A-Level Economics - 1 - Basic Economic Ideas and Resource Allocation (Efficiency)

1
A2 ECONOMICS
BASIC ECONOMIC IDEAS
AND RESOURCE ALLOCATION
- EFFICIENCY -
Dr. Sylvain Hours

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Where to Begin?
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Opening Activity: Robinson’s Dilemma
 Robinson Crusoe is cast away on a desert island.
 The only resource at his disposal is his own

labour, which he can use for up to 6 hours to
« produce » 2 goods: fish and coconuts.
 Task: Use the following information to help

Robinson decide how he should use the time at
his disposal in order to maximise his satisfaction,
measured by the total number of .
 You may work in pairs or in small groups.

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FISHING FISH COLLECTING COCONUT
HOURS OUTPUT HOURS OUTPUT
1 3 1 4
2 5 2 8
3 7 3 9
4 9 4 10
5 11 5 11
6 12 6 12
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FISHING FISH COLLECTING COCONUT

HOURS OUTPUT HOURS OUTPUT
1 3 1 4
2 5 2 8
3 7 3 9
4 9 4 10
5 11 5 11
6 12 6 12
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FISH FISH COCONUT COCONUT
OUTPUT BENEFIT (  ) OUTPUT BENEFIT (  )
0 0 0 0
1 3 1 3
2 6 2 6
3 9 3 9
4 12 4 12
5 14 5 14
6 16 6 16
7 18 7 18
8 20 8 20
9 21 9 21
10 22 10 22
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COCONUTS
FISH
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COCONUTS A
12 B
11 C
10 D
9 E
8
PPC
F
4
G
FISH
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3 5 7 9 11 12
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COCONUTS A
12 B
11 C
10 D
9 E
8
I PPC
F
4
H
G
FISH
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3 5 7 9 11 12
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FISH (H) FISH COCONUT TOTAL

FISH COCONUT
- BENEFIT BENEFIT BENEFIT
OUTPUT OUTPUT
COCONUT (H) () () ()
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FISH COCONUT
OUTPUT OUTPUT
COCONUT (H) () () ()
0–6
1–5
2–4
3–3
4–2
5–1
6-0
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FISH COCONUT
OUTPUT OUTPUT
COCONUT (H) () () ()
0–6 0 12
1–5 3 11
2–4 5 10
3–3 7 9
4–2 9 8
5–1 11 4
6-0 12 0
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FISH COCONUT
OUTPUT OUTPUT
COCONUT (H) () () ()
0–6 0 12 0 24
1–5 3 11 9 23
2–4 5 10 14 22
3–3 7 9 18 21
4–2 9 8 21 20
5–1 11 4 23 12
6-0 12 0 24 0
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FISH COCONUT
OUTPUT OUTPUT
COCONUT (H) () () ()
0–6 0 12 0 24 24
1–5 3 11 9 23 32
2–4 5 10 14 22 36
3–3 7 9 18 21 39
4–2 9 8 21 20 41
5–1 11 4 23 12 35
6-0 12 0 24 0 24
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FISH COCONUT
OUTPUT OUTPUT
COCONUT (H) () () ()
0–6 0 12 0 24 24
1–5 3 11 9 23 32
2–4 5 10 14 22 36
3–3 7 9 18 21 39
4–2 9 8 21 20 41
5–1 11 4 23 12 35
6-0 12 0 24 0 24
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Economic Efficiency
 Problem: Determine how to allocate an economy’s scarce resources
between competing uses in order to best satisfy people’s needs and
wants.
 The resource allocation that solves the basic economic problem is said
to be economically efficient.
 In other words, Economic Efficiency (EE) is achieved when an

economy’s scarce resources are used in the best possible way.
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Economic Efficiency
 In order to achieve EE, two conditions must be satisfied:
 On the one hand, resources must be used fully and efficiently (i.e. no
waste), a condition known as Productive Efficiency (PE).
 On the other hand, resources must be used to produce the output-mix

that provides the highest possible satisfaction, a condition known as
Allocative Efficiency (AE).
EE = PE + AE
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Productive Efficiency
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Productive Efficiency in an Economy
 For an economy, PE is achieved when it is impossible to produce more of
one good without producing less of another.
 All output combinations that lie on the PPC are productively efficient.
 All output combinations that lie below the PPC are productively inefficient.
 Question 1: How should we label the axes of the PPC diagram?
 Question 2: Should we illustrate PE in an economy with a constant or

increasing OC PPC?
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 Activity: Discuss the possible causes of productive inefficiency in an postmaster@econdoctor.com
economy. WeChat: sylvainhoursCN
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PE in an Economy
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PE in an Economy
CAPITAL
GOODS
CONSUMER
GOODS Dr. Sylvain Hours
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PE in an Economy
CAPITAL
GOODS
PPC
CONSUMER
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PE in an Economy
CAPITAL
GOODS
PRODUCTIVELY
INEFFICIENT
PPC
CONSUMER
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PE in an Economy
CAPITAL
GOODS
𝑦 𝐴
A
PPC
CONSUMER
𝑥 𝐴 postmaster@econdoctor.com
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PE in an Economy
CAPITAL
GOODS
D
𝑦 𝐴 / 𝐷
A
PPC
CONSUMER
𝑥 𝐷 GOODS Dr. Sylvain Hours
𝑥 𝐴 postmaster@econdoctor.com
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PE in an Economy
CAPITAL
GOODS
E
𝑦 𝐸
D
𝑦 𝐴 / 𝐷
A
PPC
CONSUMER
𝑥 𝐴 / 𝐸 postmaster@econdoctor.com
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PE in an Economy
CAPITAL
GOODS
E
𝑦 𝐸
D
𝑦 𝐴 / 𝐷
A
PPC
CONSUMER
𝑥 𝐴 / 𝐸 postmaster@econdoctor.com
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PE in an Economy
CAPITAL
GOODS
E
𝑦 𝐸
B
𝑦 𝐵
D
𝑦 𝐴 / 𝐷
A
PPC
CONSUMER
𝑥 𝐴 / 𝐸 𝑥 𝐵 postmaster@econdoctor.com
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PE in an Economy
CAPITAL
GOODS
E
𝑦 𝐸
PPC
CONSUMER
𝑥 𝐸 GOODS Dr. Sylvain Hours
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PE in an Economy
CAPITAL
GOODS
E
𝑦 𝐸
B
𝑦 𝐵
PPC
CONSUMER
𝑥 𝐸 GOODS Dr. Sylvain Hours
𝑥 𝐵 postmaster@econdoctor.com
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PE in an Economy
CAPITAL
GOODS
D
𝑦 𝐷
PPC
CONSUMER
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PE in an Economy
CAPITAL
GOODS
B
𝑦 𝐵
D
𝑦 𝐷
PPC
CONSUMER
𝑥 𝐵 postmaster@econdoctor.com
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Productive Efficiency in a Firm
 For a firm, PE is achieved when it produces at the lowest possible per-
unit cost.
 Graphically speaking, PE in a firm is achieved at the lowest point of its

Average Total Cost Curve (ATC).
 That is, a firm achieves PE if it produces the ATC-minimizing level of

output (QPE) at the lowest possible ATC (ATCPE).
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AVERAGE
TOTAL
COST
QUANTITY
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AVERAGE
TOTAL
COST ATC
QUANTITY
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AVERAGE
TOTAL
COST ATC
A
𝐴𝑇𝐶 𝑃𝐸
QUANTITY
𝑞
𝑃𝐸 Dr. Sylvain Hours
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Technical & Cost Efficiency ONE STEP
FURTHER
 PE requires both Technical Efficiency (TE) and Cost Efficiency (CE).
 Technical Efficiency is achieved when a firm produces the greatest

possible level of output for any given combination of inputs.
 Example: If a firm produces 100 units of output with 10 employees and 2 machines
when it could have produced 120 units of output with the same combination of
inputs, then the firm is technically inefficient.
 Cost Efficiency is achieved when a firm chooses the optimal input-mix to

produce a given level of output.
 Example: Assume that a firm wants to produce 100 units of output. It can either
use 1 machine and 10 employees (Combination A) or 2 machines and 4 employees
(Combination B). Combination A entails an ATC of $10. Combination A entails an Dr. Sylvain Hours
ATC of $20. If the firm chooses Combination B, then it is cost inefficient. postmaster@econdoctor.com
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Technical Efficiency ONE STEP
FURTHER
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FURTHER
TOTAL
PRODUCT
QUANTITY
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OF LABOUR
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FURTHER
TOTAL
PRODUCT
F
QUANTITY
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OF LABOUR
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FURTHER
TOTAL
PRODUCT UNATTAINABLE F
TECHNICALLY
INEFFICIENT
QUANTITY
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OF LABOUR
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FURTHER
TOTAL
PRODUCT UNATTAINABLE F
120
100
80
TECHNICALLY
INEFFICIENT
QUANTITY
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10 OF LABOUR
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Cost Efficiency ONE STEP
FURTHER
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FURTHER
AVERAGE
TOTAL
COST
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QUANTITY
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FURTHER
AVERAGE
TOTAL
COST
ATC1
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QUANTITY
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FURTHER
AVERAGE
TOTAL
COST
ATC1
ATC2
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QUANTITY
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FURTHER
AVERAGE
TOTAL
COST
ATC1 ATC3
ATC2
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QUANTITY
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FURTHER
AVERAGE
TOTAL
COST
ATC1 ATC3
ATC2
𝐴𝑇 𝐶 3 (𝑞 1)
𝐴𝑇 𝐶 2(𝑞1 )
𝐴𝑇 𝐶 1(𝑞1 )
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QUANTITY
𝑞 1 WeChat: sylvainhoursCN
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FURTHER
AVERAGE
TOTAL
COST
ATC1 ATC3
ATC2
𝐴𝑇 𝐶 3 (𝑞 2)
𝐴𝑇 𝐶 1(𝑞2 )
𝐴𝑇 𝐶 2(𝑞2 )
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QUANTITY
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FURTHER
AVERAGE
TOTAL
COST
ATC1 ATC3
ATC2
𝐴𝑇 𝐶 1(𝑞3 )
𝐴𝑇 𝐶 2(𝑞3 )
𝐴𝑇 𝐶 3 (𝑞 2)
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QUANTITY
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Productive Efficiency in a Firm ONE STEP
FURTHER
 Overall, in order to achieve PE, a firm must…
 …produce the level of output that minimizes its ATC curve.
 …choose the optimal input-mix (i.e. cost efficiency).
 …ensure all inputs are used to their full potential (i.e. technical efficiency).
 Example:
 Huawei produces 100k smartphones per day, the level of output at which the ATC
curve reaches its minimum.
 Huawei produces this level of output at minimum cost by hiring 2k employees and
using 200 machines (i.e. optimal input-mix).
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 Huawei ensures that all workers and all machines are used to their full potential. WeChat: sylvainhoursCN
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Allocative Efficiency
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Consumer & Producer Surplus R
REMINDERS
 Consumer Surplus (CS) is the difference between the price buyers were ready
to pay for a good or service (i.e. maximum willingness to pay) and the price
that they actually pay (i.e. the market price).
 In a competitive market, the CS generated by the purchase of a product at a

given price is equal to the area that lies below the demand curve and above
that price.
 Producer Surplus (PS) is the difference between the price sellers actually
receive (i.e. the market price) and the price at which they were ready to
supply the good or service (i.e. minimum willingness to accept).
 In a competitive market, the PS generated by the sale of a product at a given

price is equal to the area that lies above the supply curve and below that price.
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 Activity: Use your mini-whiteboards to graph CS & PS. WeChat: sylvainhoursCN
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Consumer & Producer Surplus R
REMINDERS
PRICE
S
CS
E
∗
𝑝
PS
QUANTITY Dr. Sylvain Hours

∗
𝑞 postmaster@econdoctor.com
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Total Surplus
 Total Surplus (TS) is defined as the sum of CS and PS.
TS = CS + PS
 Therefore, the TS generated when trading 1 unit of a product is equal to

the difference between the buyer’s maximum willingness to pay and the
seller’s minimum willingness to accept.
TS = Max W2P – Min W2A
 Simply put, the TS generated when trading 1 unit of a product measures the
gain to society (i.e. the gain to both the buyer and the seller).
 Nb: The price at which a given unit of a product is traded has no influence Dr. Sylvain Hours
on the amount of TS that is generated because the price is simply a transfer postmaster@econdoctor.com
from the buyer to the seller. WeChat: sylvainhoursCN
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Total Surplus
 Example: If Jason is willing and able to pay at most $100 for 1 headset (i.e.
max w2p) and if Lucy accepts to sell 1 headset given that she receives at least
$60 (i.e. min w2a), then trading 1 headset at any price between $60 and
$100 generates a TS of $100 - $60 = $40.
 The TS generated when trading a given number of units of a product is

simply equal to the sum of the TS generated when trading each of these
units.
 In a competitive market in equilibrium, TS is equal to the area that lies below

the demand curve and above the supply curve.
 In that case, and if both demand and supply are linear (i.e. represented by
straight lines), then:
TS = (Demand Res. Price – Supply Res. Price) x Equilibrium Quantity / Dr. Sylvain Hours
2 WeChat: sylvainhoursCN
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Total Surplus in a Competitive Market
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PRICE

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PRICE
S

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PRICE
S

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PRICE
S

𝑞
1 postmaster@econdoctor.com
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PRICE
S
∆TS > 0

𝑞
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PRICE
S
∆TS > 0

𝑞
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PRICE
S
∆TS > 0

𝑞
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PRICE
S
∆TS > 0

𝑞
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PRICE
S
TS

𝑞
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PRICE
S

∗
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PRICE
S
∆TS > 0

∗
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PRICE
S
∆TS > 0

∗
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PRICE
S
∆TS > 0

∗
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PRICE
S
∆TS > 0

∗
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PRICE
S
∆TS > 0

∗
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PRICE
S
∆TS > 0

∗
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PRICE
S
∆TS = 0

∗
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PRICE
S
TS

∗
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PRICE
S

𝑞 2 postmaster@econdoctor.com
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PRICE
S
∆TS > 0

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PRICE
S
∆TS > 0

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PRICE
S
∆TS > 0

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PRICE
S
∆TS > 0

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PRICE
S
∆TS > 0

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PRICE
S
∆TS > 0

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PRICE
S
∆TS = 0

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PRICE
S
∆TS < 0

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PRICE
S
∆TS < 0

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PRICE
S
TS = A - B
A B

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 In a market, Allocative Efficiency (AE) is achieved at the level of output
QAE where TS is maximized.
 The level of output QAE is such that the MB of consumption is equal to the
MC of production.
QAE : MB of consumption = MC of production
 Remark: Many textbooks define Allocative Efficiency (AE) as a situation in

which the Price (P) is equal to the Marginal Cost (MC). In my opinion, this
definition is extremely misleading. In particular, you should acknowledge
that the so-called price actually refers to the demand price.
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 If the MB of consumption is larger than the MC of production, then the
maximum price that the buyer is willing and able to pay for the purchase of
one additional unit is greater than the minimum price that the seller is
willing and able to accept to supply one additional unit.
 Therefore, increasing production by one unit would improve TS.
 In other words, more resources should be allocated to the production of the

good or service.
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 If the MB of consumption is smaller than the MC of production, then the
maximum price that the buyer was willing and able to pay for the purchase
of the last unit is lower than the minimum price that the seller was willing
and able to accept to supply the last unit.
 Therefore, reducing production by one unit would increase TS.
 In other words, fewer resources should be allocated to the production of the

good or service.
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 In a market, if the level of output is different from QAE (i.e. allocative
inefficiency), then TS is not maximized.
 In that case, the loss in TS is known as a Deadweight Loss (DWL).
 It follows that there is no DWL in a market that achieves AE.
 Question: Is it correct to state that AE is about allocating resources to the

production of the goods and services that are the most wanted by
consumers?
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Revisiting Demand & Supply
 The demand curve represents the Marginal Benefit (MB) of consumption.
D = MB of consumption
 Simply put, this is because buyers demand the product up to the point
where the market price is equal to their MB of consumption.
 The supply curve represents the Marginal Cost (MC) of production.
S = MC of production
 Simply put, this is because sellers supply the product up to the point where Dr. Sylvain Hours
the market price is equal to their MC of production. postmaster@econdoctor.com
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Revisiting Demand & Supply ONE STEP
FURTHER
 For any given quantity of a product:
 The demand price (PD) is the price at which a buyer demands that particular
quantity.
 The demand price is equal to the maximum price that the buyer is willing and able
to pay for the last unit of the product (i.e. the marginal maximum willingness to
pay).
 This maximum price is equal to the buyer’s Marginal Benefit (MB) of consumption.
 It follows that the MB of consumption is represented by the demand curve.
 Nb: For simplicity, I used an individual demand (i.e. one single buyer) but the Dr. Sylvain Hours
same goes with a market demand (i.e. sum of individual demands). postmaster@econdoctor.com
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FURTHER
 For any given quantity of a product:
 The supply price (PS) is the price at which a seller supplies that particular
quantity.
 The supply price is equal to the minimum price that the seller is willing and able
to accept to supply the last unit of the product (i.e. the marginal minimum
willingness to accept).
 This minimum price is equal to the seller’s Marginal Cost (MC) of production.
 It follows that the MC of production is represented by the supply curve.
 Nb: For simplicity, I used an individual supply (i.e. one single seller) but the Dr. Sylvain Hours
same goes with a market supply (i.e. sum of individual supplies). WeChat: sylvainhoursCN
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FURTHER
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FURTHER
PRICE
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QUANTITY postmaster@econdoctor.com
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FURTHER
PRICE
S = MC
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FURTHER
PRICE
S = MC
D = MB
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FURTHER
PRICE
S = MC
D = MB
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1
𝑞 WeChat: sylvainhoursCN
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FURTHER
PRICE
S = MC
1 1
𝑝 𝐷= 𝑀𝐵
1 1
𝑝𝑆 =𝑀 𝐶
D = MB
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1
𝑞 WeChat: sylvainhoursCN
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PRICE
QUANTITY
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PRICE S = MC
QUANTITY
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PRICE S = MC
D = MB
QUANTITY
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PRICE S = MC
𝐵∗= 𝑀 𝐶 ∗
𝑀
D = MB
QUANTITY
∗
𝑞

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PRICE S = MC
𝐵∗= 𝑀 𝐶 ∗
𝑀 TS
D = MB
QUANTITY
∗
𝑞

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PRICE S = MC
𝐵∗= 𝑀 𝐶 ∗
𝑀 TS
D = MB
QUANTITY
TOTAL
SURPLUS
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QUANTITY WeChat: sylvainhoursCN
∗
𝑞
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PRICE S = MC
𝐵∗= 𝑀 𝐶 ∗
𝑀 TS
D = MB
QUANTITY
TOTAL
SURPLUS
TS Dr. Sylvain Hours

∗
𝑞
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PRICE S = MC
𝐵∗= 𝑀 𝐶 ∗
𝑀 TS
D = MB
QUANTITY
TOTAL
SURPLUS
𝑇 𝑆∗

∗
𝑞
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PRICE
QUANTITY
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PRICE S = MC
QUANTITY
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PRICE S = MC
D = MB
QUANTITY
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PRICE S = MC
D = MB
QUANTITY
∗
𝑞

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PRICE S = MC
D = MB
QUANTITY
𝑞 1 𝑞
∗
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PRICE S = MC
𝑀
𝐵1
𝑀
𝐶1
D = MB
QUANTITY
𝑞 1 𝑞
∗
Dr. Sylvain Hours

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PRICE S = MC
𝑀
𝐵1
𝑀
𝐵1 >𝑀𝐶 1
𝑀
𝐶1
D = MB
QUANTITY
𝑞 1 𝑞
∗
Dr. Sylvain Hours

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PRICE S = MC
𝑀
𝐵1
𝑀
𝐵1 >𝑀𝐶 1 TS
𝑀
𝐶1
D = MB
QUANTITY
𝑞 1 𝑞
∗
Dr. Sylvain Hours

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PRICE S = MC
𝑀
𝐵1
𝑀
𝐵1 >𝑀𝐶 1 TS DWL
𝑀
𝐶1
D = MB
QUANTITY
𝑞 1 𝑞
∗
Dr. Sylvain Hours

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PRICE S = MC
𝑀
𝐵1
𝑀
𝑀
𝐶1
D = MB
QUANTITY
TOTAL
SURPLUS
Dr. Sylvain Hours

𝑞 1 𝑞
∗
www.econdoctor.com
PRICE S = MC
𝑀
𝐵1
𝑀
𝑀
𝐶1
D = MB
QUANTITY
TOTAL
SURPLUS

𝑞 1 𝑞
∗
www.econdoctor.com
PRICE S = MC
𝑀
𝐵1
𝑀
𝑀
𝐶1
D = MB
QUANTITY
TOTAL
SURPLUS
𝑇 𝑆∗

𝑞 1 𝑞
∗
www.econdoctor.com
PRICE S = MC
𝑀
𝐵1
𝑀
𝑀
𝐶1
D = MB
QUANTITY
TOTAL
SURPLUS
𝑇 𝑆∗
𝑇 𝑆1

𝑞 1 𝑞
∗
www.econdoctor.com
PRICE S = MC
𝑀
𝐵1
𝑀
𝑀
𝐶1
D = MB
QUANTITY
TOTAL
SURPLUS
𝑇 𝑆∗
𝐷𝑊
𝐿1
𝑇 𝑆1

𝑞 1 𝑞
∗
www.econdoctor.com
PRICE S = MC
𝑀
𝐵1
𝑀
𝑀
𝐶1
D = MB
QUANTITY
TOTAL
SURPLUS
𝑇 𝑆∗
𝐷𝑊
𝐿1
𝑇 𝑆1

∆ 𝑇𝑆 >0 postmaster@econdoctor.com
𝑞 1 𝑞
∗
www.econdoctor.com
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PRICE
QUANTITY
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PRICE S = MC
QUANTITY
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PRICE S = MC
D = MB
QUANTITY
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PRICE S = MC
D = MB
QUANTITY
∗
𝑞

Dr. Sylvain Hours

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PRICE S = MC
𝑀
𝐶2
𝑀
𝐵2
D = MB
QUANTITY
𝑞
∗
𝑞 2
Dr. Sylvain Hours

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PRICE S = MC
𝑀
𝐶2
𝑀
𝐶 2 >𝑀𝐵 2
𝑀
𝐵2
D = MB
QUANTITY
𝑞
∗
𝑞 2
Dr. Sylvain Hours

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PRICE S = MC
𝑀
𝐶2
𝑀
𝐶 2 >𝑀𝐵 2 A B
𝑀
𝐵2
D = MB
QUANTITY
𝑞
∗
𝑞 2
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PRICE S = MC
𝑀
𝐶2
TS = A – B
𝑀
𝐶 2 >𝑀𝐵 2 A B
DWL = B
𝑀
𝐵2
D = MB
QUANTITY
𝑞
∗
𝑞 2
Dr. Sylvain Hours

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PRICE S = MC
𝑀
𝐶2
TS = A – B
𝑀
𝐶 2 >𝑀𝐵 2 A B
DWL = B
𝑀
𝐵2
D = MB
QUANTITY
TOTAL
SURPLUS
Dr. Sylvain Hours

𝑞
∗
𝑞 2 www.econdoctor.com
PRICE S = MC
𝑀
𝐶2
TS = A – B
𝑀
𝐶 2 >𝑀𝐵 2 A B
DWL = B
𝑀
𝐵2
D = MB
QUANTITY
TOTAL
SURPLUS

𝑞
∗
PRICE S = MC
𝑀
𝐶2
TS = A – B
𝑀
𝐶 2 >𝑀𝐵 2 A B
DWL = B
𝑀
𝐵2
D = MB
QUANTITY
TOTAL
SURPLUS
𝑇 𝑆∗

𝑞
∗
PRICE S = MC
𝑀
𝐶2
TS = A – B
𝑀
𝐶 2 >𝑀𝐵 2 A B
DWL = B
𝑀
𝐵2
D = MB
QUANTITY
TOTAL
SURPLUS
𝑇 𝑆∗
𝑇 𝑆2

𝑞
∗
PRICE S = MC
𝑀
𝐶2
TS = A – B
𝑀
𝐶 2 >𝑀𝐵 2 A B
DWL = B
𝑀
𝐵2
D = MB
QUANTITY
TOTAL
SURPLUS
𝑇 𝑆∗
𝐷𝑊
𝐿2
𝑇 𝑆2

𝑞
∗
PRICE S = MC
𝑀
𝐶2
TS = A – B
𝑀
𝐶 2 >𝑀𝐵 2 A B
DWL = B
𝑀
𝐵2
D = MB
QUANTITY
TOTAL
SURPLUS
𝑇 𝑆∗
𝐷𝑊
𝐿2
𝑇 𝑆2

∆ 𝑇𝑆 >0 postmaster@econdoctor.com
𝑞
∗
PPC Diagram, PE & AE ONE STEP
FURTHER
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FURTHER
SIZE 43
RUNNING SHOES
(MILLIONS)
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SIZE 36
RUNNING SHOES WeChat: sylvainhoursCN
(MILLIONS) www.econdoctor.com
FURTHER
SIZE 43
RUNNING SHOES
(MILLIONS)
PPC
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SIZE 36
(MILLIONS) www.econdoctor.com
FURTHER
SIZE 43
RUNNING SHOES
(MILLIONS)
A
5
B
3
PPC
C
1
Dr. Sylvain Hours
SIZE 36
1 3 5 (MILLIONS) www.econdoctor.com
FURTHER
SIZE 43
RUNNING SHOES
(MILLIONS)
QUESTION 1:
A WHICH POINT(S) ARE
5 PRODUCTIVELY EFFICIENT?
QUESTION 2:
WHICH POINT(S) ARE
B ALLOCATIVELY EFFICIENT?
3
PPC
C
1
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SIZE 36
1 3 5 (MILLIONS) www.econdoctor.com
FURTHER
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FURTHER
BERRIES
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RABBITS postmaster@econdoctor.com
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FURTHER
BERRIES
PPC
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FURTHER
BERRIES
A
21 B
20 C
18 D
15
E
11
F
6
PPC
G
Dr. Sylvain Hours
1 2 3 4 5 6 WeChat: sylvainhoursCN
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FURTHER
BERRIES QUESTION 1:
A WHICH PONT(S) ARE
21 B PRODUCTIVELY EFFICIENT?
20 C
18 D QUESTION 2:
15 WHICH POINT(S) ARE
E ALLOCATIVELY EFFICIENT?
11
F
6
PPC
G
Dr. Sylvain Hours
1 2 3 4 5 6 WeChat: sylvainhoursCN
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PPC, PE & AE ONE STEP
FURTHER
Dr. Sylvain Hours

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FURTHER
QUANTITY MC
(RABBITS) (BERRIES)
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FURTHER
QUANTITY MC
(RABBITS) (BERRIES)
1 1
2 2
3 3
4 4
5 5
6 6
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FURTHER
MARGINAL COST
(BERRIES)
QUANTITY MC
(RABBITS) (BERRIES)
1 1
2 2
3 3
4 4
5 5
6 6
QUANTITY
(RABBITS)
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FURTHER
MARGINAL COST
(BERRIES)
QUANTITY MC MC
(RABBITS) (BERRIES) 6
1 1 5
2 2
4
3 3
3
4 4
5 5 2
6 6 1
QUANTITY
1 2 3 4 5 6 (RABBITS)
Dr. Sylvain Hours

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FURTHER
Dr. Sylvain Hours

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FURTHER
QUANTITY MB
(RABBITS) (BERRIES)
Dr. Sylvain Hours

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FURTHER
QUANTITY MB
(RABBITS) (BERRIES)
1 6
2 5
3 4
4 4
5 2
6 1
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FURTHER
MARGINAL COST
(BERRIES)
QUANTITY MB
(RABBITS) (BERRIES)
1 6
2 5
3 4
4 4
5 2
6 1
QUANTITY
(RABBITS)
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FURTHER
MARGINAL COST
(BERRIES)
QUANTITY MB
(RABBITS) (BERRIES) 6
1 6 5
2 5
4
3 4
3
4 4
5 2 2
1 MB
6 1
QUANTITY
1 2 3 4 5 6 (RABBITS)
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FURTHER
Dr. Sylvain Hours

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FURTHER
QUANTITY MC MB
(RABBITS) (BERRIES) (BERRIES)
Dr. Sylvain Hours

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FURTHER
QUANTITY MC MB
1 1 6
2 2 5
3 3 4
4 4 4
5 5 2
6 6 1
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FURTHER
MARGINAL COST
(BERRIES)
QUANTITY MC MB
1 1 6
2 2 5
3 3 4
4 4 4
5 5 2
6 6 1
QUANTITY (RABBITS) Dr. Sylvain Hours

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FURTHER
MARGINAL COST
(BERRIES)
MC
QUANTITY MC MB
6
1 1 6 5
2 2 5 4
3 3 4 3
4 4 4 2
5 5 2 MB
1
6 6 1
1 2 3 4 5 6
QUANTITY (RABBITS) Dr. Sylvain Hours
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FURTHER
MARGINAL COST
BERRIES (BERRIES)
A
21 B MC
20 C 6
18 D
15 5
PPC E
11 4
F 3
6
2
1 MB
G
1 2 3 4 5 6 1 2 3 4 5 6
RABBITS QUANTITY (RABBITS) Dr. Sylvain Hours
www.econdoctor.com
FURTHER
MARGINAL COST
BERRIES (BERRIES)
A
21 B MC
20 C 6
18 D
15 5
PPC E
11 4
F 3
6
2
1 MB
G
1 2 3 4 5 6 1 2 3 4 5 6
www.econdoctor.com
FURTHER
MARGINAL COST
BERRIES (BERRIES)
A
21 B MC
20 C 6
18 D
15 5
PPC E
11 4
F 3
6
2
1 MB
G
1 2 3 4 5 6 1 2 3 4 5 6
www.econdoctor.com
FURTHER
MARGINAL COST
BERRIES (BERRIES)
A
21 B MC
20 C 6
18 D
15 5
PPC E
11 4
F 3
6
2
1 MB
G
1 2 3 4 5 6 1 2 3 4 5 6
www.econdoctor.com
FURTHER
MARGINAL COST
BERRIES (BERRIES)
A
21 B MC
20 C 6
18 D
15 5
PPC E
11 4
F 3
6
2
1 MB
G
1 2 3 4 5 6 1 2 3 4 5 6
www.econdoctor.com
FURTHER
MARGINAL COST
BERRIES (BERRIES)
A PE & AE
21 B MC
20 C 6
18 D
15 5
PPC E
11 4
F 3
6
2
1 MB
G
1 2 3 4 5 6 1 2 3 4 5 6
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Static vs Dynamic Efficiency
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 In economics, « static » means « at a given point in time » and « dynamic »
means « over a given period of time ».
 Static Efficiency is achieved when resources are allocated efficiently at a

given point in time.
 Dynamic Efficiency is achieved when resources are allocated efficiently

over a given period of time.
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 Roughly speaking, static efficiency can be understood as « efficiency in the
short-run » and « dynamic efficiency » as « efficiency in the long-run ».
 PE & AE are both static concepts of efficiency.
 There may be a trade-off between achieving efficiency today and improving

efficiency tomorrow (i.e. achieving static efficiency may not be consistent
with achieving dynamic efficiency).
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 Example 1: “Crop rotation is the practice of growing a series of dissimilar or
different types of crops in the same area in sequenced seasons. It is done so
that the soil of farms is not used for only one set of nutrients. It helps in
reducing soil erosion and increases soil fertility and crop yield. Growing the
same crop in the same place for many years in a row (Monoculture)
disproportionately depletes the soil of certain nutrients. With rotation, a
crop that leaches the soil of one kind of nutrient is followed during the next
growing season by a dissimilar crop that returns that nutrient to the soil or
draws a different ratio of nutrients.” Source: Wikipedia
 Task: List the main costs and benefits associated with the practice of crop
rotation.
 Benefits: Prevents the depletion of nutrients in the soil
 Costs: Less overall profitability (i.e. farmers may have to reduce the number of Dr. Sylvain Hours
acres that are cultivated with the most valuable crops), high initial investment postmaster@econdoctor.com
(e.g. machinery diversification, etc.), reduction in crop flexibility (i.e. locked into WeChat: sylvainhoursCN
a particular rotation). www.econdoctor.com
 Example 2: “Sustainable development: Development that meets the needs
of the present without compromising the ability of future generations to
meet their own needs” Source: Brundtland Commission (1987)
 Task: List the main costs and benefits associated with sustainable
development.
 Benefits: Future generations do not face the exhaustion of some non-renewable

resources (e.g. oil & natural gas), future generations do not have to incur the cost
of cleaning up waste created by us today (e.g. radioactive waste), biodiversity is
preserved (i.e. option value), etc.
 Costs: Economic growth may be slowed down (i.e. slower increase in standards of
living) ; research & planning costs ; requires conflict management and education
mechanisms, unemployment might rise in some areas (e.g. coal mines), some goods
Dr. Sylvain Hours
and services might become more expensive (e.g. electricity), etc.
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Dynamic Efficiency & Innovation
 Dynamic efficiency acknowledges that the state of knowledge and
technology changes over time.
 As such, it takes into account the rate of investment in Research &

Development (R&D) projects aimed at introducing process or product
innovations.
 Firms are likely to be dynamically inefficient if they overly discount the

future (i.e. focus too much on the R&D costs which are incurred at present and
not enough on the R&D benefits that will be reaped in the future).
Dr. Sylvain Hours

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Dynamic Efficiency & Innovation ONE STEP
FURTHER
 The reasons for which firms may fail to achieve dynamic efficiency are
closely related to the market structure in which they operate.
 Firms operating in highly competitive markets typically have strong

incentives to innovate but they may not have sufficient resources to
undertake R&D investments.
 Firms operating in concentrated markets typically have sufficient resources

to undertake R&D investments but they may lack of incentives to innovate.
Dr. Sylvain Hours

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Dynamic Efficiency & Innovation
 “A patent is a form of intellectual property. A patent gives its owner the
right to exclude others from making, using, selling, and importing
an invention for a limited period of time, usually twenty years.” Source:
Wikipedia
 Question: List the main costs and benefits associated with patents.
 Benefits: Stronger incentives to innovate
 Costs: Market power, administrative costs, patent fees, etc.
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Pareto Optimality
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Pareto Optimality
 In an economy, Pareto Optimality (PO) (or Pareto efficiency) is achieved
when it is not possible to reallocate scarce resources so that at least
someone is made better off without making anyone else worse off.
 A Pareto improvement is a reallocation of scarce resources that makes at

least someone better off without making anyone else worse off.
 Therefore, a resources allocation is said to be PO if no further Pareto

improvement can be made.
Dr. Sylvain Hours

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Pareto Optimality
 PO requires both PE & AE.
 Indeed, if PE is not achieved in the economy, then it is possible to

produce more of one good without producing less of another and so
further Pareto improvements can be made.
 Besides, if AE is not achieved in a market, then TS can be improved and

so further Pareto improvements can be made.
 Question: Is an economically efficient allocation of resources necessarily

fair?
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Reviewing Economic Efficiency
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MCQs
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MCQs
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MCQs
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MCQs
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MCQs
Dr. Sylvain Hours

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MCQs
Dr. Sylvain Hours

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MCQs
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MCQs
Dr. Sylvain Hours

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MCQs
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MCQs
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MCQs
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MCQs
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MCQs
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Single-Part Essay Questions
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Single-Part Essay Questions
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Two-Part Essay Questions
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Two-Part Essay Questions
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Homework
 Task A: Write a 500-word summary of what there is to know about economic
efficiency.
 Task B: “A country moved from a point within its production possibility curve
to a point on its production possibility curve. Explain what is meant by
economic efficiency. Analyse what happened to economic efficiency in that
country as a result of this movement.” [12] 9708/42/O/N/17 (400 words max)
 Task C: Discuss the extent to which an economy which allocates most of its
scarce resources to the production of capital goods is likely to achieve
efficiency. Your answer should consider allocative, productive and dynamic
efficiency. (800 words max)
Dr. Sylvain Hours

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1

Dr. Sylvain Hours

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 The only resource at his disposal is his own

 Task: Use the following information to help

 You may work in pairs or in small groups.

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FISHING FISH COLLECTING COCONUT

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FISH (H) FISH COCONUT TOTAL

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FISH (H) FISH COCONUT TOTAL

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FISH (H) FISH COCONUT TOTAL

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FISH (H) FISH COCONUT TOTAL

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FISH (H) FISH COCONUT TOTAL

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FISH (H) FISH COCONUT TOTAL

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 In other words, Economic Efficiency (EE) is achieved when an

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 On the other hand, resources must be used to produce the output-mix

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 Question 1: How should we label the axes of the PPC diagram?

 Question 2: Should we illustrate PE in an economy with a constant or

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 Graphically speaking, PE in a firm is achieved at the lowest point of its

 That is, a firm achieves PE if it produces the ATC-minimizing level of

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 Technical Efficiency is achieved when a firm produces the greatest

 Cost Efficiency is achieved when a firm chooses the optimal input-mix to

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 …produce the level of output that minimizes its ATC curve.

 …choose the optimal input-mix (i.e. cost efficiency).

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 In a competitive market, the CS generated by the purchase of a product at a

 In a competitive market, the PS generated by the sale of a product at a given

QUANTITY Dr. Sylvain Hours

 Therefore, the TS generated when trading 1 unit of a product is equal to

TS = Max W2P – Min W2A

 The TS generated when trading a given number of units of a product is