Question

.Using a graph, explain why a competitive market in which the price is lower than the market equilibrium is not Pareto efficient.

(You can draw the graph, take a picture and attach it here. Please do *not* take a picture of your hand-written answer, it is much easier for your marker to read typed text)

Answer 1

Take the diagram above:

Pareto efficient outcome occurs when it is impossible to make one party better off without making other worse off. If current price ($5) is higher than equilibrium price ($3), supply (20) would be greater than demand (10). At this price, producers would be better off by making consumers worse off. This market will reduce price till it reaches equilibrium price. On the other hand, lower current price ($2) than equilibrium price ($3) make consumer better off and make producer worse off. This price will raise price level till it reaches equilibrium price. Thus, we can say that pareto efficient outcome occurs when demand = supply where no one is worse off.