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Efficient Markets and Government. Chapter 2. Positive and Normative Economics. Positive Economics explains “what is,” without making judgments about the appropriateness of “what is.” Normative Economics: designed to formulate recommendations about what “should be.”.

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positive and normative economics
Positive and Normative Economics
  • Positive Economics explains “what is,” without making judgments about the appropriateness of “what is.”
  • Normative Economics: designed to formulate recommendations about what “should be.”
normative evaluation of resource use the efficiency criterion
Normative Evaluation of Resource Use: The Efficiency Criterion
  • Pareto Optimality
  • The efficiency criterion is satisfied when resources are used over any given period of time in such a way as to make it impossible to increase any one person’s well-being without reducing any other person’s well-being.
figure 2 1 efficient output
Figure 2.1 Efficient Output

A

MSC

B

2.00 = P

C

E

Price, Benefit, and

Cost (Dollars)

1.50 = P*

1.00 = P2

D

A

MSB

Q1 = 10,000

Q2 = 20,000

TSC

Q* = 15,000

B

TSB

Z

Total Social Benefit

and Cost

TSB – TSC

0

Q*

Loaves of Bread per Month

conditions under which a perfectly competitive market system exists
Conditions under which a Perfectly Competitive Market System Exists
  • All productive resources are privately owned.
  • All transactions take place in markets, and in each separate market many competing sellers offer a standardized product to many competing buyers.
  • Economic power is dispersed in the sense that no buyers or sellers alone can influence prices.
  • All relevant information is freely available to buyers and sellers.
  • Resources are mobile and may be freely employed in any enterprise.
if these conditions are met
If These Conditions are Met

P = MPB = MSB

and

P = MPC = MSC

so

P = MSB = MSC

figure 2 2 loss in net benefits due to monopolies
Figure 2.2 Loss in Net Benefits Due to Monopolies

B

MSB = P

MSC

E

Price, Benefit, and

Cost (Dollars)

Loss in Net Benefits

MSCM

A

D = MSB

MR

QM

Q*

0

Output per Month

figure 2 3 taxes and efficiency
Figure 2.3 Taxes and Efficiency

MPC + T > MSC

New Supply =

MSC = MPC

Supply =

E'

6

E

5

Price (Cents per

Message Unit)

4

B

MSB

Demand =

0

3

4

Billions of Message Units per Month

figure 2 4 subsidies and efficiency
Figure 2.4 Subsidies and Efficiency

MSC

Supply =

5

A

E

4

Price (Dollars per Bushel)

C

3

MSB

Demand =

Q*

QS

0

Bushels of Wheat per Year

market failure a preview of the basis for government activity
Market Failure: A Preview of the Basis for Government Activity

Government intervention may be warranted if a market exhibits:

  • Monopoly power by one supplier
  • Effects of market transactions on third parties
  • Lack of a market for a good where MSB>MSC (i.e. a public good)
  • Incomplete information about goods being sold
  • An unstable market
figure 2 5 utility possibility curve
Figure 2.5 Utility Possibility Curve

UA

Z

E1

UA2

Annual Well-Being of A

X

E2

UA1

E3

UB1

UB2

UB

0

Annual Well-Being of B

positive analysis trade off between equity and efficiency
Positive Analysis Trade-off Between Equity and Efficiency
  • When making choices about public policy issues, we are usually faced with the inevitable situation that you make one person worse off while making another better off.
compensation criteria
Compensation Criteria
  • An attempt is made to compare the dollar value of the gain to the gainers and the dollar value of the loss to the losers.
  • If the gainers gain more than the losers lose, then the gainers can pay the losers enough to compensate the losers for their loss.
  • Everyone can be made at least as well off as they were without the change as long as compensation is paid.