Question

1. i) What do we mean by Pareto efficiency? ii) What is a market failure? iii) Have you ever encounter a situation where the allocation was not efficient? iv) Efficiency is not the same than equity. Explain the difference v) (Difficult) Why efficiency is a commonly used as an objective for public policy (more than equity). (Hint: think about which type of policies will be easier to pass in the congress?) vi) One hundred people are distributed in two beaches. In Beach A, there are 98 people (A = 98), while in Beach B only 2 (B = 2). Is this allocation efficient? Is equalitarian? (assume that people are more happy if the beach is less crowded). vii) Answer to the same questions with (A = 100, B = 0) and with (A = 50, B = 50). viii) Find an allocation that is NOT Pareto efficient an NOT equalitarian (Hint: you might need more than one beach).

Answer 1

Answer:

i) Pareto efficiency is a situation where there is no other way that reallocates goods such that at least one person is made better off without making anyone else worse off. Thus if goods are reallocated and even one gets worse off although many may get better off then this situation is called pareto efficiency.

ii) Market failure is a phenomenum where markets do not clear. This means there arises either shortage (excess demand) or surplus (excess supply). This creates market inefficiency which means that those who should get goods (by paying equilibrium price) do not get it.

iii) Yes. Price ceiling below equilibrium price causes allocative inefficiency. If maximum price that a firm can charge on medicinal drug is restricted below equilibrium price, then there arises excess demand and this shows inefficiency in allocation.

iv) Efficiency is a concept which refers to market clearance. This means there remains neither excess demand nor excess supply. The equilibrium price is determined on the basis of purely demand and supply. Those who could pay get the good and those who could not do not get.

Equity is a concept which defines allocation of goods on moral basis. It seeks how goods are distributed across the society. Thus even if a person can not pay the equilibrium price can get the good. Hence this leads to inefficiency.