Today

 Economic Efficiency
 Producer’s surplus

 Perfect competition and economic

efficiency
 Return exams at end of class
Economic Efficiency

Reading: end of Chapter 21

Definition
 Economic Efficiency: When goods are
produced in the least costly manner and
distributed to those who value them most.
 Requires:
 Productive Efficiency

 Allocative Efficiency
Productive Efficiency
 There is no way to re-direct production
among firms to increase total output.
Perfect Comp and Productive
Efficiency
 In LR firms produce at lowest possible LRAC.
 There is no way to cut costs by changing plant

size.
 Since all firms take the same price, all firms have
same MC (why?)
 There is no way to re-direct production to other

firms and get lower marginal costs.

 Productive efficiency holds.
Allocative Efficiency
 Goods are consumed by those who most
value them.
 There is no alternative comb. of goods that
could be produced that would increase
society’s well-being.
Measuring Allocative Efficiency
 The sum of consumers’ surplus and
producers’ surplus.
 Recall: Consumers’ Surplus
 The difference
$/unit
between what a
consumer is willing to
8 pay & what he does
A pay.
6

4 B
D
2

1 2 3 4 5 6 7 units
Producers’ Surplus-SR
perspective
 The difference between the amount of
revenue the firm earns and the minimum
amount necessary to get the firm to produce
that quantity of the good in the short run.
 PS = Revenue - total variable costs.
 Producers’ Surplus-Market
 Selling 4 units
$/unit
@$6/unit.
SRS  Total revenue = B + C.
8  TVC for all firms is
6 represented by the area
B under the SRS curve
4 (why?) = C
2 C D
 B = producers’ surplus
1 2 3 4 5 6 7 units
 Allocative Efficiency
 A + B = The sum of
$/unit consumers’ and
producers’ surplus.
SRS
8
 Vertical distance
A between D and S is the
6 difference between
B value to consumer and
4 MC to producer.
2 C D
 What Q maximizes
CS+PS?
1 2 3 4 5 6 7 units
Allocative Efficiency & Perfect
Competition
 Perfectly competitive markets provide the
allocatively efficient quantity of a good.
Perfect Comp and Econ
Efficiency
 Conclusion: Perfectly competitive markets
are economically efficient!
 This is one reason why we use them as a
benchmark for our study of other market
structures.
Excise Taxes and Allocative
Efficiency
 Assume the market for wheat is perfectly
competitive.
 Shade in the sum of consumers’ and
producers’ surpluses for the competitive
market equilibrium.
 Wheat
Price/Gal.  Identify the
market
S
equilibrium
1.25 price and
1.00 quantity.
0.75
 Shade in the CS
D + PS.

4 5 6 Bushels of
wheat
Excise Tax
 Add an excise tax of $0.50 per bushel to
this market.
 What happens to market price and quantity?
 Shade in CS + PS in light of the tax.
 Compare your answer to before the tax. Is
it allocatively efficient to tax this industry?
 Excise tax on wheat-50¢
S’
Price/Gal.  Price paid by
elevator is $1.25
0.50 S
 Price kept by
1.25 farmer is $0.75.
1.00  What is quantity?
0.75
 How is CS + PS
D affected?

4 5 6 Bushels of
wheat
Conclusions on Taxes &
Efficiency
 An excise tax cuts the quantity exchanged
below the optimal level.
 This reduces the surplus that consumers and
producers receive.
 Conclusion: Excise taxes reduce market
efficiency.
Next Time
 Note: We are now one class period behind
the syllabus.
 April 2-4: Monopoly, Ch. 22
 April 9-11: Oligopoly and Monopolistic
Competition, Ch. 23