Econ 2113: Principles of Microeconomics. Spring 2009 ECU

Transcription

1 Econ 2113: Principles of Microeconomics Spring 2009 ECU

2 Chapter 5 Efficiency and Equity

3 Resource Allocation Methods You re on a bus filled to capacity going up to snowboard at Mammoth and the bus breaks down 2 miles away from your lodge. A replacement bus comes but it only holds half the number of people as the old bus and it can only make one trip up tonight (the road down is blocked by snow). Who gets to ride up on the replacement bus?

4 Resource Allocation Methods Scarce resources might be allocated by using any or some combination of the following methods: Market price Command Majority rule Contest First-come, first-served Sharing equally Lottery Personal characteristics Force

5 Demand and Marginal Benefit Demand, Willingness to Pay, and Value Value is what we get, price is what we pay. The value of one more unit of a good or service is its marginal benefit. We measure value as the maximum price that a person is willing to pay. Willingness to pay determines demand. A demand curve is a marginal benefit curve.

6 Demand and Marginal Benefit Individual Demand and Market Demand The relationship between the price of a good and the quantity demanded by one person is called individual demand. The relationship between the price of a good and the quantity demanded by all buyers in the market is called market demand.

7 Demand and Marginal Benefit The market demand curve is the horizontal sum of the individual demand curves.

8 Market Demand P 11 6 D 2 Market demand 5 7 D 1 12 Q

9 Demand and Marginal Benefit Consumer Surplus (Buyers Surplus) Consumer surplus is the value of a good minus the price paid for it, summed over the quantity bought. It is measured by the area under the demand curve and above the price paid, up to the quantity bought. Example: What is the market consumer surplus of consuming 5 million sodas?

10 Demand and Marginal Benefit P 11 If the price of a soda is $6 per can, then: 6 CS Total Paid 5 Q (mill.)

11 Demand and Marginal Benefit Notice that total value is the area under the demand curve (green plus grey). The total shaded area is equal to $42.5 mill. The grey area is called consumer surplus, and it is equal to $12.5 mill. in the example CS measures the benefit for the consumers beyond what they pay, and therefore it is a gain to the consumers from buying the good

12 Supply and Marginal Cost Supply, Cost, and Minimum Supply-Price Cost is what the producer gives up, price is what the producer receives. The cost of one more unit of a good or service is its marginal cost. Marginal cost is the minimum price that a firm is willing to accept. The minimum supply-price determines supply. A supply curve is a marginal cost curve.

13 Supply and Marginal Cost Individual Supply and Market Supply The relationship between the price of a good and the quantity supplied by one producer is called individual supply. The relationship between the price of a good and the quantity supplied by all producers in the market is called market supply.

14 Supply and Marginal Cost The market supply curve is the horizontal sum of the individual supply curves. Blackboard

15 Supply and Marginal Cost Producer Surplus (Sellers Surplus) Producer surplus is the price received for a good minus the minimum-supply price (marginal cost), summed over the quantity sold. It is measured by the area below the market price and above the supply curve, summed over the quantity sold. Question: What is the producer surplus of producing 5 mill. sodas?

16 Supply and Marginal Cost If the price of a soda is $6 per can, then: S P 6 PS 1 TC 5 Q (mill.)

17 Supply and Marginal Cost Total cost is the area under the supply curve, equal to $17.5 mill. The red area is called producer surplus, and equals $12.5 mill. PS measures the benefit for producers beyond what they spend to produce the good, and therefore it is a gain to producers from selling the good

18 Total surplus Total surplus is the sum of CS and PS TS = PS + CS

19 Total Surplus P 11 S 6 CS PS 1 5 D Q (mill.)

20 Total Surplus If the market clears (i.e. it is in equilibrium), then demand must equal supply In this case there are 5 mill. sodas sold at a price of $6 each Total surplus is the sum of consumer and producer surplus. That is the net benefit for all market participants combined In this case total surplus equals $25 mill. (gray plus red)

21 The Market and Efficiency At the equilibrium quantity marginal benefit equals marginal cost. This is the efficient quantity. When the efficient quantity is produced, total surplus (the sum of consumer surplus and producer surplus) is maximized

22 The Market and Efficiency The Invisible Hand Adam Smith s invisible hand idea in the Wealth of Nations implied that competitive markets send resources to their highest valued use in society. Consumers and producers pursue their own self-interest and interact in markets. Market transactions generate an efficient highest valued use of resources.

23 Deadweight loss from underproduction Underproduction The efficient quantity is 10,000 pizzas a day. If production is restricted to 5,000 pizzas a day, there is underproduction and the quantity is inefficient. A deadweight loss equals the decrease in total surplus the gray triangle. This loss is a social loss.

24 Deadweight loss from overproduction Overproduction Again, the efficient quantity is 10,000 pizzas a day. If production is expanded to 15,000 pizzas a day, a deadweight loss arises from overproduction. This loss is a social loss.

25 Obstacles to Efficiency In competitive markets, underproduction or overproduction arise when there are Price and quantity regulations Taxes and subsidies Monopoly

26 Price and Quantity Regulations Price regulations sometimes put a block on price adjustments and lead to underproduction. Quantity regulations limit the amount that a firm is permitted to produce also leads to underproduction.

27 Taxes and Subsidies Taxes increase the prices paid by buyers and lower the prices received by sellers. So taxes decrease the quantity produced and lead to underproduction. Subsidies lower the prices paid by buyers and increase the prices received by sellers. So subsidies increase the quantity produced and lead to overproduction.

28 Monopoly A monopoly is a firm that has sole provider of a good or service. The self-interest of a monopoly is to maximize its profit. To do so, a monopoly sets a price to achieve its self-interested goal. As a result, a monopoly produces too little and underproduction results.

29 Markets and Fairness Ideas about fairness can be divided into two groups: It s not fair if the result isn t fair It s not fair if the rules aren t fair

30 It s Not Fair if the Result Isn t Fair Utilitarianism: the principle that states that we should strive to achieve the greatest happiness for the greatest number. If everyone gets the same marginal utility from a given amount of income, and if the marginal benefit of income decreases as income increases, taking a dollar from a richer person and giving it to a poorer person increases the total benefit. Only when income is equally distributed has the greatest happiness been achieved.

31 Big Tradeoff Utilitarianism ignores the cost of making income transfers. Recognizing these costs leads to the big tradeoff between efficiency and fairness. You re at an oasis in a desert. You have ice cream in an unmovable fridge. Some people at the next oasis are starving. Ice cream is the only food available. If you try to transport your ice cream to them some of the ice cream will melt along the way. How much of the ice cream would have to make it to be worth transporting it?

32 Big Tradeoff Similarly to the example, usually income is lost when redistribution takes place Redistribution diminishes the incentives to work Higher taxes encourage people to work less Higher transfers encourage receivers to work less

33 It s Not Fair If the Rules Aren t Fair The idea that it s not fair if the rules aren t fair is based on the symmetry principle, which is the requirement that people in similar situations be treated similarly.

34 Equality of Opportunity In economics, this principle means equality of opportunity, not equality of income. Robert Nozick suggested that fairness must be based on two rules: The state must create and enforce laws that establish and protect private property. Private property may be transferred from one person to another only by voluntary exchange. This means that if resources are allocated efficiently, they may also be allocated fairly.