When Markets Fail to Provide the Optimum Social Outcome.


The prospect that social economic efficiency can be reached through perfect competition is so compelling it serves as the foundation for antitrust policy in the United States, as well as competition policy in Canada, the European Union, and elsewhere around the world. These are examples of developed countries that have enhanced good business terms that create a good and fair competitive environment (Musgrave, Kacapyr & Barrons Educational Series, 2001).&nbsp.

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We now wish to demonstrate that&nbsp.Social Surplus&nbsp.is maximized in competitive equilibrium. Consider again the 400th unit of output in Figure 16.1. The marginal value of this unit is $100. The buyer who purchases the 400th unit must pay the market price of $60 to get it, and so enjoys&nbsp.Consumer Surplus&nbsp.on this unit equal to $40 (= $100 – $60). The producer who supplies the 400th unit is willing to do so for a price as low as $40. The supplier of the 400th unit gains&nbsp.Producer Surplus&nbsp.equal to $20 (= $60 – $40). (Recall that the $20 producer surplus is economic rent if S in the figure represents long-run industry supply.) Thus, the consumption and production of the 400th unit generates $60 of net gain for society (Musgrave, Kacapyr & Barrons Educational Series, 2001).&nbsp.

For consumption and production levels greater than competitive equilibrium— beyond point A in the figure—social surplus will be smaller than at point A. Consider the 1,000th unit, for which demand price, $40, is less than supply price, $70. Production and consumption of this unit are inefficient because $70 worth of scarce resources is transformed through production into a good worth only $40. Obviously, this would be wasteful for society. Fortunately, there is no price for this good that would stimulate buyers and sellers voluntarily to make such a wasteful transaction.

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