Question 1

a) .General Equilibrium in competitive markets

The term "general equilibrium" refers to the phenomenon in which all markets
are balanced at the same time. The general equilibrium paradigm examines the market as
a whole instead of particular sectors, as partial equilibrium analysis does. The cost at
which supply equals demand and markets clear in individual markets. It had failed
to demonstrate that equilibrium can exist in the long term for all markets. A competitive
market is one in which several producers contend with each other in order to deliver the
products or services that consumers desire and want. To put it differently, no individual
firm has the ability to dominate the market. Similarly to producers, no single consumer
can control the market. This principle holds true in terms of both price and quantity of
items. One buyer and one supplier cannot agree on the price of the product or the amount
to be provided. In ideally competitive markets, general long term equilibrium satisfies
two crucial criteria: allocative efficiency and production efficiency.

Producing with minimal waste is described to as productive efficiency, and the

choice is made on the productive capability frontier. Due to the process of inflow and
outflow, the pricing in a completely free economy is equivalent to the lowest of the long
term equilibrium cost. On the other hand, allocative efficiency is an economic situation in
which product is linked with customer demand; in particularly, every commodity is
produced until the final unit gives margin measurable profits equal to the marginal costs
of production.
Illustration

General Market equilibrium

Prices Quantity Supplied Quantity demanded
0 0 12
2 2 10
4 4 8
6 6 6
8 8 4
10 10 2
 General Market Equilibrium
12 Product
efficiency
10
explanation
8
Quantity supplied Productive
6 Quantity demanded efficiency is achieved
Price
4 when firms produce

2 their output in the

least possible manner.
0
0 2 4 6 8 10 12 14 Firms must produce at
Quantity
the minimum average
costs. When a firm is achieving minimum average costs, this means its resources are being
efficiently utilized. Nothing is going to waste.

Therefore, from the illustration productive efficiency occurs when;

Price (P) =Minimum average costs (ATC)

At the equilibrium point (6, 6), Marginal cost (MC) =Marginal revenue (MR), the profit
maximizing level output. Equally, the price of commodity (P) is equal to the total minimum
average costs (ATC). If the price was any value higher, the demand and supply in a competitive
market shifts. A firm producing commodities in the short run may not achieve productive
efficiency since a shift of the equilibrium point to either would mean a shift in the total minimum
average costs side P > MC OR P < MC which affects production efficiency. The marginal cost
curve intersects the minimum total average cost curve at its lowest implying that the producing
firm is no longer productively efficient. Marginal revenue points closer to the equilibrium point
do not indicate the general long term equilibrium in a perfect competitive market. If the price a
producing firm is selling its commodities at a price higher than the minimum average costs, then
other competitor firm s will enter the market and force the firm to lower its prices until the price
of commodity becomes equivalent to the total minimum average costs. Any marginal profits
being made in the short run will eventually be eliminated in the long run general equilibrium as a
result of the firm reducing its output to a point where it will be equal to the total average
minimum costs.

Meanwhile, allocative efficiency is when quantity been produced attains the greatest level
of welfare or fairness. The demand curve represents the marginal benefits while the supply
represents the marginal costs. The surplus for both supply (PS) and demand (CS) must be equal
for allocative efficiency to be realized. From the illustration, a decrease in the price will imply a
greater consumer surplus than the producer surplus hence allocative inefficient. In this situation
in a competitive market, other producers will enter the market and increase the production
surplus and force the consumer surplus to the equal the producer surplus CS=PS. This explains
how a competitive market is able to achieve both efficiency and a fair economy.

CS=Consumer surplus

PS=Producer surplus

TC=Total cost

AR=Average Revenue
 Perfect competition relation
250

200

TC
150 TR
ATC
Price AR
100 MC
MR

50

0
0 2 4 6 8 10 12 14
Quantity

b) Government intervention in mitigating market failures using the Theory of

Second Best

The second best theory explains that when ideal equilibrium circumstances cannot be
achieved, attempt to attain this conditions cannot be the best second option as they may be
harmful and cause a shift further away from the Pareto efficiency. Market failures occur when
markets take individual interest to produce less optimal otcomes. They occur in explicit
economies where commodities are purchased and sold completely in economies regarded as
viable markets. Government intervention in mitigating these market failures include through
taxation, regulation and subsidies. For example, government can intervene through legislation
and disrupt monopoly markets. The second best theory of taxation is a government intervention
method to mitigate the effects of market failures. This theory analyses the welfare losses
influenced by distorted taxes. Once the expenditure decision criteria signal the requirement for
certain public spending without concurrently stating how such expenses are to be supported the
taxation theory becomes important.

Taking an example a mining monopoly which is also a cause of pollution: mining results
in the disposal of wastes in rivers and the inhalation of dangerous dust by workers. Assume that
there is nothing that can be done to reduce pollution without decreasing the production as well.
The government, on the other hand, has the ability to break up the dominance. The issue here is
that as the market becomes more competitive, production is going to. Since contamination is so
closely linked to output, waste will almost certainly rise. As a result, it's unclear if abolishing the
monopoly improves total welfare. Profits from trade in mined minerals would rise, but pollution-
related externalities will rise as well, potentially surpassing trade benefits... According to the
theory of the second best, removing a market distortion (such as a tax) often does not imply an
increase in efficiency if additional distortions remain.