitiesExternalities • AnAn externalityexternality is 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 or transaction.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 of decisions. 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.
  33. 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 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.
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