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Lecture 8

Lecture Eight: Efficiency and Equity

4 Pages

Course Code
ECON 1000
George Georgopoulos

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Lecture Eight: Efficiency and Equity Con’t October 25, 2011 Underproduction and Overproduction Inefficiency can occur because too little of an item is produced, or too much of an item is produced. Deadweight loss - the decrease in total surplus, coming from the inefficient allocation of resources. Social loss - the marginal benefit to society is less than the marginal cost to society. Obstacles to Efficiency In competitive markets, underproduction and overproduction arise when there are - Price and quantity regulations - Taxes and subsidies - Externalities - Public goods and common resources - Monopoly - High transaction costs Price and Quantity Regulations Price Regulations sometimes put a block of the price adjustments and lead to underproduction Quantity regulations that limit the amount that a firm is allowed to product and lead to underproduction Taxes and Subsidies Taxes increase the prices paid by buyers and lower the prices received by sellers. Taxes lead to decreases the quantity produced. Subsidies lower the prices paid by buyers and increase the prices received by sellers, which leads to overproduction because the price doesn't accurately reflect the cost of producing the good. Externalities An externality is a cost of benefit that affects someone other than the seller or buyer of a good. An electric utility creates an external cost by burning coal that creates acid rain. The utility doesn't consider this cost when it chooses the quantity of power to produce, overproduction results. Public Goods and Common Resources A public good benefits everyone and no one can be excluded from its benefits. It is in everyone’s self interest to avoid paying for a public good (called the free- rider problem), which leads to underproduction Examples - national defense, roads, public green spaces (such as parks) A common resource is owned by no one but can be used by everyone. It is in everyones self interest to ignore the cost of their own use of this good. There is no one person who can enforce who uses the good, or who can determine the exact usage of each person. 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. High Transaction Costs Transaction coss are the opportunity ost of making rades in a mark
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