You might want to get whatever you buy for the cheapest price possible. You might even want it for free. But have you thought about the consequences of this? Whatever you buy was produced by someone else, and this person must get back the money they spent in making the product. This is important so they can keep making it. If you pay less than what is "right", they will end up having to go out of business, and you will no longer get your favorite products. This describes the underlying idea of social efficiency, and we will discuss it in detail in this article!
Social Efficiency Definition
Social efficiency suggests that resources must be distributed in a way that benefits all of society.
Social efficiency is the optimal distribution of resources in society taking into consideration all the internal and external costs and benefits.
Social efficiency is important to keep a market alive! For this to be possible, every economic decision must take into consideration the internal and external costs and benefits. So, what are these internal and external costs and benefits?
The internal costs and benefits, also known as the private costs and benefits, are the direct costs and benefits of an economic decision. This falls directly on whoever makes the economic decision. On the other hand, external costs and benefits are the indirect costs and benefits of an economic decision felt by third parties. These are also referred to as externalities.
Private costs and benefits (internal costs and benefits) are the direct costs and benefits of an economic decision.
Externalities (external costs and benefits) are the indirect costs and benefits of an economic decision felt by third parties.
Let's help you understand things better with an example.
Let's say you purchase a car. You pay money out of your pocket to acquire this car, and the car makes your movements around town easier. The car emits greenhouse gases that affect everybody else in your community through air pollution, and your friends get free rides from you as you now have a car.
Let's list the private costs and benefits as well as the externalities found in the above example. The private cost is the money you paid out of your pocket. The private benefit is the ease of movement you now get as a result of owning a car. The external cost is the air pollution the entire community now has to endure, and the external benefit is the free rides your friends now enjoy since you now own a car.
Figure 1 will help you remember the most important condition for social efficiency.
Social Efficiency Theory
Based on the theory of social efficiency, the social benefits of an economic decision must equal the social costs of that decision. The benefits are often measured in the form of marginal social benefits (MSB) and marginal social costs (MSC).
Social efficiency theory states that the marginal benefits of an economic decision must be equal to the marginal costs of that economic decision.
So, what is marginal social benefit? And what is marginal social cost? Marginal social benefit is the additional benefit acquired by society as a whole from the consumption of an additional unit of a good or service. On the other hand, marginal social cost is the additional cost paid by society as a whole for the consumption of an additional unit of a good or service.
Marginal social benefit is the additional benefit acquired by society as a whole from the consumption of an additional unit of a good or service.
Marginal social cost is the additional cost paid by society as a whole for the consumption of an additional unit of a good or service.
Social benefit includes both private benefit and external benefit whereas social cost includes both private cost and external cost. Let's give you the formulas involved.
For social efficiency,
Figure 2 shows social efficiency.
Figure 2. Social Efficiency, StudySmarter Originals
In a perfectly competitive market, all rational agents have full information about the market, and this means that the firms will sell products at the market price and the consumers will buy products at this same market price. Therefore, there is social efficiency in a perfectly competitive market as the marginal social benefits match the marginal social costs at equilibrium. This is shown in Figure 2 at the point labeled "equilibrium".
There is social efficiency in a perfectly competitive market as the marginal social benefits match the marginal social costs at equilibrium.
At this point, the optimal quantity has been achieved. Firms are selling just the right quantity for consumers to buy, and there is no waste. Economists say that the economic surplus has been maximized, and there is no deadweight loss.
Optimal quantity is the quantity at which the marginal social benefit equals the marginal social cost and economic surplus has been maximized.
Economic surplus simply refers to the benefit remaining after paying all necessary costs.
Deadweight loss refers to the cost society pays when the market is not at equilibrium and marginal social benefit is not equal to marginal social cost.
When the optimal quantity has not been achieved, this means that firms are either producing less than needed or they are producing more than needed. To maximize economic surplus, economists must make sure there is no benefit left on the table and the cost has not exceeded the benefit either.
Social Efficiency Ideology
In economics, social efficiency ideology says that economic decisions must be taken while considering the implications for society as a whole. Here, both positive and negative implications must be considered. This is done by considering externalities. There are two types of externalities: positive externalities and negative externalities.
Positive externalities are the benefits enjoyed by third parties as a result of the consumption of a good or service. On the other hand, negative externalities are the costs incurred by third parties as a result of the consumption of a good or service.
Positive externalities are the benefits enjoyed by third parties as a result of the consumption of a good or service.
Negative externalities are the costs incurred by third parties as a result of the consumption of a good or service.
In a market where externalities are not considered, there is significant deadweight loss. Look at Figure 3.
Figure 3. Deadweight loss with positive externalities, StudySmarter Originals
Instead of producing quantity QOPT, and selling at price POPT, the producer does not consider the extra cost to the consumer and produces quantity QMKT instead, but sells at price PMKT. In order to remove deadweight loss, the producer should produce quantity QOPT and sell at price POPT, where the marginal social benefit (MSB) = the marginal social cost, or supply (S).
Social Efficiency and Inefficiency
Given the chance, economic agents can make economic decisions solely based on private considerations. These decisions can lead to negative externalities, since only the private costs and private benefits were considered. A monopoly is a perfect example of such a scenario. As the firm sets prices higher than the market price would be in perfect competition, economists say that the firm is exercising or exploiting market power.
A firm exercises market power when it can control the price of a product in a market.
So, what can happen when a firm exploits or exercises market power? Social inefficiency! Yes, social inefficiency results since the producer surplus now does not match the consumer surplus. The firm only considers the private benefits and private costs, leaving room for inefficiencies since the external costs may exceed the external benefits. Look at the following example.
A town had several firms selling shirts. Since these firms were competing, the price of a shirt was $5 at equilibrium when the market supply was matching the market demand for shirts. A new, bigger firm moved into the town and acquired all these smaller firms, making it the only firm producing shirts. Since there are no other firms to put pressure on this firm, it sets the price for a shirt at $10, doubling the competitive equilibrium price.
In the example above, the firm exploited market power since it was the only firm producing shirts. It doubled the price of a shirt, exceeding the price at which the benefit of consumers would match their cost. This results in a
higher producer surplus and a
lower consumer surplus!
Social Efficiency Examples
Here is an example of social efficiency:
A football game at the 100-capacity stadium charges $50 per ticket. The cost to set up the game is $5000. The game takes place and records the attendance of 100 people. The crowd gets their money's worth of entertainment and the football teams get paid their service's worth.
That's it! You're done with the article on social efficiency! You should look at our article on Economic Inefficiency where we discuss some pretty cool efficiency stuff related to this article.
Socially Efficiency - Key Takeaways
- Social efficiency is the optimal distribution of resources in society taking into consideration all the internal and external costs and benefits.
- Private costs and benefits (internal costs and benefits) are the direct costs and benefits of an economic decision.
- Marginal social benefit is the additional benefit acquired by society as a whole from the consumption of an additional unit of a good or service. Marginal social cost is the cost paid by society as a whole for the consumption of an additional unit of a good or service.
- Optimal quantity is the quantity at which the marginal social benefit equals the marginal social cost and economic surplus has been maximized.
- Deadweight loss refers to the cost society pays when the market is not at equilibrium and marginal social benefit is not equal to marginal social cost.
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