When output is produced so that the marginal benefit equals the marginal cost there is efficiency?

Economics is a science of efficiency in the use of scarce resources. Efficiency requires full employment of available resources and full production. Full employment means all available resources should be employed. Full production means that employed resources are providing maximum satisfaction for our material wants. Full production implies two kinds of efficiency:

1. Allocative efficiency means that resources are used for producing the combination of goods and services most wanted by society. For example, producing computers with word processors rather than producing manual typewriters.

2. Productive efficiency means that least costly production techniques are used to produce wanted goods and services.

Productive efficiency occurs where price is equal to minimum average total cost (min ATC); at this point firms must use the lease-cost technology or they won�t survive. Under pure competition, this outcome will be achieved, as the long run equilibrium price of pure competitive firms would be at the min ATC

Allocative efficiency occurs where price is equal to marginal cost ( P=MC), because price is society�s measure of relative worth of a product at the margin or its marginal benefit. And the marginal cost of producing product X measures the relative worth of the other goods that the resources used in producing an extra unit of X could otherwise have produced. In short, price measures the benefit that society gets from additional units of good X, and the marginal cost of this unit of X measures the sacrifice or cost to society of other goods given up to produce more of X. Under pure competition, this outcome will be achieved. Dynamic adjustments will occur automatically in pure competition when changes in demand or in resources supply, or in technology occur. Disequilibrium will cause expansion or contraction of the industry until the new equilibrium at P=MC occurs.

Price of non-perfect competitive firms will exceed marginal cost, because price exceeds marginal revenue and the firms produce where marginal revenue (MR) and marginal cost are equal. Then the firms can charge the price that consumers will pay for that output level. Allocative efficiency is not achieved because price (what product is worth to consumers) is above marginal cost (opportunity cost of product). Ideally, output should expand to a level where P=MC, but this will occur only under pure competitive conditions where P = MR.

Productive efficiency is not achieved because the firms� output is less than the output at which average total cost is minimum.

Economies of scale (natural monopoly) may make monopoly the most efficient market model in some industries. X-inefficiency, the inefficiency that occurs in the absence of fear of entry and rivalry, may occur in monopoly since there is no competitive pressure to produce at the minimum possible costs. Rent-seeking behavior often occurs as monopolies seek to acquire or maintain government �granted monopoly privileges. Such rent-seeking may entail substantial cost (lobbying, legal fees, public relations advertising etc.) which are inefficient.

There are several policy options available when monopoly creates substantial economic inefficiency:

1. Antitrust laws could be used to break up the monopoly if the monopoly�s inefficiency appears to be long-lasting.

2. Society may choose to regulate its prices and operations if it is a natural monopoly.

3. Society may simply ignore it if the monopoly appears to be short-lived because of changing conditions or technology.

Allocative efficiency is improved when technological advance involves a new product that increases the utility consumers can obtain from their limited income. Process innovation can lower production cost and improve productive efficiency. Innovation can create monopoly power through patents or the advantages of being first, reducing the benefit to society from the innovation. Innovation can also reduce or even disintegrate existing monopoly power by providing competition where there was none. In this case economic efficiency is enhanced because the competition drives prices down closer to marginal cost and minimum average total cost.

Resource use is efficient when we cannot produce more of a good or service without giving up some other good or service we value more highly.

Concept of Marginal Benefit and Marginal Cost

Marginal Benefit:  The increase in value an individual receives from consuming one more unit of a good or service.  Measured as the maximum amount of a good or service a  person is willing to sacrifice to get one more unit of the good or service in question.

[What is the maximum amount of soda I would sacrifice to get one more slice of pizza?]

In general, Marginal Benefits decrease as the quantity of the good consumed increases.

Marginal Cost:  The opportunity cost of producing one more unit of a good or service.

   Measured as the value of the best alternative foregone, or the amount of some good or service I must sacrifice to get one more unit of another.

[ So, how many sodas must be sacrificed to get one more unit of pizza?]

In general, the marginal cost of a good increases as the quantity of a good produced increases.

What is efficiency?

If MB > MC, then we should increase production of pizza,
and decrease the production of other goods, since the value of
one more unit of pizza, MB, is greater than the value of
goods we must forego to make it, MC.

If MB<MC, then we should decrease the production of pizza,
and increase the production of other good, since the value of
the last unit of pizza produced is less than the goods we had to
forego to make it.

When MB = MC, then the value of the last unit of pizza
consumed is exactly equal to the value of the goods we
had to forego to make it.

Market Demand and Marginal Benefits.

The value of one more unit of a good or service is its
marginal benefit.

The marginal benefit can be expressed as the maximum price
that people are willing and able to pay for another unit of
the good. [The maximum amount of other goods and services
they are willing to sacrifice for one more unit of the good.]

Therefore, the demand curve is the marginal benefit curve.

Consumer Surplus

When an individual pays less than his or her marginal benefit
for a unit of a good, he or she is gaining a surplus.

Example:

Market demand:  P = $5-Q/20.

The equilibrium point is Q = 20, P = $4.  Suppose you buy the
10th unit.  According to the demand curve, you are willing
to pay  P(10)=$4.50, but only need to pay $4.

Therefore, for you, MB>P.  The maximum price you
are willing and able to pay is greater than the price in the market.

This is the definition of consumer surplus.

Market Supply and Marginal Cost

The marginal cost or opportunity cost of producing a good or
service is the minimum supply price, the minimum price that
producers must be offered to provide one more unit of the good.

Marginal cost is shown by the supply curve.

Producer surplus is the price received from the sale of a good,
minus the opportunity cost of producing it.

Example:  Competitive market

D:  P = 25-Q
S:   P = 5+Q

Market equilibrium, where MB = MC, is found at:

            25-Q = 5+Q

                 10 = Q
                 15=P

Therefore, the efficient production point is (Q,P)=(10,15).

Summary

• Competitive markets allocate resources efficiently:  Marginal Benefit and Marginal Cost are equal at equilibrium.

• Price ceilings, taxes, subsidies, quotas, monopoly,public good, external effects, all lead to inefficiency in resource allocation.

• If output is more or less than the market equilibrium, or efficient level, deadweight loss occurs.  This means that resources are not being used in their most valuable ways, according to the attitudes expressed in the demand and supply curves.  Deadweight loss is zero at the market equilibrium.

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