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Chapter 2 - Benchmark model of the economy
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Chapter 2Benchmark model of the economy:
Positive and Normative Approach
Public Economics (Calitz, et al. Chapter 1)
2.1 Basic assumptions of the benchmark model
The benchmark model – based on a host of patently unrealistic assumptions that are
set out below
- Describes a stable economy in which all resources are used optimally → can
help us understand and appreciate real world problems better as a result.
- Depicts how the economy should run in the ideal economy → does not
provide an accurate picture of the real world.
- It is a general equilibrium model (all markets are in equilibrium at the same
time) that is used to determine the “ideal situation” with relation to economic
efficiency (a country’s ability to achieve economic growth)
Model assumptions: relates to normative economics
1. 2x2x2 model
a. 2 producers of commodities, 2 consumers, 2 suppliers of factors of
production
b. Labour and capital are used to produce goods X and Y that are both
consumed by an individual.
2. No external influences
a. All parties are fully informed about the economy.
b. All parties are unaffected by the actions of other consumers and
producers.
c. Consumers have fixed tastes.
d. No external effects associated with consumption.
3. The 2 Production processes have:
a. Unlimited factor substitutability → labour and capital can be instantly
moved from one sector to another.
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, b. Diminishing marginal productivities
c. Constant returns to scale → rules out (dis)economies of scale, while
there are also no external costs/benefits in production
d. Isoquant – is a curve that shows combinations of inputs that yield the
same level of output
4. Consumers maximise utility and producers maximise profits.
a. Both are perfectly informed about their respective environments
5. Commodity and factor markets are perfectly competitive
a. It implies that each market behaves ‘as if’ there were a large number of
individual demanders & suppliers involved.
b. both markets clear and there is neither a surplus nor deficit.
The assumptions ensure the existence, uniqueness, and stability of the general
equilibrium.
2.2 Benchmark model and allocative efficiency: (relates to
normative economics)
Economic efficiency → consists of allocative efficiency and technical efficiency (X-
efficiency) → a country’s ability to achieve economic growth.
Achieving perfect economic efficiency ensures the ability to achieve optimal
economic growth → want to achieve economic efficiency so that we can achieve
optimal economic growth.
Government should intervene to help the economy improve its economic efficiency
and societal welfare and diminish it → government should help achieve economic
efficiency and not hamper it.
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