Hello! Could you please help me solve the following Microeconomics question? \"
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Hello! Could you please help me solve the following Microeconomics question? "What is meant by Pareto efficiency? Discuss how a competitive market can efficiently allocate resources in an economy. Describe two sets of circumstances where government intervention could improve the efficient allocation of resources." I would be very grateful if you could give me some detailed explanation. Thank you very much! Hello! Could you please help me solve the following Microeconomics question? "What is meant by Pareto efficiency? Discuss how a competitive market can efficiently allocate resources in an economy. Describe two sets of circumstances where government intervention could improve the efficient allocation of resources." I would be very grateful if you could give me some detailed explanation. Thank you very much! Hello! Could you please help me solve the following Microeconomics question? "What is meant by Pareto efficiency? Discuss how a competitive market can efficiently allocate resources in an economy. Describe two sets of circumstances where government intervention could improve the efficient allocation of resources." I would be very grateful if you could give me some detailed explanation. Thank you very much!Explanation / Answer
1. Vilfredo Pareto, an Italian engineer and economist drafted this concept of Pareto Efficiency.
The term " Pareto efficiency " or "Pareto optimality" is a condition of allocation of resources where every individual has optimally allocated resources; and where it is impossible to make an individual better off without making an individual worse off.
This means that, when every individual agent in an economy were holding or been allocated with some optimum resources ,and now if anyone is being provided or even planned to be allocated with some extra resources, then the extra resources have to be obtained from some other person who had his optimum. This situation where in order to make some one better off , another individual is being made worse off, is practically impossible in a Pareto efficiency condition. Thus every one has their optimal resource allocation.
2. At first the three Pareto efficiency or Economic efficiency conditions can be stated below,
i. Same marginal benefit for all users of products or resources
ii. Same marginal cost for all producers or suppliers of products or resources.
iii. Marginal benefit of users = Marginal Cost of suppliers,
In a competitive market, buyers and sellers acting selfishly , individually and independently , channel scarce resources into economically efficient uses (satisfying all the above three conditions). Here the market prices act as the standard for equating the marginal benefit or marginal cost. Since in a perfectly competitive economy we know Price = Marginal Cost , and Price should also equate with marginal benefit in order to provide the consumer or user with equal marginal benefit for each unit of commodity or product or resource use for respective price paid by the users.Explaining below,
i. Since in a competitive economy users of products don't buy until they receive marginal benefit equal to the price paid for each respective product unit. Hence, all commodities a user wishes to buy or uses, goes through a rigorous analysis of equal marginal benefit principle, otherwise the user would not pay as much of price for the commodity and go for some other brand of same unit of the product where his marginal benefit equals to his price paid. Thus all products available in an economy for users should follow the equal marginal benefit principle.
ii. We all know that in a competitive economy Price= Marginal cost , thus it is very much clear that if the producers or providers or suppliers of products or resources could not find marginal cost equals to price per unit of product supplied, there will be no efficient production for the economy. Hence, they put price equals to their marginal cost. Now if in a competitive economy with large number of sellers or suppliers and large number of buyers, every seller have to take price as given and thus the least cost per unit of production of a commodity would end up being equal to its marginal cost. This marginal cost for large number of producers would be same for the same product. Hence equal marginal cost principle acts.
iii. Now as discussed earlier, the price of a commodity or product acts as the standard of this market analysis. Hence, when Price = Marginal benefit and Price = Marginal cost , we can easily find out that the third condition of efficiency is fulfilled,
i.e., Marginal benefit of users = Marginal cost of suppliers.
Hence a competitive market can efficiently allocate resources in an economy.
3. The two sets of circumstances where government intervention could improve the efficient allocation of resources could be,
i. Existent Imperfect competition in an economy :
Free market often lead to imperfect competition in an economy, creating a sense of inequality for competitive producers or suppliers and exploitation for the consumers. In imperfect competition almost everyone is worse off, since price is set by the monopolist, the price does not equal to the marginal cost but is actually much higher than that. This creates inefficiency in the economy since the monopolist is getting better off by making almost all other individuals worse off. Hence, in such a situation the government could intervene to make the market more equitable and reduce the monopoly power of the monopolists by taking stringent steps of law and order.
ii. Negative externalities through environmental pollution :
Free market often lead to negative externalities since selfish product producing firms emits hazardous pollutants to the environment polluting the atmosphere , water resources or soil. This pollution acts as a negative externality on the society and economy. Thus in order to put restrictions on such environmental hazards the government could intervene by putting taxes and increasing the pollutant costs to the economy. Moreover, this could lead to efficient allocation of resources,as the taxes could serve as incentives to clean energy producers as subsidies. The environment being pure could lead to better health conditions of individuals who could lead a long, healthy and workable life.
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