Econ 2 Files
Econ 2 Lecture
Notes
Lecture 26: Efficiency
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Econ 2 Files
Econ 2 Lecture
Notes
Lecture 26: Efficiency
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Economics 2 |
In a competitive market, equilibrium occurs at the intersection of the supply and demand curves. At that point, the marginal private benefits as represented by the demand curve equal the marginal private costs.
Economists make a distinction between private costs and external costs. Private costs are borne by the firm that produces the good. External costs are borne by someone else. The same distinction is made between private and external benefits.
Social costs = private costs + external costs
Social benefits = private benefits + external benefits
 | Economic efficiency occurs at the level of output at which the marginal social benefits (MSB) equal the marginal social costs (MSC). Demand and supply determine equilibrium prices and quantities in a free market. A free market will result in efficiency when (1) the demand curve is the same as the MSB curve and (2) the supply curve is the same as the MSC curve. |
Externalities are side effects of production or consumption.
When there are external costs or benefits, a free market produces too much or too little of the good.
When there is a harmful production externality, the production of a good imposes external costs. The marginal social costs exceed marginal private costs by the amount of the external costs. When choosing how much to produce, firms are only concerned with their own costs, the marginal private costs (MPC). The market supply curve is the MPC curve. Although the firm is unconcerned with the external costs, society counts these costs as part of the cost of producing the good. So the free market results in too much of the good being produced.
In the case of a positive or beneficial externality, too little of good is provided in a market because the producer or consumer of the good does not take the external benefits into account.
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David A. Latzko Business and Economics Division Pennsylvania State University, York Campus office: 13 Main Classroom Building phone: (717) 771-4115 fax: (717) 771-4062 e-mail: 
web: www.yk.psu.edu/~dxl31 |
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