Economics Questions Thread

[Rachelle]

Can somebody please
Explain why the existence of negative externalities may lead to an over allocation of resources in some industries?

Thankyou!!

[Gentoo]

A negative externality (a cost incurred by a 3rd party as a result of the production or consumption of a good or service) is not factored into the price of the good or service in question. This results in these goods and services effectively being 'overvalued' by the market mechanism, which means that on the whole, profit-driven firms will allocate more resources to producing such goods and services (because the price is higher), more than what 'should' occur if you took all the nasty side-effects (negative externalities) into consideration.

[Rachelle]

A negative externality (a cost incurred by a 3rd party as a result of the production or consumption of a good or service) is not factored into the price of the good or service in question. This results in these goods and services effectively being 'overvalued' by the market mechanism, which means that on the whole, profit-driven firms will allocate more resources to producing such goods and services (because the price is higher), more than what 'should' occur if you took all the nasty side-effects (negative externalities) into consideration.

Thankyou.

[Rachelle]

I read somewhere that:
"All production points along the PPC are equally efficient in the respect that the economy is producing the maximum volume of goods and services possible with its available resources (that is, technical or productive efficiency is being achieved)."

I don't really understand what it is saying. I thought only one point could be the most efficient allocation of resources (allocative efficiency)and not every point on the production possibility frontier?

[Gentoo]

Er, yeah, that doesn't sound right. Only one point on the PPF is going to be the most efficient (where they've defined 'efficient' as being the maximum volume of goods and services produced with the available resources).

Are you sure it wasn't just referencing a particular PPF curve? Because you could theoretically set up a curve where that statement is true (it'd be a straight line on a 45 degree angle point downwards), but it won't make sense for almost all of them. There'll generally be SOME points that add up to a greater number of goods and services total.

[Rachelle]

Er, yeah, that doesn't sound right. Only one point on the PPF is going to be the most efficient (where they've defined 'efficient' as being the maximum volume of goods and services produced with the available resources).

Are you sure it wasn't just referencing a particular PPF curve? Because you could theoretically set up a curve where that statement is true (it'd be a straight line on a 45 degree angle point downwards), but it won't make sense for almost all of them. There'll generally be SOME points that add up to a greater number of goods and services total.

Also my textbook says 'All points along the productive possibility frontier are technically efficient, regardless of what combination of goods and services are produced'.
So it must be a general definition of technical (i.e. productive) efficiency.
Can it mean that if you have one point of the curve that gives the maximum volume of goods and services, then all other points are also efficient because it has ALLOWED for only one point to add to the greatest no. of goods and services in total?

[Gentoo]

Okay, I think I understand the apparent problem. While one point on the PPF will give the greatest number of total goods and services, this is a SEPARATE concept to technical efficiency, which is merely how many outputs of a particular good or service you get after putting a certain number of resources into the production process.

So take an example of a hypothetical economy that could only produce strawberries or fountain pens. As we know, the more they produce of one good, the less they can produce of the other good. And while there will be an optimal point somewhere along the curve where the greatest volume of the two goods combined will be achieved, the land, labour and capital resources that are being used to create these goods are being used to the same efficiency regardless of how many of each good are being produced. The workers and machines producing the fountain pens are experiencing the same technical efficiency regardless of whether they end up producing 1,000 or 5,000 fountain pens and same for the strawberries. It's just a different concept.

It all comes down to which tpye of efficiency we're talking about. Technical efficiency is very different from allocative efficiency (the main, big definition of efficiency - an allocation of resources that maximises the satisfaction of society) for example.

[Rachelle]

Okay, I think I understand the apparent problem. While one point on the PPF will give the greatest number of total goods and services, this is a SEPARATE concept to technical efficiency, which is merely how many outputs of a particular good or service you get after putting a certain number of resources into the production process.

So take an example of a hypothetical economy that could only produce strawberries or fountain pens. As we know, the more they produce of one good, the less they can produce of the other good. And while there will be an optimal point somewhere along the curve where the greatest volume of the two goods combined will be achieved, the land, labour and capital resources that are being used to create these goods are being used to the same efficiency regardless of how many of each good are being produced. The workers and machines producing the fountain pens are experiencing the same technical efficiency regardless of whether they end up producing 1,000 or 5,000 fountain pens and same for the strawberries. It's just a different concept.

It all comes down to which tpye of efficiency we're talking about. Technical efficiency is very different from allocative efficiency (the main, big definition of efficiency - an allocation of resources that maximises the satisfaction of society) for example.

Thanks for the detailed explanation. I understand the concept better now. Thank you. 

[Rachelle]

'A rise in the equilibrium price for a particular g/s may reflect: an increase in the qty of that particular g/s demanded or a decrease in the quantity supplied at a given price.'

I don't know if I understand what it's saying. If the equilibrium price is increasing, doesn't it mean the price is increasing and there demand will contract. And that supply will increase instead?

[Gentoo]

We're analysing what would have caused the equilibrium price to change in the first place due to shifts in the demand/supply curves (note how the question said 'at a given price'), not what happens after a change in price (which you're right about; a contraction in demand and supply would occur; this would be described as a movement along the demand/supply curve though).

A shift on the demand curve to the right (an increase in demand at any given price, which could be caused by factors like an increase in disposable income levels, etc.) would lead to shortages and the price being bidded up by consumers, which incentivises firms to allocate more resources to the production of the g/s, increasing supply until a new equilibrium Qty traded is found (higher demand and supply). This causes a movement along the supply curve to the right. So that's one way the equilibrium price can increase.

The other way is if there is a shift in the supply curve to the left (a reduction in supply at any given price, caused by factors like higher production costs etc.), which would again lead to shortages as firms are producing less, causing the price to be bidded up, resulting in a movement along the demand curve to the left and a higher equilibrium price but lower equilibrium quantity. That's the other way that results in a higher equilibrium price.

[Rachelle]

We're analysing what would have caused the equilibrium price to change in the first place due to shifts in the demand/supply curves (note how the question said 'at a given price'), not what happens after a change in price (which you're right about; a contraction in demand and supply would occur; this would be described as a movement along the demand/supply curve though).

A shift on the demand curve to the right (an increase in demand at any given price, which could be caused by factors like an increase in disposable income levels, etc.) would lead to shortages and the price being bidded up by consumers, which incentivises firms to allocate more resources to the production of the g/s, increasing supply until a new equilibrium Qty traded is found (higher demand and supply). This causes a movement along the supply curve to the right. So that's one way the equilibrium price can increase.

The other way is if there is a shift in the supply curve to the left (a reduction in supply at any given price, caused by factors like higher production costs etc.), which would again lead to shortages as firms are producing less, causing the price to be bidded up, resulting in a movement along the demand curve to the left and a higher equilibrium price but lower equilibrium quantity. That's the other way that results in a higher equilibrium price.

Oh that makes sense. Just to clarify in what circumstances do you say a shift of the whole demand line. Or an expansion along the D line. Because I know there is a difference between shifts of a whole curve and simply movements along THAT curve.
Thanks.

[Rachelle]

We're analysing what would have caused the equilibrium price to change in the first place due to shifts in the demand/supply curves (note how the question said 'at a given price'), not what happens after a change in price (which you're right about; a contraction in demand and supply would occur; this would be described as a movement along the demand/supply curve though).

A shift on the demand curve to the right (an increase in demand at any given price, which could be caused by factors like an increase in disposable income levels, etc.) would lead to shortages and the price being bidded up by consumers, which incentivises firms to allocate more resources to the production of the g/s, increasing supply until a new equilibrium Qty traded is found (higher demand and supply). This causes a movement along the supply curve to the right. So that's one way the equilibrium price can increase.

The other way is if there is a shift in the supply curve to the left (a reduction in supply at any given price, caused by factors like higher production costs etc.), which would again lead to shortages as firms are producing less, causing the price to be bidded up, resulting in a movement along the demand curve to the left and a higher equilibrium price but lower equilibrium quantity. That's the other way that results in a higher equilibrium price.

Oh sorry! You have said that. So microeconomic conditions of supply and demand cause the whole curve to shift in position. But what causes the movements along the cruve?

[thaaanyan]

Oh sorry! You have said that. So microeconomic conditions of supply and demand cause the whole curve to shift in position. But what causes the movements along the cruve?

correct me if i'm wrong but i thought a change in price....?

[Rachelle]

How does the price system answer the 3 key economic decisions?

#AOS1 review

[Rachelle]

correct me if i'm wrong but i thought a change in price....?

I think you're right..