Review of Lec 3
Conditions for a Well-Functioning Market
Theoretically, competition should ensure resources are allocated efficiently
(assuming property rights, well-functioning legal systems, etc.), with goods going to
those who value them the most as measured by their willingness to pay.
Due to market imperfections this outcome is rarely, if ever realized.
Conditions necessary for efficient market allocation:
1) An absence of Market Power (on both the demand and supply sides)
2) Adequate Information (sufficient for both purchasers and producers to make
3) Absence of Externalities
The Mechanics of the Market
Individual Behavior and the Demand for Goods and Services
Income and Substitution Effect:
The movement along the original indifference curve from A to B is the substitution
The movement from B to C (moving up to the new budget line) is the income effect.
The income effect always starts where the substitution effect leaves off.
Demand and Supply Together:
Markets with Imperfect Competition
Markets and Market Failure
The Welfare Effects of Externalities
The Welfare Effects of Market Power
The Welfare Effects of Informational Problems
Methods of Economic Evaluation An economic evaluation is the systematic, comparative analysis of two (or more)
courses of action in terms of both their costs and their consequences.
Three Methods of Economic Evaluation:
1. Cost-Effectiveness Analysis:
Measures consequences in the natural units in which they occur; does not
assign a social value to the consequences as part of the evaluation. Assesses
efficiency in terms of costs per unit effect achieved.
Incremental Cost-Effectiveness Ratio (ICER):
----For a comparison of two programs A and B
ICER = (CostA – CostB)/(EffectA – EffectB)
Tells us the additional cost incurred per additional unit of effect achieved
when we use alternative A compared to alternative B
2. Cost-Utility Analysis:
Uses the same structure as Cost-Effectiveness Analysis, but outcomes are
valued in terms o