Allocative efficiency

• What is achieved at free market equilibrium?

  Efficient allocation of scarce resources
• Why does efficient allocation occur at equilibrium?

  Supply equals demand at equilibrium
• What does the supply curve represent?

  Private costs for a firm
• What are private costs?

  Costs of production for a producer
• What does "marginal" mean in economics?

  Extra cost or benefit from one more unit
• Why is the supply curve upward sloping?

  Due to the law of diminishing marginal returns
• What are social costs?

  Private costs plus external costs
• What are external costs?

  Impacts on third parties not involved
• What is the relationship between marginal social cost and marginal private cost in a free market?

  They are equal when no external costs exist
• What does the demand curve represent?

  Private benefits for consumers
• What are private benefits?

  Individual consumer benefits from consumption
• Why is the demand curve downward sloping?

  Due to the law of diminishing marginal utility
• What are social benefits?

  Private benefits plus external benefits
• What are external benefits?

  Positive impacts on third parties from consumption
• What does it mean for a market to be operating efficiently?

  No external costs or benefits exist
• What is allocative efficiency?

  Maximization of society's surplus
• What are the three conditions for allocative efficiency at equilibrium?

  • Maximization of society's surplus
  • Maximization of net social benefit
  • Perfect alignment of resources with consumer demand
• What is society's surplus?

  Sum of consumer and producer surplus
• What happens to welfare if price is above or below equilibrium?

  There will be a loss of welfare
• What is the relationship between marginal social benefit and marginal social cost at equilibrium?

  They are equal at equilibrium
• What occurs if quantity produced is below Q star?

  Social benefit will be greater than social cost
• What occurs if quantity produced is above Q star?

  Social costs will exceed social benefits
• What are the assumptions underpinning a free market equilibrium?

  • Many buyers and sellers exist
  • Perfect information for consumers and producers
  • No barriers to entry or exit
  • Firms are profit maximizers
  • Consumers are utility maximizers
• What is market failure?

  When market equilibrium isn't efficient
• What is the difference between private optimum and social optimum?

  Private optimum is where supply equals demand
• What can cause market failures?

  Breaking down of key assumptions
• What is the significance of MSC and MSB in a free market?

  They indicate allocative efficiency
• What happens when MSC does not equal MSB?

  Market failure may occur
• What is the outcome of a market operating efficiently?

  Resources perfectly follow consumer demand
• What is the importance of understanding these economic concepts?

  To achieve high marks in economics