Today
Economic Efficiency
 Producer’s surplus
 Perfect competition and economic
efficiency
 Return exams at end of class

Economic Efficiency
Reading: end of Chapter 21
Definition
Economic Efficiency: When goods are
produced in the least costly manner and
distributed to those who value them most.
 Requires:
 Productive Efficiency
 Allocative Efficiency

Productive Efficiency

There is no way to re-direct production
among firms to increase total output.
Perfect Comp and Productive
Efficiency



In LR firms produce at lowest possible LRAC.
 There is no way to cut costs by changing plant
size.
Since all firms take the same price, all firms have
same MC (why?)
 There is no way to re-direct production to other
firms and get lower marginal costs.
Productive efficiency holds.
Allocative Efficiency
Goods are consumed by those who most
value them.
 There is no alternative comb. of goods that
could be produced that would increase
society’s well-being.

Measuring Allocative Efficiency

The sum of consumers’ surplus and
producers’ surplus.
Recall: Consumers’ Surplus

$/unit
8
A
6
4
B
D
2
1
2
3 4
5 6
7
units
The difference
between what a
consumer is willing to
pay & what he does
pay.
Producers’ Surplus-SR
perspective
The difference between the amount of
revenue the firm earns and the minimum
amount necessary to get the firm to produce
that quantity of the good in the short run.
 PS = Revenue - total variable costs.

Producers’ Surplus-Market

$/unit
SRS
8


6
4
B
C
2
1
2
3 4
D

5 6
7
units
Selling 4 units
@$6/unit.
Total revenue = B + C.
TVC for all firms is
represented by the area
under the SRS curve
(why?) = C
B = producers’ surplus
Allocative Efficiency

$/unit
SRS
8

A
6
4
B
C
2
1
2
3 4
D
5 6
7

units
A + B = The sum of
consumers’ and
producers’ surplus.
Vertical distance
between D and S is the
difference between
value to consumer and
MC to producer.
What Q maximizes
CS+PS?
Allocative Efficiency & Perfect
Competition

Perfectly competitive markets provide the
allocatively efficient quantity of a good.
Perfect Comp and Econ
Efficiency
Conclusion: Perfectly competitive markets
are economically efficient!
 This is one reason why we use them as a
benchmark for our study of other market
structures.

Excise Taxes and Allocative
Efficiency
Assume the market for wheat is perfectly
competitive.
 Shade in the sum of consumers’ and
producers’ surpluses for the competitive
market equilibrium.

Wheat
Price/Gal.

Identify the
market
equilibrium
price and
quantity.

Shade in the CS
+ PS.
S
1.25
1.00
0.75
D
4
5
6 Bushels of
wheat
Excise Tax
Add an excise tax of $0.50 per bushel to
this market.
 What happens to market price and quantity?
 Shade in CS + PS in light of the tax.
 Compare your answer to before the tax. Is
it allocatively efficient to tax this industry?

Excise tax on wheat-50¢
S’
Price/Gal.
0.50

Price paid by
elevator is $1.25

Price kept by
farmer is $0.75.

What is quantity?

How is CS + PS
affected?
S
1.25
1.00
0.75
D
4
5
6 Bushels of
wheat
Conclusions on Taxes &
Efficiency
An excise tax cuts the quantity exchanged
below the optimal level.
 This reduces the surplus that consumers and
producers receive.
 Conclusion: Excise taxes reduce market
efficiency.

Next Time

Note: We are now one class period behind
the syllabus.

April 2-4: Monopoly, Ch. 22

April 9-11: Oligopoly and Monopolistic
Competition, Ch. 23