1. Economic Efficiency

2. 2 (c) 1999-2007, I.P.L. Png & D.E. Lehman Outline  Conditions for economic efficiency  Invisible Hand  Incidence

3. 3 (c) 1999-2007, I.P.L. Png & D.E. Lehman Economic efficiency: Conditions  For all users, same marginal benefit  For all suppliers, same marginal cost  Marginal benefit = marginal cost ?

4. 4 (c) 1999-2007, I.P.L. Png & D.E. Lehman Economic efficiency: Conditions  Equal marginal benefit  If not equal,  provide more to user with higher marginal benefit  take away from user with lower marginal benefit

5. 5 (c) 1999-2007, I.P.L. Png & D.E. Lehman Economic efficiency: Conditions  Equal marginal cost  If not equal,  supplier with lower marginal cost should produce more  supplier with higher marginal cost should produce less

6. 6 (c) 1999-2007, I.P.L. Png & D.E. Lehman Economic efficiency: Conditions  Marginal benefit = marginal cost  If not equal,  if marginal benefit > marginal cost, produce more of the item  if marginal benefit > marginal cost, produce less of the item

7. 7 (c) 1999-2007, I.P.L. Png & D.E. Lehman Economic efficiency  Contrast economic efficiency vis-à-vis technical efficiency  Technical efficiency  producing at lowest possible cost  doesn’t consider how much benefit the item provides

8. 8 (c) 1999-2007, I.P.L. Png & D.E. Lehman Outline  Conditions for economic efficiency  Invisible Hand  Decentralization  Incidence

9. 9 (c) 1999-2007, I.P.L. Png & D.E. Lehman Adam Smith (1723-1790)

10. 10 (c) 1999-2007, I.P.L. Png & D.E. Lehman Adam Smith  “He intends only his own gain, and he is … led by an invisible hand to promote an end which was no part of his intention” Wealth of Nations, 1776  Invisible Hand: market price guides buyers and sellers, acting independently and selfishly, to channel scarce resources.

11. 11 (c) 1999-2007, I.P.L. Png & D.E. Lehman Invisible Hand  Market system (price system): Economic system in which resources are allocated through the independent decisions of buyers and sellers, guided by freely moving prices.

12. Invisible Hand  Outcome of price competition in market  Marginal benefit = price  Marginal cost = price  Single price in market

13. 13 (c) 1999-2007, I.P.L. Png & D.E. Lehman Outline  Conditions for economic efficiency  Invisible Hand  Incidence

14. 14 (c) 1999-2007, I.P.L. Png & D.E. Lehman Outline  Conditions for economic efficiency  Invisible Hand  Incidence

15. 15 (c) 1999-2007, I.P.L. Png & D.E. Lehman Incidence: Pricing and freight  Cost and freight: includes cost of delivery  Ex-works pricing: does not include cost of delivery  How does pricing policy affect sales?

16. Incidence: Pricing and freight  Change from cost and freight pricing to ex- works pricing  Demand curve down  Supply curve up

17. 17 (c) 1999-2007, I.P.L. Png & D.E. Lehman Incidence  Definition: change in price for buyer/seller resulting from shift in demand or supply  Incidence is same  Whether buyer or seller pays freight charge

18. 18 (c) 1999-2007, I.P.L. Png & D.E. Lehman Incidence: Tax  “The only things certain in life are death and taxes.” Benjamin Franklin  Buyer’s price + tax = seller’s price  Payment vis-à-vis incidence  U.S.: airlines pay tax  Asia: passengers pay

19. Incidence: Tax

22. 22 (c) 1999-2007, I.P.L. Png & D.E. Lehman Incidence: Tax  Incidence and deadweight loss depend on price elasticities of demand and supply  Ideal tax: inelastic demand/supply  Who pays the tax not relevant

23. 23 (c) 1999-2007, I.P.L. Png & D.E. Lehman Retailing: How should manufacturer cut price?  Wholesale price cut: Will retailers pass on the price cut?  Coupons: Will this provide consumers with more effective price cut?

24. Incidence: Reducing retail prices

25. 25 (c) 1999-2007, I.P.L. Png & D.E. Lehman Summary  Conditions for economic efficiency  Invisible Hand  Incidence

26. 26 (c) 1999-2007, I.P.L. Png & D.E. Lehman Discussion question  Compare two promotion strategy 1. membership card: if your one-time purchase is above a certain amount, you can get a membership card. With this card, you can get a point for each yuan of future purchase. Whenever your total points reach 1000, you can get a gift card of 50. 2. rebate: whenever buy 1000, you get a gift card of 50. No points accumulation.