Detailed explanation of allocative efficiency with the aid of PPC diagram:
Allocative efficiency is achieved when the value consumers place on a good or service (reflected in the price they are willing to pay) equals the cost of the resources used up in production. Allocative efficiency occurs when price = marginal cost, when this condition is satisfied, total economic welfare is maximised.
Pareto defined allocative efficiency as a situation where no one could be made better off without making someone else at least as worth off. In the perfect competition diagram below, where MC = MR for the firm, we have allocative efficiency because the firm’s price is the marginal revenue (it can sell any amount at the unchanged price – each extra unit sold at that price provides the marginal revenue), so MC = P. In fact, at that point we have more equalities MC = P = MR = AR.
Thorough explanation of X- efficiency with aid if a PPF graph:
This kind of productivity exists when we are on the production frontier; this means we are using the least resources possible to produce any given output. This also means that we are at the minimum point on the AC curve. This happens when we are in perfect competition – so economists prefer this state and may refer to as it “X-efficiency” – it is where we are truly efficient. Where market equilibrium is efficient, we cannot make someone better off without making someone else worse off
To what extent does government intervention improve efficiency in an economy? [15]
Discussion should focus on extent government improve efficiency in an economy:
Markets usually work well, ensuring an efficient allocation of resources between different consumption and investment activities; – however, there are many circumstances in which market forces, left to themselves, will fail to maximize economic and social welfare and, as a consequence, there will be a case for Government intervention;
- the efficiency arguments for Government intervention include : the existence of public goods, externalities, imperfect competition and imperfect information;
- the efficiency arguments for Government intervention most relevant to public services such as health and education are externalities, imperfect competition and imperfect information;
- imperfect information is particularly important not only because it may contribute to imperfect competition, but because it may undermine the efficient functioning of insurance and capital markets on which efficient provision of health care and education depend. As a consequence, health insurance may not be available at any price, for example, for high cost medical conditions of uncertain likelihood;
- there are a range of equity arguments for Government intervention including vertical and horizontal equity; social inclusion and intergenerational equity.
- ethical considerations may also lead to Government intervention. For ideological reasons (beyond the scope of this note), some people may be averse to market provision of health care or to the involvement of profit-making providers. Others may not wish to see markets operating (however economically efficient) in for example human blood, human organs or human embryos.
Discuss the benefits to society of changing from a command economy to a market economy. [25]
Discussion may centered on the advantages of a free market economy vs disadvantages of command or planned economy: these includes
Advantages of free market economy:
- Competition in markets promotes an efficient use of resources.
- Competition produces a greater variety of goods and hence more choice for consumers.
- Risk taking and initiative are encouraged by the profit motive, and these are likely to promote economic growth.
- The price mechanism adjusts quite quickly to changing economic conditions so that resources are not wasted producing unwanted goods or being unemployed.
Disadvantages of planned economy:
- Resources used in planning are not available to produce goods and services to satisfy wants.
- Planners may get the plan wrong causing gluts and shortages of goods.
- Once in operation it is difficult to adjust the plan to cope with changing economic conditions.
- There is limited choice and variety of goods for consumers.
- There is little incentive to work hard or to take risks because the state owns all resources and planners decide on the distribution of goods. The economy is likely to grow more slowly and technology may lag behind others.
- Planners may be corrupt in their decision making.
Evaluation may also focus of Problems of transition from planned to a free market economy such as:
- Falling growth
- Lack of legal institutions;
- Lack of financial resources;
- High unequal distribution.;
- Corruption at highest level;
- High inflation rates and falling exchange rate;
- Development of Barter economies.;
- Black markets and organised crimes;
- Increased unemployment and falling demand for domestic goods.;
- Lack of necessary funds
