Now let’s discuss how efficiency is impacted
in the competitive market.
When I say competitive market, I’m referring
to an unregulated market that is governed
by the forces of supply and demand.
Left alone, the market will reach a point
of equilibrium where the quantity supplied
of a good equals its quantity demanded at
some price.
At equilibrium, the total surplus of the economy,
equal to the consumer surplus plus the producer
surplus, is maximized.
There are instances where the market isn’t
as efficient as it could be.
Market failure refers to a situation where
the market is not producing at equilibrium
for whatever reason.
We’ll discuss these reasons in just a bit.
Suppose that for whatever reason, the market
is underproducing the good in question, which
means that the quantity supplied of the good
is less than the equilibrium quantity.
This drives the price up because buyers start
to bid for the good, but it creates something
known as deadweight loss.
In essence, deadweight loss is a decrease
in social surplus due to inefficient resource
allocation.
The red triangle represents the deadweight
loss in this particular scenario.
Similarly, sometimes an economy might overproduce
a good.
Again, I’ll go through some of the reasons
why this might happen in just a bit.
In this scenario, the quantity supplied of
the good exceeds the equilibrium quantity,
so producers are producing more than the optimal
amount.
This results in the price being driven down
and creates a similar deadweight loss situation
as the previous example.
It might not be as intuitive from the graph
on screen right now, but I encourage you to
find problem sets with questions relating
to market failure and practicing social surplus
calculations to understand why overproduction
and underproduction result in lower socials
surplus.
Market failure can happen for a number of
reasons, and in the rest of the course I’ll
explore them in more detail.
For now, just understand that any sort of
regulations, taxes or subsidies, externalities,
etc. change the amount that is actually produced
and consumed relative to the equilibrium in
the economy.
Thus, all of these are considered to be sources
of market failure.
If we don’t use the competitive market as
a means of allocating resources, we can consider
using any of the allocation methods I talked
about in the first part of this lecture.
The idea is that there is no “perfect”
allocation method, but the competitive market
seems to work the best for goods and services.
