Question

Assume that candle wax is traded in a perfectly competitive market in which the demand curve captures buyers' full willingness to pay while the supply curve reflects all production costs. For each of the following situations, indicate whether the total output should be increased, decreased, or kept the same in order to achieve allocative and productive efficiency. a. Maximum willingness to pay exceeds minimum acceptable price. b. \(\mathrm{MC}>\mathrm{MB}\) c. Total surplus is at a maximum. d. The current quantity produced exceeds the market equilibrium quantity.

Short answer

a. Increase output. b. Decrease output. c. Keep output the same. d. Decrease output.

Step-by-step solution

Analyze Maximum Willingness to Pay vs. Minimum Acceptable Price

In a competitive market, if the maximum willingness to pay exceeds the minimum acceptable price, it indicates that buyers value the product more than the cost of production. This suggests that increasing the output could lead to greater total surplus as more mutually beneficial trades occur.

Examine Marginal Cost and Marginal Benefit

When the marginal cost (MC) is greater than the marginal benefit (MB), producing an additional unit costs more than the value it brings to consumers. In this situation, the output should be decreased to achieve allocative efficiency, as resources are being over-utilized beyond their productive value.

Consider Total Surplus at Maximum

Total surplus is the sum of consumer and producer surplus. If total surplus is at a maximum, the market is at its most efficient state, with resources being optimally allocated. Here, the output should be kept the same to maintain this efficiency level.

Evaluate Quantity Compared to Market Equilibrium

If the current quantity produced exceeds the market equilibrium quantity, there is overproduction, leading to inefficiencies. To restore equilibrium and achieve efficient allocation, the total output should be decreased to match the equilibrium quantity.

Key concepts

Allocative Efficiency

Allocative efficiency occurs when resources in a market are distributed in such a way that consumer satisfaction is maximized. This means the goods produced are exactly what consumers desire, and they're willing to pay an equivalent value for them.
In a perfectly competitive market, allocative efficiency is achieved when the quantity of goods being supplied just equals the quantity demanded. This happens at the market equilibrium price and quantity where no further trades can make one party better off without making another worse off.
For allocative efficiency to be present, the price of the product should match the marginal cost of producing it. This indicates that resources are being used to produce goods and services most wanted by society, aligning production with consumer preferences.

• If the marginal benefit (MB) of consumption exceeds the marginal cost (MC), more production is needed.
• If the MC exceeds the MB, then production should be decreased.

Reaching allocative efficiency ensures that there's no overproduction or underproduction in the market.

Productive Efficiency

Productive efficiency occurs when goods are produced at the lowest possible cost. This is achieved when firms utilize all inputs in the most efficient manner. In a competitive market, productive efficiency happens at the point of production where average total cost is minimized. This means there is no waste of resources, and production takes place on the production possibility frontier.
It's important to avoid producing less or more than this optimal quantity, as doing so would lead to inefficiencies:

• Conversely, if less than the optimal quantity is produced, not all resources are used efficiently, resulting in higher costs per unit.
• Overproduction means producing more than necessary, leading to wastage and higher than necessary costs.

When productive efficiency is achieved, we make full use of resources at the lowest cost while maximizing output.

Consumer Surplus

Consumer surplus is the difference between what consumers are willing to pay for a good or service and what they actually pay for it.
This concept represents the extra benefit consumers receive by being able to purchase a product for less than the maximum amount they would be willing to pay:

• Consumer surplus increases as prices decrease, provided that consumer's willingness to pay remains the same.
• A surplus occurs in a market where demand is kept higher than the market price.
• It is often illustrated as the area under the demand curve and above the market price line.

Increasing consumer surplus contributes to economic welfare by allowing consumers more value, retaining more income to spend elsewhere.

Producer Surplus

Producer surplus is the amount producers benefit by selling products at a market price that is higher than the lowest price they are willing to accept. In simpler terms, it is the extra profit producers gain when they sell a good at a higher price than the minimum they would accept:

• Producer surplus increases as market prices rise, assuming the cost of production remains constant.
• Graphically, it appears as the area above the supply curve and below the market price line.

Achieving a maximum producer surplus indicates an efficient use of resources, allowing firms to reinvest and innovate, contributing to further market development. Understanding producer surplus helps businesses set competitive prices that maximize profitability while maintaining market stability.