AGEC 21700 Lecture Notes - Lecture 13: Economic Efficiency, Consumer Sovereignty, Economic Surplus

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grayhornet779

22 Sep 2016

School

Purdue University

Department

Agricultural Economics

Course

AGEC 21700

Professor

Weinstein Michael

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Document Summary

Economic efficiency is a necessary condition for maximizing social welfare. In a decentralized decision making society, price signals will provide incentives for agents (households and firm to determine what, how, when, and for to produce. Firm economic efficiency: a necessary condition for economic efficiency. Allocative efficient: minimize cost for a given level of output. Consumer and producer surplus are measures of economic efficiency. Their sum, total surplus, is employed as a surrogate for measuring economic efficiency. When total surplus is maximized for a market, that market is considered operating efficiently. Adam smith"s invisible hand no government is needed. The degree of government intervention depends on how much weight is given to the favorable vs the unfavorable features. Consumer surplus: the net benefit a consumer receives from a commodity. Willing to pay only paid net benefit is . Producer surplus: pure profit plus total fixed cost, which is equivalent to total revenue minus total variable cost.

Related Questions

Market Analysis Market Participants Market participants act as if they are rational, self-interested, and forward-looking. For example, financial managers try to maximize the present value of profits for their particular companies, rather than ignore future values. Companies pursue many goals, but it is a financial mistake for managers to pursue any goal that conflicts with the primary goal of maximizing their firm's profits. Decentralized decision making by individual market participants is more economically efficient that centralized decision making by government policymakers. For example, it is more economically efficient to have financial managers obtain financing for their particular companies than to have government obtain it. A high degree of competition among market participants is the most economically efficient disciplining mechanism. For example, highly competitive financial markets discipline financial managers to pay fair market interest rates on the debt securities issued by their particular companies. The market system of prices is the most economically efficient allocative mechanism. For example, it is more economically efficient to distribute a firm's corporate stock to those buyers who are willing and able to pay the market price of the stock than to have the government distribute the stock. It is economically efficient for market participants to buy low and sell high globally. For example, it is economically efficient for U.S. firms to sell their financial securities to the highest bidders, no matter where they live in the world economy. Market imperfections can create considerable risk to market participants. For example, because of market imperfections, firms operating in the international financial markets encounter foreign exchange rate risk, political risk, interest rate risk, and default risk. Consumer Sovereignty The principle of consumer sovereignty tells us that by making their dollar votes, consumers indirectly determine the quantity and quality of products that firms will produce. For example, it is not economically efficient for financial managers to obtain more financing for their particular firms than is needed for their firms to produce the profit-maximizing level of output demanded by consumers. Market Economy A highly competitive market economy is largely self-regulating, in the absence of substantial market imperfections, in that economic conditions cannot be substantially improved by government regulation or other types of government intervention beyond laissez-faire policies. For example, if a firm's corporate stock is overvalued by a market economy, market forces will tend to drive down the value of the stock to a market price at which it is neither overvalued nor undervalued. As if by an invisible hand, highly competitive market forces will tend to create a harmony of interests among individual market participants, in the absence of substantial market imperfections. Consequently, the interests of shareholders and other stakeholders are compatible. For example, in trying to maximize profits, firms produce employment, income, consumer products, and wealth for households, as well as tax revenue for government, which helps maximize consumer utility and maximize social welfare. In a market economy, resources, products, and assets flow to their highest valued uses among alternative uses. For example, the shares of firms' corporate stocks will be acquired by those market participants who most highly value them, as indicated by the fact that they are willing to pay the most to acquire them. The efficient economic role of government is limited to Laissez-Faire ("hands off") policies, which create very little intervention in a market economy. For example, government regulations of banking and securities industries to maintain healthy, reasonably profitable, consumer-oriented financial markets would not be needed in a highly competitive market economy in the absence of substantial market imperfections. In a market economy, it is economically efficient for each market participant to specialize according to comparative advantage in producing what they can produce relatively better than other market participants, rather than produce all the outputs they can produce absolutely better than others. For example, it is economically efficient for people who are relatively better at being financial managers than others, to specialize in financial management even if they are absolutely better than others in doing many other types of work. If all labor were allocated to its comparative advantage, then no possible reallocation of labor would exist that could increase the rate of return to labor (i.e., the wage). There is no such thing as a free lunch, because all resources, products, and assets in a market economy are scarce. For example, current federal government budget deficits are not free to current market participants in that the deficits must be financed by future tax increases and/or future decreases in government spending and/or future inflation. For additional information on the Market Economy click here. Marks, R. E. (2006, December). There Is No Such Thing As Free Lunch. Australian Journal of Management. 31(2). 1-7. Financial Decisions An efficient financial decision, practice, transaction, or condition is one that is optimal -- meaning best; it cannot be improved, from society's perspective. If there is some profitable way to improve some business practice that would benefit society, that practice is somewhat inefficient. Any change in a financial decision, practice, transaction, or condition that improves society is an efficiency improvement. For example, it is an efficiency improvement for a business to cut production costs by reducing waste (e.g., by reducing spending on unprofitable activity. A financial decision, practice, transaction, or condition is fair-- meaning just or equitable, if the financial benefits are distributed to those involved in proportion to how much they each voluntarily contributed to produce those benefits. For example, a financial practice that discriminates against some people on the basis of race, age, gender, nationality, or religion is unfair. For example, an unethical business practice is unfair. For additional information relating to Market Analysis and fair financial decisions, click on the following: Teaching Ethical Economic Practices to Business Managers. Johnston, C. (2009, October). The Proceedings of the Annual Conference of The International Academy of Business and Economics. Fairness is a necessary condition, but not a sufficient condition, for efficiency. All efficient financial practices are fair, but some fair practices may still fail to be efficient. For example, embezzling company funds is an unfair and inefficient, criminal financial activity. As another example, an ethical business practice that could be improved is fair but not efficient. Opportunity Cost Principle Opportunity cost principle: The efficient measure of the cost of any allocation of resources, products, money income, wealth, or time is its opportunity cost -- the value of the next best use. The opportunity cost of how one uses his or her resources is the value of the highest valued alternative use. The opportunity cost of one investment is the expected return on the next best investment available to the firm. For example, the opportunity cost of a firm using some of its profits to pay dividends to its stockholders would be the present value of future income those profits could have earned if invested in the firm's highest valued investment project.

Discussion Questions These questions stem from the Class Discussion Questions you will be anwering in the Discussion Board. Think about the questions and how they relate to the financial management principles above.

2. Applications: State the financial management principle that appears to be violated in each of the following cases and explain how it is violated:

(a) A corporation is maximizing sales growth and the price of its corporate stock is falling.

(b) A highly paid financial manager in the auto industry quit his job to set up his own small auto repair shop, which is expected to incur a loss for the first three years then earn normal profits.

1).

A consumer spends more time searching for a good when her reservation price is:

increased.

reduced.

fixed.

None of the statements is correct.

2).

In the game shown below, firms 1 and 2 must independently decide whether to charge high or low prices.

Which of the following are Nash equilibrium payoffs in the one-shot game?

(0, 0)

(5, -5)

(-5, 5)

(10, 10)

3).

A risk-neutral individual would:

prefer $5 with certainty to a risky prospect with the expected value of $5.

prefer a risky prospect with an expected value of $5 to a certain amount of $5.

be indifferent between a risky prospect with an expect value of $5 to a certain amount of $5.

prefer a risky prospect with the expected value of $0.50 to $5 with certainty.

4).

Snowpeak Ski Resort offers a price for a lift ticket that is barely over its marginal cost, but the high equipment rental fee keeps generating big profits. Which pricing strategy is the management using?

Price discrimination

Two-part pricing

Commodity bundling

Cross-subsidization

5).

The short run is defined as the time frame:

in which there are no fixed factors of production.

in which there are fixed factors of production.

less than one year.

less than three years.

6).

Fixed costs exist only in:

the long run.

capital-intensive markets.

the short run.

labor-intensive markets.

7).

Top of Form

Non-fed ground beef is an inferior good. In economic booms, grocery managers should:

increase their orders of non-fed ground beef.

reduce their orders of non-fed ground beef.

not change their orders of non-fed ground beef.

neither increase, reduce, nor maintain their current orders for non-fed ground beef.

Bottom of Form

8).

Which of the following pricing strategies is NOT used in markets with special cost and demand structures?

Peak-load pricing

Cross-subsidization

Transfer pricing

Low-price guarantees

9).

A perfectly competitive firm faces a:

perfectly elastic demand function.

perfectly inelastic demand function.

demand function with unitary elasticity.

None of the answers is correct.

10).

The special demand structure that induces a firm to use a cross-subsidization strategy is:

perfect substitution among products.

imperfect substitution among products.

independent demand for products.

interdependent demand for products.

11).

Which of the following factors reduces the need for government involvement in the marketplace?

The presence of externalities

The incentive to rent-seek

The need for public goods

Incomplete information

12).

Which of the following statements is true?

A mineral rights auction is not the same as a common-value auction.

An auctioneer is always indifferent between different kinds of auctions.

The Dutch and first-price, sealed-bid auctions are strategically equivalent.

An English auction always yields lower expected revenues than a second-price, sealed-bid auction.

13).

Which of the following is true concerning negative externalities?

Firms tend to produce more than the efficient level of output.

Society gains because firms do not pay the external costs of production.

Perfect competition is better than monopoly from the viewpoint of society even in the presence of negative externalities.

With negative externalities, a monopoly will always produce an output level less than is socially efficient.

14).

Which of the following is true under monopoly?

P > ATC

P > MC

P = MR

P = ATC

15).

Differentiated goods are NOT a feature of a:

perfectly competitive market.

monopolistically competitive market.

monopolistic market.

perfectly competitive market and monopolistic market.

16).

Producer surplus is measured as the area

below the demand curve and above the market price.

above the demand curve and below the market price.

above the supply curve and below the market price.

below the supply curve and above the market price.

17).

Jaynet spends $25,000 per year on painting supplies and storage space. She recently received two job offers from a famous marketing firm â one offer was for $105,000 per year, and the other was for $85,000. However, she turned both jobs down to continue a painting career. If Jaynet sells 30 paintings per year at a price of $9,000 each:

a. What are her accounting profits?

$

b. What are her economic profits?

$

18).

You are the manager of a monopoly that sells a product to two groups of consumers in different parts of the country. Group 1âs elasticity of demand is -2, while group 2âs is -4. Your marginal cost of producing the product is $40.

a. Determine your optimal markups and prices under third-degree price discrimination.

Instruction: Round your answers to two decimal places.

Markup for group 1:
Price for group 1: $

Markup for group 2:
Price for group 2: $

b. Which of the following are necessary conditions for third-degree price discrimination to enhance profits.

Instructions: You may select more than one answer. Click the box with a check mark for the correct answers and click twice to empty the box for the wrong answers. You must click to select or deselect each option in order to receive full credit.

	At least one group has elasticity of demand less than one in absolute value.
	There are two different groups with different (and identifiable) elasticities of demand.
	We are able to prevent resale between the groups.
	At least one group has elasticity of demand greater than 1 in absolute value.

19).

You are the manager of a firm that receives revenues of $60,000 per year from product X and $80,000 per year from product Y. The own price elasticity of demand for product X is -1.5, and the cross-price elasticity of demand between productY and X is -1.4.

How much will your firm's total revenues (revenues from both products) change if you increase the price of good X by 2 percent?

Instructions: Round your answer to the nearest dollar. Include a minus (-) sign if applicable.

$

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AGEC 21700 Lecture Notes - Lecture 13: Economic Efficiency, Consumer Sovereignty, Economic Surplus

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