Lecture 02. Chapter 2 Efficiency, Markets, and Government

Transcription

1 Lecture 02 Chapter 2 Efficiency, Markets, and Government

2 Positive vs. Normative Analysis Positive Analysis: concerned with what is. They are factual Statements Useful to the normative approach Normative needs to understand the facts of human behavior in order to achieve outcomes believed to be desirable Example: How much will health care reform cost? Normative Analysis: concerned with what ought to be. They are Opinion, Value Judgments Useful to the positive approach Normative side defines relevant issues Example: We should try to reform health care so that everyone is covered

3 Positive vs. Normative Analysis Positive Analysis: concerned with what is. They are factual Statements Normative Analysis: concerned with what ought to be. They are Opinion, Value Judgments Examples: Normative or Positive? 1. An increase in the minimum wage will cause a decrease in the employment among the least skilled. Ans: Positive, it can be compared to fact. 2. The income Gains from a higher minimum wage are worth more than any slight reductions in employment. Ans: Normative worth expresses a value judgment 3. State governments should be allowed to collect from tobacco companies the costs of treating smoking-related illness among the poor. Ans: Normative should expresses a value judgment

4 Establishing the Baseline Markets and welfare When do markets work to maximize welfare? What criteria do we have to judge over all welfare?

5 Economic Surplus: An Introduction Economists like markets. WHY? Operations of markets make people better off Because people are better off, society is better off Economists use surplus to describe the better-offness of society Efficiency is when surplus is as large as possible Example: Please share when you got a good deal on something Willingness to pay above market price is called Consumer Surplus Commercial Illustrating this idea Need two things: (1) How much you are willing to pay and (2) Price Ebay Please share when you sold something for more than you were expecting Received more for a good than the minimum you would have accepted Producer Surplus

6 A Market Whose behavior is represented by the demand curve? Consumers Whose behavior is represented by the supply curve? Producers/Firms

7 Consumer Surplus How Many cups would be Sold at a Price of $3.50? 3, Tim does not value tea more than $3 Does Each person have to pay their willingness to pay? No, each person pays the market price Key Point: The demand curve can be thought of as the marginal benefit curve

8 Consumer Surplus Consumer Surplus: The difference between the highest price a consumer is willing to pay and the price the consumer actually pays Example: New chair Measures the net benefits from participating in the market (ie what you would pay minus what it actually costs.

9 Consumer Surplus for an Entire Market. $3.50

10 Producer Surplus When will a producer supply a cup of tea? When the producer receives more than the cost to produce that cup (that is, when Price > Marginal Cost) 1.75 Why isn t this area part of the Producer s Surplus? Ans: Because it represents the cost the producer must incur to produce For each unit, the area below the supply curve represents the marginal (or extra) cost of production

11 Surplus Producer Surplus: Difference between the price a firm receives and the lowest amount it would be willing to accept Measures the net benefit to producers of participating in the market (i.e. Amount Firms receive from consumers costs)

12 Economic Surplus Economic surplus The sum of consumer surplus and producer surplus. CS: Area Below Demand Curve and above price. PS: Above Supply Curve, Below Price Blue area + Red Area = Economic Surplus

13 Your Turn 1. True, False, or Uncertain? Explain When a market is in equilibrium, there is no consumer surplus. We know this because in equilibrium, the market price is equal to the price consumes are willing to pay for the good.

14 Terms to help us understand Efficiency Marginal social benefit the extra benefit by making one more unit of that good available in a given time period Downward sloping Think Demand Curve Marginal social cost minimum sum required to compensate the owners of inputs used for making an extra unit of the good available Upward sloping Think Supply curve

15 Economic Efficiency and Deadweight Loss When Surplus (our measure of better-off-ness) is as big as possible Economic Efficiency Marginal Benefit =Marginal Cost Equilibrium Deadweight Loss Def: The surplus lost from the market not being at the best point. LOST = MSC 14,000 = MSB

16 Deadweight Loss At 14,000 cups, there is surplus that society could be enjoying, but they are not. Extra Benefits = $2.20 Extra Costs = $1.80 Should society consume the 14,000 th unit? A good Deal? Yes, Society could be better off by $0.40 If not produced/consumed, that surplus will be lost $2.20 $ ,000 LOST = MSC = MSB

17 Deadweight Loss 16,000 cups is too much! Extra Benefits = $1.80 Extra Costs = $2.20 Should society consume the 16,000 th unit? A good deal No, Society would be worse off by $0.40 If produced/consumed, that surplus will be lost $2.20 $1.80 The lost triangle is subtracted from surplus LOST 16,000 = MSC = MSB

18 Efficiency Criterion Way to judge if a resource allocation is in everyone s welfare. This is our foundation for evaluating markets and the role of government Definition: Resources are allocated efficiently when it is impossible to increase the well being of another person without reducing the well-being of another person. Example: Allocating three pieces of pizza to everyone in the class.

19 At Q1, the output is inefficient because suppliers can be made better off without harming any consumers. The flip side: At Q1, if sellers made the bread available for $1, the buyers would be better off without harming the sellers. Marginal conditions for efficiency MSB = MSC

20 Mutually Beneficial Trade Even when production is accomplished with out waste, additional gains are usually possible through mutually agreeable exchanges. Ticket Trading Example Discussion: Markets for Organs Take home point: Efficiency is not the only criterion by which society judges outcomes.

21 Example At lunch, a friend of yours named Ryan stands up to buy an ice cream. You ask him if he would buy you a cookie. He does and when he gives it to you, you offer him the dollar it cost. You friend refuses the dollar and you feel very guilty. Another friend, Tom, offers to take the dollar and so you give it to him. Is this an example of an efficiency enhancing transaction?

22 More Terms: Total Social benefit: The total benefit to society of enjoyed through the consumption of an economic good. Total Social Cost: Cost (or value) of all resources necessary to make a given amount of an economic good.

23 Total Costs and Total Benefits Graphically Moving from Marginal quantities to Total Quantities When we thinking about being well off, do we want total benefit to be way above total costs, or equal to total costs?

24 Marginals, Totals, and Efficiency When MSB = MSC, surplus is maximize Efficiency When no more beneficial trades can take place Efficiency When TSB is as far above TSC as possible Efficiency

25 Question for Review Draw the Market For ipads. Label completely Identify the efficient quantity. Label the Point Q* At the efficient point, What is the marginal net benefit of ipads? Note, marginal net benefit = MSB - MSC Below the market for ipads, Draw the Total Benefit and Total Cost Curves. In this new graph, identify the efficient quantity. Label the quantity Q*

26 Assumptions of the Model of Perfect Competition In a perfectly competitive market: 1. All productive resources are privately owned. Why does this matter? Fishing Example Elephant in Africa Example ANS: All firms are selling identical products. Example: Wheat, Film Development, lawn care 2. There are many buyers and sellers such that no single entity can influence Why can t any one buyer or seller influence Price? Examples by contrast: Can WalMart as a buyer influence price? Can Microsoft influence price?

27 Assumptions of the Model of Perfect Competition (continued) 4. All relevant information is available to buyers and sellers. What are the implications? 5. Resources are mobile and may be freely employed in any enterprise. Often thought of as free entry and free exit assumption. Implicit assumption in economics: Economics agents seek to maximize their own utility (well being) Can you think of any examples of markets that satisfy the assumptions of perfect competition?

28 Markets and Efficiency Purchasers consider their own Marginal Private Benefit Purchasers trade until their benefit = what they must forgo to obtain one more unit of the good. What must we forgo to obtain one more unit? Price = MPB = MSB Notice how privately owned resources comes into play here. If everything is privately owned, then the extra private benefit = the extra social benefit MPB = MSB Sandwich example and private benefits Pizza Example and price = MPB

29 Markets and Efficiency Producers trade until the revenue obtained from selling one more unit is equal to the cost of producing the unit What do producers receive per unit? Price = MPC = MSC Notice the use of privately owned resources Under the assumptions of perfect competition, are markets efficient? Ans: Yes WHY? Price = MPB = MSB = MPC = MSC In other words MB = MC for society

30 When do markets fail to allocate efficiently? When one or more of the assumptions of a well functioning market do not hold. Taxes and Subsidies What is the main assumption that is violated? Price no longer contains perfect information about the scarcity of resources or the preferences of the public.

31 Taxes and Efficiency Tax causes the amount of a good or service that is traded to be influenced by tax paid per unit, not only marginal social benefit/cost Note: We begin to see that any time the marginal social cost or marginal social benefit is not accurately reflected in price, there is a case for efficiency loss Therefore, the tax distorts decisions of market participants Occurs in product and factor markets. What kind of distortion may occur in the market for labor?

32 Surplus and Taxes Assume the government requires sellers to pay a dollar tax per pack, what is going to happen to our graph? Supply curve shifts vertically one dollar. Why? Result: Taxes Cause a DWL Loss in Competitive Markets Because sellers require $1.00 more to sell the same quantity. Consumers pay $4.90, How much do producers receive? $3.90, WHY? They had to pay a dollar Tax Notice the wedge between how consumers value cigarettes and how much it costs to produce them. MSB > MSC When MSB > MSC the surplus is not as large as possible. This causes a deadweight loss.

33 Loss of Efficiency Due to Taxes

34 Efficiency and Subsidies Is efficiency loss also possible due to subsidies? Remember: Any time price does not reflect the marginal social benefits or costs, there is the possibility for a loss of efficiency. Supply1 = MSC + Subsidy

35 When do market fail to allocate efficiently? When one or more of the assumptions of a well functioning market do not hold. Monopoly Power What is the main assumption that is violated? Many sellers assumption is violated. This allows the monopolist to influence the supply of goods and services.

36 Does Monopoly Reduce Economic Efficiency? Comparing Monopoly and Perfect Competition

37 Monopoly and Surplus (or efficiency) loss Surplus is reduced because society does not get to consume those units. Monopoly is associated with a deadweight loss Note that Price goes from P C to P M. for a monopolist. Do you think this is better for consumers or producers? Producers Some of consumer surplus is transferred to the monopolist If this were a perfectly competitive industry, where would the economic surplus be? Since the monopolist does not produce the competitive amount, what happens to surplus?

38 Figure 2.2 page 63

39 Efficiency vs. Equity Many people think that resources should be allocated according to some measure of fairness Any problems with fairness? Whose opinion of fair? What if imposing fairness inhibits individual productivity? How can we model these ideas?

40 Utility Possibilities Curve Definition: a curve presents the maximum attainable level of well-being (utility) for one individual, given the utility level of others in the economy, their tastes, resource availability, and technology.

41 Utility Possibility Curve Is E1 Efficient? Is E2 Efficient? Is X Efficient? How Might Efficiency be obtained from X? Would Anyone oppose a move from X to E3? Could B Convince A to move from X to E3?

42 Utility Possibility Curve What Relevance does this Graph have to Public Policy? Individuals/Organizations wanting point X are content with a larger share of a smaller pie