What kind of factors can disrupt allocative efficiency and economic welfare?

Question

What kind of factors can disrupt allocative efficiency and economic welfare?

Answer 1

a big one is externalities. When private marginal costs are not the same as social marginal costs (or sub benefits) then markets can not produce allocative efficiency and max welfare.

Answer 2

Market Power: When a company has market power, the demand curve it faces is not perfectly elastic as in a perfectly competitive market. Because of this, its marginal revenue is not constant throughout all levels of output and is always less than price with the exception of the first unit. Marginal cost and Revenue intersect at a lower output than when marginal cost and price (demand curve) do. Basically, there are people still willing to pay for the cost of producing the extra unit but it is more profitable for the firm to restrict output.

Sorry my answer is somewhat vague, it is just that a college level course would spend a couple of weeks on this alone (It can get alot more complicated), and I don't have that kind of time.

Answer 3

These are microeconomics questions, so we'll examine from a quantitative perspective. Economic welfare is measured as a comparable unit, so we can think of it as the amount of total "utility" derived within a market system. Allocative efficiency is close to pareto efficiency - that the last unit allocated is given to the consumer who derives the most utility.

Transaction costs are a big item, though often underappreciated in theory. Consider that the cost of getting goods to market is one of the largest factors hampering growth in much of the 3rd world. Information costs (which may be considered part of transaction costs) are another disruption - something that is being remedied of late in many rural markets by the introduction of cell phones and cell phone networks which allow farmers to learn the market price without having to take a day off work and walk down to the markets.

One factor that cannot impact allocative efficiency or economic welfare is initial allocation. If you begin with several consumers and a fixed amount of goods, it does not matter who gets what at the start, so long as there are no transaction costs the end result will have allocative efficiency, and this is primarily because the market will work to price goods relative to their scarcities.