When Markets Fail to Provide the Optimum Social Outcome - Book Report/Review Example

When markets fail to provide the optimum social outcome When markets fail to provide the optimum social outcome In the study of economics, there is need to perfectly determine how the scarce resources of capita, labor, natural and environmental resources so that there is a maximum production and realization of maximum profits. The aim of any business is to get maximum profits with minimum costs incurred (Musgrave, Kacapyr & Barrons Educational Series, 2001). Under ideal circumstances, a perfectly competitive market reaches an equilibrium that is both productively efficient and allocatively efficient.

Unfortunately, market conditions are not always ideal, and perfectly competitive markets then fail to bring about social economic efficiency of the customers. The prospect that social economic efficiency can be reached through perfect competition is so compelling it serves as the foundation for antitrust policy in the United States, as well as competition policy in Canada, the European Union, and elsewhere around the world. These are examples of developed countries that have enhanced good business terms that create a good and fair competitive environment (Musgrave, Kacapyr & Barrons Educational Series, 2001).

 Demonstration of Social economic efficiency and maximization of social surplusWe now wish to demonstrate that Social Surplus is maximized in competitive equilibrium. Consider again the 400th unit of output in Figure 16.1. The marginal value of this unit is $100. The buyer who purchases the 400th unit must pay the market price of $60 to get it, and so enjoys Consumer Surplus on this unit equal to $40 (= $100 - $60). The producer who supplies the 400th unit is willing to do so for a price as low as $40.

The supplier of the 400th unit gains Producer Surplus equal to $20 (= $60 - $40). (Recall that the $20 producer surplus is economic rent if S in the figure represents long-run industry supply.) Thus, the consumption and production of the 400th unit generates $60 of net gain for society (Musgrave, Kacapyr & Barrons Educational Series, 2001). For consumption and production levels greater than competitive equilibrium— beyond point A in the figure—social surplus will be smaller than at point A.

Consider the 1,000th unit, for which demand price, $40, is less than supply price, $70. Production and consumption of this unit are inefficient because $70 worth of scarce resources is transformed through production into a good worth only $40. Obviously, this would be wasteful for society. Fortunately, there is no price for this good that would stimulate buyers and sellers voluntarily to make such a wasteful transaction. Therefore, competitive market forces lead to the exact level of consumption and production that maximizes social surplus, and hence maximizes the value of this free market to society (Musgrave, Kacapyr & Barrons Educational Series, 2001).

  Markets in perfectly competitive equilibrium achieve social economic efficiency because, at the intersection of demand and supply curves, conditions for both productive efficiency and a locative efficiency are met. At the competitive market-clearing price, buyers and sellers engage in voluntarily exchange that maximizes social surplus (Musgrave, Kacapyr & Barrons Educational Series, 2001). MARKET FAILURE AND THE CASE FOR GOVERNMENT INTERVENTIONCompetitive markets can do a number of desirable things for society.

Under perfect competition, producers supply the right amount of goods and services, charge the right price, and the right consumers get the goods produced. The “right” amount to produce is the efficient amount. All units of output are produced for which consumers’ value those units by more than society values the resources required to produce them. No units are produced that cost more to supply than they are worth to buyers. Competitive suppliers cannot control the price of the product, because there are many producers and the products they sell are virtually identical.

Consequently, prices in competitive markets are determined by the impersonal forces of market demand and supply. In the long run, consumers get the very lowest price possible, consistent with firms remaining financially viable since market forces drive prices down to minimum long-run average cost. Even in the short run, however, market prices are determined by the cost structure of firms that operate on their short-run expansion paths, so costs are minimized given the fixed amount of productive capacity in the short run (Musgrave, Kacapyr & Barrons Educational Series, 2001).

 ReferenceMusgrave, F., Kacapyr, E., & Barrons Educational Series, Inc. (2001). Barrons how to prepare for the AP microeconomics/macroeconomics advanced placement examinations. Hauppauge, N.Y: Barrons Educational Series.