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ECONOMIC EFFICIENCY IN A PRIVATE MARKET ECONOMY

What are the basic assumptions of a perfectly competitive private market economy?
1. Motivational Assumptions
a. Consumers seek to maximize utility, or satisfaction from the consumption of
goods and the enjoyment of services and amenities.
b. Producers seek to maximize profits or economic wealth.
2. Full Information
a. Consumers have, in advance, complete information about product performance
and the satisfactions that various goods, services, and amenities will provide them.
b. Producers have complete information about the production processes from which
they choose.
c. Both producers and consumers have full information about all relevant prices.
3. Resource Mobility
Resources are mobile, at least in the long run - they can be transferred from one use
to another in response to economic incentives such as price changes.
4. Homogeneous Commodities
Each unit of each commodity and input is undifferentiated from other units of the
same commodity or input. Consumers have no preference as to which producer
provides the commodities they purchase. Producers have no preferences among
suppliers of the same input or consumers of the same output.
5. Large Industries, Small Individuals
The purchases of each consumer represent such a small proportion of the total output
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of any commodity that the decisions of a consumer have no influence on the price of
the commodity. Similarly, each producer purchases such a small proportion of the
total output of a given industry that his/her actions have no influence on the price of
the product or the inputs used in its production.
PARETO EFFICIENCY
A resource allocation in an economy is Pareto Efficient if no individual or group of
individuals can be made better off without making at least one other person worse off. In
other words, it is impossible, even conceptually, to make any readjustment of production or
consumption arrangements that would make even one person better off without making
some other individual worse off.
A competitive free market economy relies on prices as signals to direct independent
producers and consumers to behave individually in such a way that the aggregate outcome
of their independent endeavors is Pareto Efficient.
To achieve this result, the competitive economy relies on free and unrestrained trade.
The conditions for Pareto Efficiency are the conditions for all potential gains from free trade
in all sectors of an economy to be exhausted.
The institutional conditions that encourage the achievement of Pareto Efficiency in a
competitive economy are institutional conditions that facilitate trade. This amounts to the
definition, assignment, transfer, and enforcement of individual rights in the society. In a
private market economy, these rights are called .
property rights
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PROPERTY RIGHTS

What are the characteristics of an adequate set of property rights?

1. Ownership

Ownership is a legal device that assigns the right to use. In a market economy based on the
concept of private property, payments results in ownership. Ownership carries with it the
right to use, subject to various possible restrictions. The least restrictive kind of ownership is
exclusive ownership , which carries with it the right to use and to determine who, if anyone,
else may use and under what conditions. Ownership is an essential precondition for trade.
2. Specification of Rights

Individuals independently exercising their various ownership rights may often come into
conflict. To permit resolution of these conflicts, it is insufficient merely to declare that
exclusive ownership exists. It is also necessary to specify the rights that accompany
ownership. Clearly, restrictions must accompany ownership.
In order that exclusive property rights may achieve their fullest effectiveness, thus
permitting resolution of conflicts among owners and between owners and nonowners by
trade, property rights must be specified in detail, along with the restrictions that apply to
owners and the corresponding rights of nonowners.
3. Transferability

If trade is to be effective in allocating resources and in resolving conflicts, rights must be

transferable. An individual who desires to acquire a specific right must be permitted to make
an offer to some other individual who already owns that right. An individual who is willing
to relinquish a right he owns, in exchange for some consideration of greater value to him,
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must have the right to sell. In that way, rights can gravitate to their highest-valued uses.
Restrictions on the transfer of rights are sources of inefficiency. Such restrictions erect
barriers to the achievement of equality between price ratios and the relevant rates of
substitution between various uses of a resource, good, or service.
Since complete specification of rights entails the specification of a variety of different kinds
of rights associated with a particular piece of property, complete transferability of rights
requires that the different types of rights associated with ownership of the resource be
transferable independently from one another.
The fundamental characteristic of trade is the transfer of rights, rather than the physical
transfer and removal of things. When one "buys" land, he or she does not pick up that piece
of land and carry it home. Rather, he or she acquires certain specified rights to make use of
that land.
4. Enforcement
Incentives exist for violation of the rights pertaining to ownership and transfer of property.
To be effective, a system of rights must be enforceable, and effectively enforced. An
unenforced property right is no right at all.