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Microeconomics Question from Walter E. Williams:Edit

"Atomistic markets are supposed to permit the achievement of Pareto optimality where externalities are absent. Explain the meaning of this statement. Do externalities offer unambiguous proof of market inefficiency or is it possible for externalities to be consistent with market efficiency? Explain."

AnswerEdit

Atomistic Markets == Alchain's word for very competitive firms. [Atom] originally mean the smallest unit (by analogy, this is also true of a competitive firm)

The first statement simply means that competitive markets will bring about a state of affairs where all mutually beneficial exchanges have been made, or that no more exchange can take place without making at least one individual worse off (Pareto optimal).

  • Marginal Benefit of the item equals Marginal Costs (the opportunity costs of the items included in the finished item)

As far as externalities are concerned, they do not necessarily imply market inefficiency. Externalities arise in cases where property rights have not been defined, or are only defined ambiguously. However, this does not mean the situation is inefficient. For instance, as Demsetz explained, property rights institutions will arise only when it is economically efficient. Lack of property rights could mean that it is too costly to enfore said rights.

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