Learning outcome of this chapter 2: Identify the critical assumptions of the two-sector model, define what is meant by a Pareto-optimal allocation of resources; articulate the three conditions for a general equilibrium; distinguish between allocative efficiency, X-efficiency, and ‘dynamic’ efficiency (or economic growth); discuss the broad categories of market failure; explain the allocative, distributive, and stabilisation functions of government; distinguish between direct and indirect forms of government intervention.
• • • • • • • Identify the critical assumptions of the two-sector model Define what is meant by a Pareto-optimal allocation of resources Articulate the three conditions for a general equilibrium Distinguish between allocative efficiency, X-efficiency, and ‘dynamic’ efficiency (or economic growth) Discuss the broad categories of market failure Explain the allocative, distributive, and stabilisation functions of government Distinguish between direct and indirect forms of government intervention • Individual consumer or producer is: – – – – • Fully informed about the economy Unaffected by the actions of other consumers or producers Completely mobile Always striving to maximise his/her own utility of profit Disturbances will cause instantaneous adjustments to return the system to a stable equilibrium Allocative efficiency refers to a situation in which the limited resources of a country are allocated in accordance with the wishes of its consumers • • Optimal mix of commodities Interaction between: – Consumption activities of consumers – Production activities of producers • Simultaneous concurrence of conditions: – Pareto optimality – Maximising utility subject to budget constraints – Producers and consumers achieve equilibrium simultaneously Technical efficiency or X-efficiency refers to a situation in which existing resources are utilised in the most efficient manner • • • • • • Lack of information Friction and lags in adjustments Incomplete markets Non-competitive markets Macroeconomic instability Distribution of income • • Market failures distort the allocation of resources in the economy Incomplete markets – Characteristics of goods and services prevent efficient supply – Existence of externalities • • • Fairness Inequality in income distribution Criteria for evaluation • • Macro-economic objectives premises of stabilisation (Keynes): – The market economy is inherently unstable – Macroeconomic instability is a form of market failure that is highly costly to an economy – Governments are able to stabilise the economy by means of appropriate macroeconomic policies • • New Classical Macroeconomics Neo-Keynsian theory Direct government intervention refers to the actual participation of government in the economy Indirect government intervention to the regulatory function of government • Actual participation in the economy • Tax individuals and companies • Borrow on financial markets • Execute budgeted spending • Examples: – – – – National defence Electricity Infrastructure Provision of school text books • Regulatory function • Enacting law or proclaiming legally binding rule • Indirect taxes and subsidies • Examples: – Labour laws – Anti-tobacco laws ...• • • • • • • Identify the critical assumptions of the two-sector model Define what is meant by a Pareto-optimal allocation of resources Articulate the three conditions for a general... efficiency, X-efficiency, and ‘dynamic’ efficiency (or economic growth) Discuss the broad categories of market failure Explain the allocative, distributive, and stabilisation functions of government... stabilise the economy by means of appropriate macroeconomic policies • • New Classical Macroeconomics Neo-Keynsian theory Direct government intervention refers to the actual participation of government