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Chapter 5

Chapter 5 Efficiency and Equity-ECON.docx

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University of Waterloo
ECON 101
Flora Ng

Chapter 5 Efficiency and Equity Resource Allocation Methods Scare resources might be allocated by  Market price  Command  Majority rule  Contest  First-come, first-served  Sharing equally  Lottery  Personal characteristics  Force How does each method work? Market Price When a market allocates a scarce resource, the people who get the resource are those who are willing to pay the market price. Most of the scarce resources that you supply get allocated by market price. You sell your labour services in a market, and you buy most of what you consume in markets. For most goods and services, the market turns out to do a good job. Command Command system allocates resources by the order (command) of someone in authority. For example, if you have a job, most likely someone tells you what to do. Your labour time is allocated to specific tasks by command. A command system works well in organizations with clear lines of authority but badly in an entire economy. Cuba, North Korea: central planner decides what to produce, how to produce (insufficient supply of food) Majority Rule Majority rule allocates resources in the way the majority of voters choose. Societies use majority rule for some of their biggest decisions. For example, tax rates that allocate resources between private and public use and tax dollars between competing uses such as defense and health care. Majority rule works well when the decision affects lots of people and self-interest must be suppressed to use resources efficiently. Contest A contest allocates resources to a winner (or group of winners). The most obvious contests are sporting events but they occur in other arenas: For example, The Oscars are a type of contest. Contest works well when the efforts of the “players” are hard to monitor and reward directly. First-Come, First-Served A first-come, first-served allocates resources to those who are first in line. Casual restaurants use first-come, first served to allocate tables. Supermarkets also uses first-come, first-served at checkout. First-come, first-served works best when scarce resources can serves just one person at a time in a sequence. Sharing Equally When a resource is shared equally, everyone gets the same amount of it. You might use this method to share a dessert in a restaurant. To make sharing equally work, people must be in agreement about its use and implementation. It works best for small groups who share common goals and ideals. Lottery Lotteries allocate resources to those with the winning number, draw the lucky cards, or come up lucky on some other gaming system. Provincial lotteries and casinos reallocate millions of dollars worth of goods and services each year. But lotteries are more widespread. For example, they are used to allocate landing slots at some airports. Lotteries work well when there is no effective way to distinguish among potential users of a scarce resource. Personal Characteristics Personal characteristics allocate resources to those with the “right” characteristics. For example, people choose marriage partners on the basis of personal characteristics. But this method gets used in unacceptable ways: allocating the best jobs to white males and discriminating against women. Force Force plays a role in allocating resources. For example, war has played an enormous role historically in allocating resources. Theft, taking property of others without their consent, also plays a large role. But force provides an effective way of allocating resources—for the state to transfer wealth from the rich to the poor and establish the legal framework in which voluntary exchange can take place in markets Demand and Marginal Benefit Demand, Willingness to Pay, and Value Value is what we get, price is what we pay. The value of one more unit of a good or service is its marginal benefit. We measure value as the maximum price that a person is willing to pay. But willingness to pay determines demand. A demand curve is a marginal benefit curve. Marginal Benefit Marginal benefit is the benefit that a person receives from consuming one more unit of a good or service. People’s preferences determine marginal benefit. The marginal benefit from a good is what people are willing to forgo to get one more unit of the good. Marginal benefit decreases as the quantity of the good increases—the principle of decreasing marginal benefit. Individual Demand and Market Demand The relationship between the price of a good and the quantity demanded by one person is called individual demand. The relationship between the price of a good and the quantity demanded by all buyers in the market is called market demand. Consumer Surplus Consumer surplus is the value of a good minus the price paid for it, summed over the quantity bought. It is measured by the area under the demand curve and above the price paid, up to the quantity bought. Supply and Marginal Cost Supply, Cost, and Minimum Supply-Price Cost is what the producer gives up, price is what the producer receives. The cost of one more unit of a good or service is its marginal cost. Marginal cost is the minimum price that a firm is willing to accept. But the minimum supply-price determines supply. A supply curve is a marginal cost curve. Individual Supply and Market Supply The relationship between the price of a good and the quantity supplied by one producer is called individual supply. The relationship between the price of a good and the quantity supplied by all producers in the market is called market supply. Producer Surplus Producer surplus is the price received for a good minus the minimum-supply price (marginal cost), summed over the quantity sold. It is measured by the area below the market price and above the supply curve, summed over the quantity sold. Is the Competitive Market Efficient? At the equilibrium quantity, marginal benefit equals margin
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