PAPER 3

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INSTRUCTIONS

Explain how the market system achieves allocative and productive efficiency. Use supply and demand graphs clearly labeled with MARGINAL SOCIAL BENEFITS and MARGINAL SOCIAL COSTS to illustrate allocative efficiency. State any relative assumptions. Use graph to show how the "wrong" price results in allocative inefficiency. Discuss the role of prices and profits in productive efficiency. What about equity and unemployment?

SUGGESTED OUTLINE AND ISSUES TO BE ADDRESSED

INTRODUCTION

What is a market economy (or capitalism)?
What is the goal of business in a market economy?
What is the goal of society? (5Es)

Question to be discussed in paper: Are these goals in conflict or are they the same?

PRODUCTIVE EFFICIENCY

Definitionof productive efficiency
Why will businesses be productively efficient?
Remember the goal of businesses

ALLOCATIVE EFFICIENCY

Definition of allocative efficiency
Review: goal of businesses|
ADD: how to find this goal on a Supply/Demand graph ("what we get")

Is this quantity (goal of businesses) the same as the allocatively efficient quantity?
(Do business in a market economy achieve allocative efficiency?)

Review: benefit cost analysis
allocative efficiency and benefit cost analysis
another graph illustrating the allocatively efficient quantity ("what we want")

"what we get" equals "what we want" if:

S = MSC
explain why (this is difficult!)
assumption

D = MSB
explain why (this is difficult!)
assumption

Show that the quantity business will produce is the same quantity that society wants on a third graph

What if a different quantity is produced?

smaller quantity:

profits are not maximized
also, MSB>MSC
UNDERallocation of resources
show on graph

larger quantity:

profits not maximized
also, MSB<MSC
OVERallocation of resources
show on graph

EQUITY AND FULL EMPLOYMENT

Does capitalism achieve equity and full employment?

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