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Social equilibrium is the socially desirable state for the market, achieved when
whole societys welfare is maximised (Take into account external costs and
benefits incurred (MEC and MEB)
Social equilibrium and market equilibrium only coincide under FREE MARKETS
and PERFECT COMPETITION
ZERO EXTERNAL COSTS OR BENEFITS , allocatively efficient outcome
Externality occurs when activity of a person or firm directly affects the welfare of
another, without transmission in market prices
MSB=MPB+MEB
Negative externality: Occurs when third parties who are not consuming or
producing the good are affected adversely
MSC>MPC
CURES:
Command Approach:
Legal Regulation: Directly influence firms or consumers behaviour, compel firms
and consumers to moderate their actions
Banning: Only used when it is very difficult to use oter policies to limit
externalities or when damage caused is very severe (Can be on consumption or
production)
Banning is socially optimal if MEC is so high that socially optimum level of output
is actually zero
Compare net social benefit via diagram when comparing socially optimu level of
pollution vs zero pollution
Subsidies
Firms will only produce up to the level of Q, since profit maximising firms only
look at their own private benefit and cost. Demand is deemed as too low as it
does not reflect the true vale to society. MSB reflects the true value, but does not
show up as demand
Social efficiency can be attained by giving a unit subsidy
When unit subsidy equal to MEB at Q* is given, MPC drops to MPC as private
party internalises the external benefit to society
Govt aims to mimic what would happen to output when all people who benefitted
from the good would pay what it is worth to them
Advantages:
1) Market mechanism can continue to operate, internalising the external benefit
2) Subsidy is adjustable according to magnitude of externalities
3) Incentivises firms to adopt good practices
Disadvantages
Direct Provisions Directly supplied by the govt. free of charge. Non profit state
run hospitals can prevent asymmetric information from happening
Disadvantages:
1) Without profit motive, lack the incentive to minimise costs Productively
inefficient
2) Mismanagement of resources and poor quality of services could be provided
Underpaid and overworked labour since without market pricing to guide Lead
to chronic shortages and poor quality
3) Overconsumption of goods could occur since its free, worsening allocative
inefficiency Greater social inefficiency