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Chapter 1: Problem 8

In a market economy, why does a firm have a strong incentive to be productively efficient and allocatively efficient? What does the firm earn if it is productively and allocatively efficient, and what happens if it is not?

Short Answer

Expert verified
In a market economy, a firm is incentivized to be productively and allocatively efficient because doing so maximizes its profits: productive efficiency minimizes costs while allocative efficiency maximizes consumer satisfaction and sales. If a firm fails to achieve these efficiencies, it can experience lower profits, lose market share and may even face business failure due to increased competition.

Step by step solution

01

Understanding Allocative and Productive Efficiency

Allocative efficiency refers to a situation where resources are allocated in such a way that consumer satisfaction is maximized. This means that the firm is producing the right mix of goods so that consumer's preferences are fully met. Productive efficiency, on the other hand, refers to a situation where a firm is producing goods or services at lowest possible cost. This usually involves optimizing processes and minimizing waste.
02

Benefits of Being Productively and Allocatively Efficient

When a firm is productively and allocatively efficient, it produces the most desirable goods at the lowest costs. As a result, it maximizes its profits because costs are minimized and revenues are maximized as consumers are getting exactly what they want and are willing to pay for, leading to increased sales.
03

Consequences of Inefficiency

If a firm is not productively efficient, it incurs unnecessary costs. If it is not allocatively efficient, it fails to fully meet consumer needs and demands. Either situation can lead to lower profits. In a market economy characterized by competition, persistent inefficiency can make the firm less competitive, leading to a loss of market share and even business failure.

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Most popular questions from this chapter

Dr. Strangelove's theory is that the price of mushrooms is determined by the activity of subatomic particles that exist in another universe parallel to ours. When the subatomic particles are emitted in profusion, the price of mushrooms is high. When subatomic particle emissions are low, the price of mushrooms is also low. How would you go about testing Dr. Strangelove's theory? Discuss whether this theory is useful.

(Related to the Apply the Concept on page 5) Many universities and corporations offer a health and wellness program that helps their employees improve or maintain their health and get paid (a relatively small amount) for doing so. The programs vary but typically consist of employees completing a health assessment, receiving a program for healthy living, and monitoring their monthly health activities. a. Why would universities and corporations pay employees to improve or maintain their health? b. How does health insurance affect the incentive of employees to improve or maintain their health? c. Would a wellness program increase or decrease the health insurance premiums that an insurance company would charge the university or corporation to provide insurance coverage? Briefly explain.

Leonard Fleck, a philosophy professor at Michigan State University, has written: When it comes to health care in America, we have limited resources for unlimited health care needs. We want everything contemporary medical technology can offer that will improve the length or quality of our lives as we age. But as presently healthy taxpayers, we want costs controlled. Why is it necessary for all economic systems to limit services such as health care? How does a market system prevent people from getting as many goods and services as they want?

Suppose that your college decides to give away 1,000 tickets to the football game against your school's biggest rival. The athletic department elects to distribute the tickets by giving them away to the first 1,000 students who show up at the department's office at 10 A.M. the following Monday. a. Which groups of students will be most likely to try to get the tickets? Think of specific examples and then generalize. b. What is the opportunity cost to students of distributing the tickets this way? c. Productive efficiency occurs when a good or service (such as the distribution of tickets) is produced at the lowest possible cost. Is this an efficient way to distribute the tickets? If possible, think of a more efficient method of distributing the tickets. d. Is this an equitable way to distribute the tickets? Briefly explain.

Why do economists use models? How are economic data used to test models?
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