1. Managerial Economics Jack Wu
Economic Efficiency
Managerial Economics
Jack Wu

2. Economic Efficiency

3. Econ Efficiency: Conditions
for all users, same marginal benefit
for all suppliers, same marginal cost
marginal benefit = marginal cost

4. Equal Marginal Benefit
if not equal
provide more to user with higher marginal benefit
take away from user with lower marginal benefit

5. Equal Marginal Cost if not equal
supplier with lower marginal cost should produce more
supplier with higher marginal cost should produce less

6. Marginal Benefit/Cost
if marginal benefit > marginal cost, produce more of the item
if marginal benefit > marginal cost, produce less of the item

7. Economic efficiency v.s. Technical 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. ADAM SMITH’S INVISIBLE HAND: PRICE
Competitive market achieves three sufficient condition for economic efficiency:
buyers and sellers in a market system act independently and selfishly, yet the overall outcome is efficient
i) users buy until marginal benefit equals price;
ii) producers supply until marginal cost equals prices;
iii) users and producers face same price.

9. Invisible Hand Outcome of price competition in market
Marginal benefit = price
Marginal cost = price
Single price in market
Competitive market achieves three sufficient condition for economic efficiency:
buyers and sellers in a market system act independently and selfishly, yet the overall outcome is efficient
i) users buy until marginal benefit equals price;
ii) producers supply until marginal cost equals prices;
iii) users and producers face same price.

10. Example of Invisible Hand
Major policy issue: how to allocate licenses for 3G wireless telecommunications;
“beauty contest” -- France
auction – Germany, UK, US
pioneer: in early 1990s, US Federal Communications Commission showed that spectrum licenses were worth billions;
created pressure on other governments to allocate by auction and not favoritism.
Auction ensures that item goes to user with highest marginal benefit.

11. 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.
Successes of market system
West/East Germany
North/South Korea
China after Deng Xiaoping’s reforms

12. De-centralization create internal market
if there is a competitive market for an item, set transfer price equal to market price
consuming units should be allowed to outsource
Note:
Transfer price: price charged for the sale of an item within an organization;
Outsourcing: purchase of services or supplies from external sources

13. Decentralization Within organization
For all users, marginal benefit = transfer price
For all producers, marginal cost = transfer price
Marginal benefit = transfer price = marginal cost

14. UCLA Anderson School, 1989 Half an invisible hand is worse than none
priced photocopying paper
free bond paper

15. Price Ceiling Upper limit that sellers can charge and buyers can pay
rent control
regulated price for electricity

16. RENT CONTROL: EQUILIBRIUM
1100
supply
Price ($ per month) b
1000
equilibrium
900
excess demand
demand
290
300
310
Quantity (Thousand units a month)

17. RENT CONTROL: SURPLUSES
buyer surplus gain = cfeg
buyer surplus loss = dgb
seller surplus loss = cfeg + geb d
1100
supply
Price ($ per month) b
1000 c g
900 f e
demand
290
300
310
Quantity (Thousand units a month)

18. Rent Control: Losses
deadweight losses -- sellers willing to provide item at price that buyers willing to pay, but provision doesn’t occur
price elasticities of demand and supply
_demand more inelastic --> larger loss
_ supply more elastic --> larger loss

19. Price Floor Lower limit that sellers can charge and buyers can pay
minimum wage
agricultural price supports

20. MINIMUM WAGE: EQUILIBRIUM
excess supply
supply
Wage ($ per hour)
4.20 b
4.00
equilibrium c
demand 8 10 11
Quantity (Billion worker-hours a week)

21. MINIMUM WAGE: SURPLUSES
seller surplus gain = fdge
seller surplus loss = ghb
buyer surplus loss = fdge + egb a
supply
Wage ($ per hour) f e
4.20 b
4.00 d g h c
demand 8 10 11
Quantity (Billion worker-hours a week)

22. Minimum Wage: Losses
deadweight losses -- sellers willing to provide item at price that buyers willing to pay, but provision doesn’t occur
price elasticities of demand and supply
_supply more inelastic --> larger loss
_demand more elastic --> larger loss

23. Tax: Commodity Tax
“the only two sure things in life are death and taxes”
buyer’s price - tax = seller’s price
payment vis-à-vis incidence
US: airlines pay tax
Asia: passengers pay

24. TAX: EQUILIBRIUM $10 804 e supply Price ($ per ticket) 800 b 794 h
demand
900
920
Quantity (Thousand tickets a year)

25. TAX: SURPLUSES
buyer surplus loss = fdge + egb seller surplus loss = djhg + ghb
revenue gain = fdge + djhg
$10
804 f e
supply
Price ($ per ticket)
800 d g b
794 j h
demand
900
920
Quantity (Thousand tickets a year)

26. Incidence
incidence and deadweight loss depend on price elasticities of demand and supply
ideal tax (no deadweight loss): inelastic demand/supply
who pays the tax not relevant

27. 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?

28. Incidence: Reducing retail prices