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Understanding Performance Measures: Efficiency, Profits, and Deadweight Loss in Markets

This document explores critical concepts of performance in economics, focusing on efficiency, profits, and deadweight loss. It explains the significance of technical and allocative efficiency, emphasizing the role of perfect competition in minimizing costs. The relationship between price, marginal cost, and economic surplus is analyzed, alongside factors influencing deadweight loss in markets with differentiated products. Additionally, the distinctions between economic and accounting profit are examined, including the impact of monopolistic competition and the importance of innovation in reducing costs and enhancing product variety.

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Understanding Performance Measures: Efficiency, Profits, and Deadweight Loss in Markets

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  1. Measures of Performance Concepts and Graphs

  2. Performance • Profits • Efficiency • Technical – best technology (minimize cost) • Allocative – Marginal Benefit (P)=Marginal Cost (MC) • Deadweight Loss • Product Variety • Technical Progress

  3. Efficiency • Only Perfectly Competitive markets are efficient • Many buyers and sellers • Homogeneous products • Easy entry • P = MC in the short run • P = MC = Min AC in the long run • Supply = Demand maximizes Economic Surplus, no Deadweight Loss

  4. Efficiency • Departures from P=MC cause Deadweight Losses of Economic Surplus • P > MC May be associated with positive economic profit in monopoly and some oligopoly models (Bertrand, for example) • Long Run equilibrium in monopolistic competition has P > MC, but zero economic profit and a dead weight loss

  5. Profit as a Measure of Performance • Economic vs. Accounting Profit • Data availability • Division or Subsidiary vs. Parent Corporation • Financial reports required only if stock is traded • High profit may indicate • Greater efficiency than other firms • Monopoly or collusive behavior • Even zero economic profit may be associated with positive deadweight loss in differentiated product markets

  6. Deadweight Loss • Does Price exceed Marginal Cost? • DWL = ½ ΔP ΔQ = ½ (P-MC)(Qc-Q1) • Lerner Index and the Price-Cost Margin • (P-MC)/P = -(1/Ep) • At profit maximizing price and quantity • DWL = ½ PQ(-Ep)[(P-MC)/P]2 • Assuming (P-MC)/P is small • DWL increases with the size of the market (PQ), the price elasticity of demand, and the square of the price-cost margin

  7. Variety and Progressivity • Does product variety offset DWL in differentiated product markets? • Technical Progress or Progressivity • Innovation in process or product technologies • Process innovation reduces cost • Production • Distribution • Advertising, marketing, etc. • Product innovation leads to new products

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