Chapter 12: General Equilibrium and the Efficiency of Perfect Competition

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Chapter 12General Equilibriumand the
Efficiencyof Perfect Competition
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Firm and Household Decisions

• Input and output markets cannot be considered
  separately or as if they operated independently.

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General Equilibrium and theEfficiency of Perfect
Competition

• Partial equilibrium analysis is the process of
  examining the equilibrium conditions in
  individual markets and for households and firms
  separately.

• General equilibrium is the condition that exists
  when all markets in an economy are in
  simultaneous equilibrium.

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A Technological Advance

• A significant technological change in a single
  industry affects many markets
• Households face a different structure of prices
  and must adjust their consumption of many
  products.
• Labor reacts to new skill requirements and is
  reallocated across markets.
• Capital is also reallocated.

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General Competitive Equilibrium

• If the assumptions of a perfectly competitive
  economic system hold, the economy will produce an
  efficient allocation of resources.

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Pareto Efficiency

• Pareto efficiency, or Pareto optimality, is a
  condition in which no change is possible that
  will make some members of society better off
  without making some other members of society
  worse off.
• This very precise concept of efficiency is known
  as allocative efficiency.

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The Efficiency of Perfect Competition

• The three basic questions in a competitive
  economy are
• What will be produced? What determines the final
  mix of output?
• How will it be produced? How do capital, labor,
  and land get divided up among firms?
• Who will get what is produced? What is the
  distribution of output among consuming households?

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The Efficiency of Perfect Competition

• In a perfectly competitive economic system
• Resources are allocated among firms efficiently.

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The Efficiency of Perfect Competition

• Efficient Distribution of Outputs Among
  Households
• Within the constraints imposed by income and
  wealth, households are free to choose among all
  the goods and services available in output
  markets. Utility value is revealed in market
  behavior.
• As long as everyone shops freely in the same
  markets, no redistribution of final outputs among
  people will make them better off.

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The Efficiency of Perfect Competition

• In a perfectly competitive economic system
• Final products are distributed among households
  efficiently.

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The Efficiency of Perfect Competition

• Efficient Allocation of Resources
• Perfectly competitive firms have incentives to
  use the best available technology.
• With a full knowledge of existing technologies,
  firms will choose the technology that produces
  the output they want at the least cost.

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The Efficiency of Perfect Competition

• In a perfectly competitive economic system
• The system produces the things that people want.

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The Efficiency of Perfect Competition

• Producing What People Wantthe Efficient Mix of
  Output
• Society will produce the efficient mix of output
  if all firms equate price and marginal cost.

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The Sources of Market Failure

• Market failure occurs when resources are
  misallocated, or allocated inefficiently. The
  result is waste or lost value. Evidence of
  market failure is revealed by the existence of
• Imperfect market structure
• Public goods
• External costs and benefits
• Imperfect information

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Imperfect Markets

• Imperfect competition is an industry in which
  single firms have some control over price and
  competition. Imperfectly competitive industries
  give rise to an inefficient allocation of
  resources.

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Imperfect Markets

• Monopoly is an industry composed of only one firm
  that produces a product for which there are no
  close substitutes and in which significant
  barriers exist to prevent new firms from entering
  the industry.

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Imperfect Markets

• In all imperfectly competitive industries, output
  is lowerthe product is underproducedand price
  is higher than it would be under perfect
  competition.
• The equilibrium condition P MC does not hold,
  and the system does not produce the most
  efficient product mix.

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Public Goods

• Public goods, or social goods are goods and
  services that bestow collective benefits on
  members of society.
• Generally, no one can be excluded from enjoying
  their benefits. The classic example is national
  defense.

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Externalities

• An externality is a cost or benefit resulting
  from some activity or transaction that is imposed
  or bestowed on parties outside the activity or
  transaction.
• The market does not always force consideration of
  all the costs and benefits of decisions. Yet for
  an economy to achieve an efficient allocation of
  resources, all costs and benefits must be weighed.

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Imperfect Information

• Imperfect information is the absence of full
  knowledge concerning product characteristics,
  available prices, and so forth.
• The absence of full information can lead to
  transactions that are ultimately disadvantageous.