Macro & Micro economics (Economics) - Essay Example

6 (E) If an economy is initially operating at its potential output, explain the short and long- run consequences of a permanent increase in government spending. 9 References 11 (A) Explain why perfectly competitive markets lead to an allocative efficient allocation of resources in the long run. It has often been argued that perfect competition is a market structure which results in efficient allocation of resources. Evidently, the efficient allocation of resources is achieved with due concern towards the profit-maximizing quantity of output produced by perfectly competitive firms which further leads towards price equality with respect to marginal cost.

Primarily, in the long run, there exists equality between price and marginal costs at minimum efficient scale of production. In other words, an efficient allocation of resources is realised when it is not possible to enhance the society’s overall degree of satisfaction by generating more of one good and less of other goods. Contextually, such efficiency can be achieved when the price of goods is equal to the marginal cost of production. Notably, in the long run, firms entering and exiting the industry maximizes profit where these firms generate the below illustrated long-run equilibrium: P=SRMC=LRMC=SRAC=LRAC [Note: P- Price for the good produced; SRMC-Short-run marginal cost; LRMC- Long-run marginal cost; SRAC- Short-run average cost; LRAC-Long–run average cost] Additionally, the above depicted conditions reveal that market price for a good is equal to marginal cost and average cost in both the circumstances i.e. in short-run as well as in long-run in equilibrium situation.

Due to the equality in the price and the marginal cost, each firm is able to maximize their profit without making any adjustment to their output quantity. Furthermore, equality of price and average cost renders each firm in the industry to earn normal profits. In such circumstances, economic profit is zero with no economic losses. Precisely stating, allocative efficiency is witnessed in a perfectly competitive market in the long run as the firms are determined to maximize their profits by producing quantity of output where marginal cost equals to the price and therefore leads to effective allocation of resources (AmosWEB LLC, 2013).

Profit Maximizing Behaviour Result in Allocative Efficiency in the Long-Run Source: (Pearson Education Limited, 2013) (B) Explain why free markets will under-produce goods with positive externalities (e.g. vaccinations against infectious diseases). Briefly suggest how government might intervene to correct this under-provision? Positive externalities are usually related with public commodities in an economy which can be defined as the situation where the goods are valued incorrectly, i.e. the goods are purchased either at under-valued or over-valued prices owing to the failure of the free-market to accurately determine to various factors when taking decisions regarding pricing.

Public goods are generally identified by their distinctive features of non-rival and non-excludability. One of the primary reasons behind the under production of such goods can be related with the emergence of free-riders. Free-riders, in the economic context, can be identified as an individual party who enjoys the direct benefits from the purchase of a public good by other parties. Notably, the primary objective of the private firm is to earn substantial profits, but wherein a problem of free-riders persist,