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Chapter 5: The Public Sector. Economic and technical efficiency. Technical efficiency – no unemployed or underemployed resources ( i.e. , operating on PPC). Economic efficiency (also known as Pareto optimality) – it is not possible to benefit one or more individuals without harming someone else

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economic and technical efficiency
Economic and technical efficiency
  • Technical efficiency – no unemployed or underemployed resources (i.e., operating on PPC).
  • Economic efficiency (also known as Pareto optimality) – it is not possible to benefit one or more individuals without harming someone else
  • Technical efficiency is a prerequisite for economic efficiency (but does not guarantee economic efficiency)
markets and economic efficiency
Markets and economic efficiency
  • voluntary trade in markets benefits each trading partner
  • under ideal conditions, markets attain a state of economic efficiency (Pareto optimality)
market failure
Market failure
  • Markets may fail to achieve economic efficiency as a result of:
    • imperfect information
    • externalities
    • public goods
    • the absence of property rights
    • monopoly, or
    • macroeconomic instability
imperfect information
Imperfect information
  • One party may not benefit from a market transaction if there is imperfect information about the item being sold
  • Possible corrective action:
    • product labeling requirements (listing ingredients or including warnings)
    • requiring guarantees (such as “lemon laws”)
    • requiring “truth in advertising”
    • licensing workers in certain professions
    • providing public information about products
externalities
Externalities
  • Externalities are side effects of production or consumption that affect individuals not directly involved in the activity or transaction
  • Positive externalities occur when one or more parties not involved in the transaction benefit from the activity
  • Negative externalities occur when third parties are harmed.
positive externalities
Positive externalities
  • Those engaged in the transaction do not take the external benefits into account in their decision making
  • This results in underproduction
  • Possible remedies:
    • subsidy
    • regulation
negative externalities
Negative externalities
  • Negative externalities result in social costs that are not borne by the parties involved in the transaction.
  • results in overproduction
  • Possible solutions:
    • taxation
    • regulation
internalizing externalities
Internalizing externalities
  • The use of taxes or subsidies to correct for an externality is sometimes referred to as “internalizing” the externality.
public goods
Public goods
  • nonrival in consumption (one person’s consumption does not affect the quantity or the quality of the good available to others)
  • free-rider problem results in underproduction
  • Possible solutions: government production or subsidization
common property resources
Common property resources
  • problem of the commons - resources are commonly owned
    • benefits are received by those who use the resource
    • costs are shared by all
  • overutilization
  • government regulation
monopolies
Monopolies
  • higher prices and lower output
  • antitrust law, regulation, or public production
macroeconomic instability
Macroeconomic instability
  • economic inefficiency caused by unemployment during recessions
  • government policies designed to stabilize the economy
public choice theory
Public choice theory
  • government policy is constructed by self-interested individuals
  • participants in policy formation are concerned about their own self interest, not the “public interest”
  • economic rent - a payment in excess of opportunity costs
  • rent-seeking behavior on the part of special-interest groups
economic policy
Economic policy
  • Microeconomic policy - designed to correct for:
    • imperfect information,
    • externalities,
    • public goods,
    • the absence of property rights, and
    • monopolies.
  • Macroeconomic policy -designed to enhance macroeconomic stability and encourage economic growth.
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