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Lecture 5

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ECON 1000
George Georgopoulos

WEEK 5: CHAPTER 5: EFFICIENCY AND EQUITY RESOURCE ALLOCATION METHODS: Resources may be allocated by:  Market price – people who are willing to pay get the resource. There are people who choose not to buy, or people who can’t afford to buy  Command – order by someone in charge (job  boss)  Majority rules – voters choose (works well when decisions affect a large group of people)  Contest – allocates resources to a winner (sporting events)  First come first served – those who are first in line (best when it can serve one user at a time)  Lottery – random, and lucky  Personal characteristics – people with the right characteristics get the resources (marriage)  Force – can be good or bad. War or Legal system DEMAND AND MARGINAL BENEFIT: Resources are allocated efficiently when they’re used in ways that people value most highly (marginal benefit = marginal cost) Value – what we get Price – what we pay Value of one more unit of a good is its marginal benefit Demand curve is a marginal benefit curve Individual demand – relationship between price of a good and quantity demanded by one person Market demand – price of a good and the quantity demanded by all buyers Market demand curve is the marginal social benefit (MSB) curve Consumer Surplus – value of good minus price paid for it (sum of all quantities sold SUPPLY AND MARGINAL COST Firms sell their output for a price that exceed the cost of production Cost – what a producer gives up Price – is what a producer receiver The cost of producing one more unit is the marginal cost (minimum price = cost) A supply curve is a marginal cost curve Individual supply – relationship between price and quantity supplied Market supply – quantity supplied by all producers The market supply curve is the marginal social cost (MSC) curve Producer surplus – price received minus marginal cost (sum of all quantities sold) IS THE COMPETITIVE MARKET EFFICIENT? When the demand curve and supply curve intersect, it shows efficient use of resources for the entire society When efficient quantity is produced, total surplus is maximized Inefficiency is when there is too little (underproduction) or too much (overproduction) of something produced Deadweight – decrease in total surplus (because of inefficiency) Obstacles to efficiency that being overproduction or underproduction are:  Price and Quantity regulations – put a cap or limit production  Tax and Subsidies – taxes increase prices paid by buyers and lower price received by seller (decrease quantities produced). Subsidies decrease the price paid by buyers and increase price received by sellers (overproduction)  Externalities – cost or benefit that affects someone other than buyer/seller  Public Goods and Common Resources – a public good is something used by everyone but they never pay for (National defense) and a common resource is something owned by no one but available to everyone  Monopoly – sole provider of a good (charge whatever and underproduction)  High Transaction costs – opportunity cost of making a trade (rent for store) IS THE COMPETITIVE MARKET FAIR? It makes sense to make the economic pie as big as possible, and to produce it at the lowest possible cost. Ideas about fairness can be divided into two broad groups: It’s not fair if the result isn’t fair – result is what matters Utilitarianism – greatest good for greatest number – no rich/no poor – the greater a person’s income, the smaller marginal benefit a dollar has The Big Tradeoff – taxing only the high income (makes the work less) and taxing their capital makes them save less (leads to smaller quantity of labour and capital) Economic pie shrinks  tradeoff is between size of pie and the equality of slices Make the poorest as well off as possible – a bigger share of a smaller pie can be less than a smaller share of a bigger pie It’s not fair if the rules aren’t fair Symmetry principle – people in similar situations should be treated similarly (equality of opportunity). Law of fairness obeys two rules: 1. State must enforce laws that establish and protect private property 2. Price property may be transferred from one person to another only by voluntary exchange The first rule prevents theft and the only way to acquire something is to buy/trade for it, and the second rules states that everyone, weak or strong, is treated the same CHAPTER 6: GOVERNMENT ACTIONS IN MARKETS A HOUSING MARKET WITH A RENT CEILING: Price ceiling/Price cap – illegal to change higher than specified level If above equilibrium  no effect If below equilibrium  powerful effects on a market Rent ceiling – cap on a housing market When set below equilibrium, it creates:  Housing short
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