SYBCom Sem IV Business Economics

Ch 3: Efficiency- Market- Government

- Alisha Liz Varghese

Asst. Prof (Economics)
 PART I: Efficiency

Minimum input, Maximum

Least wastage maximum output,
output minimum time

Peak
Productivity Effectiveness
Performance

Least cost,
Organized Maximum
Revenue - Alisha Liz Varghese
Asst. Prof (Economics)
Economics: The study of analysing optimal allocation
of scarce resources which have alternative uses to
satisfy the unlimited human wants
➢Society should get max benefits using the limited
resources available
➢Adam Smith- invisible hand- demand & supply

Efficiency can be judged using:

• Productive & Allocative Efficiency
• Consumer and Producer Surplus
- Alisha Liz Varghese
Asst. Prof (Economics)
 1) Productive & Allocative Efficiency
Production possibility curve
(PPC): different combinations Tomato
of 2 goods that can
be produced using given
resources and technology A b
(inputs) 100
d
Productive efficiency: When e c
it is impossible to reallocate 40
resources to produce more of
1 good without producing less
of another good. 30 60 B Potato
• AB → PPC
• e → productively inefficient
• b, d, c → productive & - Alisha Liz Varghese
allocative efficiency Asst. Prof (Economics)
 2) Criterion of sum of producer & consumer surplus
• Free Market Economy functions to maximise the benefit/ welfare of
both consumers & producers
• Producer’s Surplus:
Difference between market price of a commodity and the minimum
price that a producer must receive.

COP = ₹ 600
MRP = ₹ 900

Producer’s Surplus = 900-600 = 300

• Consumer’s Surplus:
Difference between the price that a consumer is willing to pay for a
- Alisha Liz Varghese
commodity and the price that he actually pays
Asst. Prof (Economics)
 Price that a consumer is willing to Pay

• ₹ 5L • ₹ 7L
• ₹ 10 L • ₹ 15 L
• ₹ 18L Withdraw

- Alisha Liz Varghese

Asst. Prof (Economics)
 Price that a consumer actually pays

MRP = ₹ 10 L

Price that a consumer actually pays = Market Price of

the commodity - Alisha Liz Varghese
Asst. Prof (Economics)
• Total Surplus = PS + CS = Price
(Market price – Minimum
S
price the producer must R
receive) + (Price that a
consumer is willing to
pay – Market price) CS E
P
PS
• Total Surplus = Price that
a consumer is willing to A D
pay – Minimum price the
O
producer must receive Q Quantity

- Alisha Liz Varghese

Asst. Prof (Economics)
• Output determined by Price
the market forces is one
S
that maximises CS & PS R

Value to
→ Outcome unlikely in buyers
E Cost to
case of socialism. P sellers

Hence, Laissez faire leads A Cost to D

Value to
to economic efficiency sellers buyers
O Q1 Q Q2 Quantity

- Alisha Liz Varghese

Asst. Prof (Economics)
 Part II- Market
• Institutional arrangement where buyers and sellers
of a good/service interact to determine price and
quantity to be bought and sold.
• Aim of sellers- maximisation of profit
• Aim of buyers- maximisation of utility
Market failure
• Situation where quantity demanded is not equal to
quantity supplied
• May occur if- resources are misallocated, allocated
inefficiently, etc. - Alisha Liz Varghese
Asst. Prof (Economics)
 Causes of Market Failure
1) PUBLIC GOODS
• In a market economy buyers pay for what they receive, sellers
get paid for what they provide
• Price acts as the signal for efficient allocation & decisions
• Public goods: A special type of good that can be consumed by
everyone, irrespective of whether they have paid for it or not

- Alisha Liz Varghese

Asst. Prof (Economics)
 Public Goods

Non- Excludability Non- Rivalry

Free-Rider Problem

Market fails to efficiently allocate production,

provision & consumption of these goods
Market fails as market will not supply public goods or
will supply insufficient quantity
Therefore, Government provides public goods
- Alisha Liz Varghese
Asst. Prof (Economics)
- Alisha Liz Varghese
Asst. Prof (Economics)
2) MARKET POWER
• Observed for imperfectly competitive markets
• Market control/ market power arises when buyers/
sellers exert influence over the price and/or
quantity of output exchanged → prevents market
from equating demand & supply efficiently.
➢Supply Side: Eg: Monopoly, Oligopoly
➢Demand Side: Eg: Monopsony, Oligopsony
• Less than optimum output is produced

- Alisha Liz Varghese

Asst. Prof (Economics)
3) Externalities
• It arises when an entity engages in an activity that affects the
well being of a third party & yet neither pays nor receives any
compensation for it.
• May be positive or negative
Positive externalities: Lead markets Negative externalities: Lead
to produce smaller quantity than is markets to produce more
socially desirable quantity than is socially desirable

Market failure arises because the social optimum is different

- Alisha Liz Varghese
from the private optimum Asst. Prof (Economics)
4) Assymetric information: Market situation where 1
party to a transaction has more information than the
other party
• Demand price does not reflect all the benefits of the
good &/or supply price does not reflect all opportunity
costs of production
• Mostly- sellers have more info than buyers

Price= ₹ 5 L
Actual worth = ₹ 3 L

Market Failure arises as true price is not reflected, therefore too much
or too little of a good may be produced / demanded - Alisha Liz Varghese
Asst. Prof (Economics)
5) Inequality:
Income is not equitably distributed
Market fails in terms of social equality
6) Incomplete Markets & Missing Markets:
• Incomplete Markets: When private markets fail to provide a good/
service even though the cost of provision is less than the price
consumers are willing to pay.

Cost of premium: ₹ 1000 / month

Price consumer is willing to pay: ₹ 1500 / month
WTP > Price → Market exists.
Medical bill of sick person: ₹3000 / month
New cost of premium: ₹ 1400 / month

• Missing Markets: Resource allocation based on competitive markets

doesn’t exist. Eg: Public goods - Alisha Liz Varghese
Asst. Prof (Economics)
7) Unstable Markets:
• Volatility in the market causes it to become unstable.
• No stable equilibrium

8) Merit Goods
• Goods & Services which the Government feels that if it is left to
market forces, people will under- consume them.
• Govt subsidizes it or provides it free of cost
• Can have a combo of both private & public sector

9) De-Merit Goods:
• Government tries to restrict manufacturing, sale and usage by
imposing tax, banning the good, etc.

10) Property Rights:

• Failure to assign property rights leads to inefficient allocation
- Alisha Liz Varghese
Asst. Prof (Economics)
 Part III: Role of the Government
Ensuring proper Provision of public
Provision of legal
functioning of goods & merit
framework
market mechanism goods

Correction of
Correction of
unequal Securing social
effects of
distribution of objectives
Externalities
income & wealth

Provision of social Guiding usage of

Public Ownership
security natural resources

- Alisha Liz Varghese

Asst. Prof (Economics)