Question

Consider the competitive market for wheat. Suppose the government suddenly decides to impose a binding production quota (possibly through a system of tradable licenses which it auctions to raise government revenue). We know that this will lower the equilibrium quantity produced and raise the price relative to the market equilibrium. How would you argue that new equilibrium is inefficient?

Simply point out that since it is not a free market equilibrium, it must be inefficient.

Point to transaction that is now blocked that would make one or more parties better off without making anyone else worse off

Point out that the policy lowers firm profits hence it must not be efficient

Argue that all government interventions are inefficient

Answer 1

Point to transaction that is now blocked that would make one or more parties better off without making anyone else worse off

The resultant outcome is Pareto inefficient because the welfare of both producers and consumers can be increased without decreasing the welfare of each other. restriction has increased the price and reduced the quantity resulting in a loss of consumer and producer welfare. Due to this reason there is an inefficiency pertaining to the allocation of resources.