I havent had econ since sophmore year and remember it being easy but as i work through theschweser book I am getting confused by allocative efficiency, and deadweight loss. does anyone have some great real life examples or easy methods for understanding them? I know this should be easy but i’m struggling. any help would be appreciated thanks.
have you tried reading the cfa materials?
You have a (good) bicycle in your basement that you rarely use. The value to you is $300 (you would sell it to anyone offering you at least $300). Your neighbour goes to work on a bike but his old bike is now good for garbage. He wants to buy a new bike and would be willing to pay at most $350 for a bike like yours. You and your neighbour could agree on a price between $300 and $350 and both of you would gain. If for example you sell you bike to your neighbour for $330, you make a surplus of 330-300=$30 on the value you put on your bike and your neighbour makes a surplus of 350-330=$20 on the value he puts on your bike. Hence a total surplus of 30+20=$50 has been realized by you and your neighbour. Gains from trade have been exploited by this transaction and thus the latter consisted in a move toward allocative efficiency (exploitation of all gains from trade, distribution of all possible surplus). Suppose now that the government imposes a tax of $75 on the sale of bicycles (you can’t evade this tax, the gov has spy cams everywhere). That is, selling your bike obliges you to send a cheque of $75 to the government. For you to end up with at least $300 in your wallet after the transaction, you need to sell you bike for at least $375. At this price your neighbour does not want is since he is willing to pay at most $350 for your bike. Because of the tax, a profitable trade does not take place and this creates a deadweight loss. I hope this helps
Market Pupil, Think of allocative efficiency as resources being moved towards their highest valued use… where it produces the most wealth. In addition to Madame _Boavary excellent explanation, I would also recommend looking at the CFAi text and get their explanation of areas you are having trouble with, I thought the econ book was really well put together.
Thank you very much. It has really cleared up for me after the excellent examples.