Question

1.List conditions for a market to be efficient? Hint: Maximize consumer surplus plus producer surplus equal total society surplus is maximized equal society is happier. Start your answer with this hint.

2. This data is very similar to the data in chapter 9, power point slide 9. Without trade, PD = $2,500, Q = 300 In world markets, PW = $1200 Under free trade, how many TVs will the country import or export? Identify consumer surplus (CS), producer surplus (PS), and total surplus without trade, and with trade. Draw the graph to justify your answers.

Answer 1

1. The conditions for market to be efficient are -

i. An efficient market means that consumers and sellers are free to buy and sell at the market price and hence maximize consumer and producer surplus. When both maximize their surplus total surplus is also maximized as T.S= C.S + P.S. Maximization of total surplus indicates more business and profits meaning more income. A higher income level for the society indicates a happier society.

ii. The most important condition for a free environment for buyers and sellers is absence of government intervention. We know that imposing taxes, tariffs, price floors and other regulatory measures decreases the amount of transactions occuring in the economy and hence causes a dead wieght loss. A dead wieght loss decreases total surplus and hence makes the market inefficient. This is why government intervention (when not needed) should be absent from the market.

iii. The next condition is to make up for externalities. This is where the government intervention is needed. production and consumption of agents in the market often create positive and negative externality. Sometimes the economic actions of individuals benefits or hampers the society and environment. This leads to inefficient distribution of resources. For e.g when a riverside factory releases waste in the river then this hampers nearby cleaning agencies situated near the river. When there is no government intervention, the factory will overuse the river to dumb its waste and hamper use of river water by cleaning agencies. Then the government must impose tax on paper factory to reduce its production (so less waste) and hence reduced overuse of the river and bring efficient allocation of resources. This was a negative externality case. When there is positive externality from some economic action then government should subsidise this action to increase social benefit and efficiency.

iv. Another condition to have a efficient market is the existence of perfect information. An asymmetry of information will lead to inefficiency in trade. For e.g a car seller knows the quality of the car he is selling. If buyer does not have the same information about the sellers car, the seller can sell a low quality car at a high price price. This will decrease consumer surplus at the cost of producer surplus. However there will still be a fall in total surplus because a higher price will drive buyers from the market and at the same time will drive out sellers who are selling legit cars at legit prices, thus a decrease in producer surplus. Hence a fall in total surplus with time. To avoid such inefficiency, information must be symmetrical and transparent in the market economy.