Competitive markets are efficient because the equilibrium reflect productive efficiency and allocative efficiency.
Productive efficiency is achieved because competition forces producers to use the best technologies and combinations of resources to minimize costs.
Allocative efficiency is achieved because the correct quantity of production in produced relative to other goods and services.
The way to see why the equilibrium quantity is the correct quantity is based on analysis of consumer and producer surplus. Only at the equilibrium quantity does society achieve the maximum of total consumer surplus ( abc ) and producer surplus ( bcd ). Geometrically, producing the equilibrium quantity maximizes the combined area between demand curve and supply curve abd.
Quantities ( Q ' ) below the equilibrium quantity ( Q* ) are inefficient. The market suffers and underproduction and is illustrated in the graph below. The maximum willingness to pay on the demand curve up to the equilibrium quantity exceeds the corresponding minimum acceptable price on the supply curve. Thus, each of these units of production adds a positive amount to the total of consumer and producer surplus. By failing to produce these units society suffers a loss of net benefits ( bef ).
Quantities ( Q ' ) beyond the equilibrium quantity ( Q* ) are inefficient. The market suffers an overproduction and is illustrated in the graph below. The maximum willingness to pay on the demand curve beyond the equilibrium quantity is less than the corresponding minimum acceptable price on the supply curve. Thus, each of these units of production adds a negative amount to the total of consumer and producer surplus. Such production is uneconomical and creates an efficiency loss for society ( bef ).
Zoning laws is justified because it eliminates over-use of certain lands. Plants that emit pollution are supposed to be located downstream and far from farms so that the pollution will not pollute water and crops. Without the zoning law, plants will not take pollution in account and tend to use lands regardless of their location. External costs can be prevented by the zoning law. Zoning law eliminates the potential impropriate use of certain lands.
Fire prevention equipment provides external benefit to neighbors. The household that install the equipment not only benefit himself from reducing risk of fair, but also provides safety for neighbors. With tax breaks government is making subsidy to household who installs the equipment. The tax breaks make the price of equipment cheaper and increase the demand. As a result, the equilibrium quantity increases to the optimal level.
Consumption of beer has potential negative externalities such as higher risk of traffic accidents, less efficiency on job, higher risk of crime, etc. The excise taxes on beer raises the price and reduces demand. As a result, the equilibrium quantity demanded decreases to the optimal level.
The two characteristics of public goods are non-rivalry and non-excludability.
Non-rivalry means that the consumption of the good by one consumer does not decrease the availability of the good to other consumers. Consider the street lights. One consumer's use of street lights does not decrease others' use.
Non-excludability means that it is impossible to withhold any consumers who do not pay for a product from consuming the good. Consider national defense. It is impossible to exclude someone from the benefit of national defense.
When private provision happens the good is rivalry and excludable. When Adams purchases and drinks a bottle of water, it is not available for Benson to purchase and consume. Thus, the significance of rivalry is much higher for private provision than for public provision. Only people who are willing and able to pay the market price for bottles of water can obtain these drinks; thus, the significance of excludability is much higher for private provision than for public provision.
Free rider problem means that once a producer has provided a public good, everyone, including non-payers, can obtain the benefit. Non-excludability means that there is no way for producers to withhold the good from the free riders without also denying it to the few who do pay. Thus, if society wants public good it will have to direct government to produce it.
U.S. border control is a public good, because it is non-rivalry and non-excludable. One person's safety brought by the border control does not decrease the safety available to others; it is impossible to withhold someone in the U.S. from obtaining the benefit of U.S. border control.
Satellite TV is a quasi-public good. It is non-rivalry - one consumer's consumption does not affect the availability of Satellite TV to others. It is excludable - by charging a price, providers of satellite TV can exclude consumers who is not willing to pay the price.