Economic Efficiency

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Economic Efficiency

Allocatively efficiency: when the consumer satisfaction is maximised. It can be reached when nobody can be made better off without making someone else worse off. This is also known as Pareto efficiency

Productive efficiency: when a firm is operating at the lowest point on its average cost curve. It is achieved by a firm when it produces goods/services using the least amount of scarce resources and also when in the long run unit cost of production is at a max

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Market Failure and Government Intervention

Market failure is a situation in which the free market mechanism does not lead to an optimal allocation of scarce resources

Failures and Intervention:
Information failure - provision of information
Negative consumption externality - tax
Positive consumption externality - subsidy
Negative production externality- tax
Positive production externality - subsidy
Merit goods - subsidy, provision of information
De-merit goods - tax, provision of information
Free rider problem - provide a public good

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Information Failure

Information failure occurs when people have inaccurate or incomplete data and so make potentially wrong choices

Causes of information failure:

  • Long term consequences
  • Complexity
  • Unbalanced knowledge
  • Price information

Asymmetric information is when there is an imbalance between information that different parties know

Government action can improve information to help consumers and producers value the actual cost/benefit of a good/service:
-Compulsory labelling on products

  • League tables for schools
  • Consumer protection laws
  • Industry standards
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Moral Hazards and Adverse Selection

Moral Hazard:
Occurs when insured consumers are likely to take greater risks, knowing that a claim will be paid for by their cover.
The consumer knows more about their intended actions than the producer

Adverse Selection:
Health insurance - those most likely to purchase it and those who are most likely to use it are those with underlying health issues. The insurance company knows this and so raises the average price of insurance cover, this then prices healthy consumers out of the market which can cause market failure

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