ECON111 Lecture Notes - Lecture 5: Demand Curve, Externality, Price Floor
Efficiency and Equity
This topic evaluates the ability of the market price to allocate scarce resources efficiently and fairly.
Under this system, the people who get the resource are those who are willing to pay the market
price. But, those who choose not to buy, and those who cannot afford to buy, at the market price do
not get the resource. For most goods and services, this does not matter and the market turns out to
do a good job. But for some items, like education and medical fees, it does matter and goods and
services are allocated by other methods.
Demand and Marginal Benefit
Consider that demand is dependent on the marginal benefit. How
much you are willing and able to pay depends on the extra benefit
you will gain from having it. Hence, the demand curve is the
marginal benefit curve.
Marginal benefit is measured by the maximum price that is
willingly paid for a good or service. But, e dot alas hae to
pay what we are willing to pay – we could get a bargain. In this
event, buyers get a consumer surplus.
Supply and Marginal Cost
Firms profit when they receive more for a good or service than the
cost of production. Marginal cost is the minimum price that
producers must receive in order to offer one more unit of a
product for sale. So, the minimum supply price determines supply,
and the supply curve is a marginal cost curve.
When price exceeds marginal cost, the firm receives a producer
surplus.
Efficiency of a Competitive Market
Resources are allocated efficiently when they are used in the ways that people value most highly.
This outcome occurs when marginal benefit equals marginal cost. When the efficient quantity is
produced, total surplus is maximised. Hence, consumer surplus and producer surplus show how the
market gives a net benefit and can be used to measure the efficiency of a market.
Market Failure
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Market transactions usually generate the most efficient use of resources. But markets dot alays
achieve an efficient outcome, and the total surplus could end up being less than its maximum
possible level. This can occur because of underproduction or overproduction. The cost of market
failure, or the scale of inefficiency, is measured as deadweight loss, which is a social loss.
Market failure can arise from:
• Price and quantity regulations:
o Price regulations that cap the amount that producers can charge, e.g. rent ceilings,
or create a minimum price, e.g. minimum wage, block price adjustments and lead to
underproduction.
o Quantity regulations that limit the amount that producers can create may also fall
short of the equilibrium quantity, and lead to underproduction.
• Taxes and subsidies:
o Taxes increase the prices paid by buyers and lower the prices received by sellers. So
taxes decrease the quantity produced, and lead to underproduction.
o Subsidies decrease the price paid by buyers and increase the price received by
sellers. So they increase the quantity produced and lead to overproduction.
• Externalities: This includes external costs like pollution, and external benefits like
immunisation. These are not taken into account, and therefore the market equilibrium may
not be the true equilibrium, creating deadweight loss.
• Public goods and common resources
o It is i eeroes est iterest to pay for their part public goods, but self-interested
people want to get a free ride. Hee, puli goods are under produced in a
market.
o Self-interested people ignore the costs they impose on others when they decide
how much of a common resource to use. In a market, that resource is thus
overused.
• Monopoly
o The oopols self-interested goal is to maximise its profits, and because of the
nature of a monopoly, it can produce too little and charge too high a price, leading
to underproduction.
Fairness of the Competitive Market
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Document Summary
This topic evaluates the ability of the market price to allocate scarce resources efficiently and fairly. Under this system, the people who get the resource are those who are willing to pay the market price. But, those who choose not to buy, and those who cannot afford to buy, at the market price do not get the resource. For most goods and services, this does not matter and the market turns out to do a good job. But for some items, like education and medical fees, it does matter and goods and services are allocated by other methods. Consider that demand is dependent on the marginal benefit. How much you are willing and able to pay depends on the extra benefit you will gain from having it. Hence, the demand curve is the marginal benefit curve. Marginal benefit is measured by the maximum price that is willingly paid for a good or service.
