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Chapter 5

Economics 1021 Chapter 5 Notes

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Economics 1021A/B
Jeannie Gillmore

Chapter 5: Efficiency and Equity Resource Allocation Methods  Market Price: The people who are willing and able to pay the allocative market price get the resource o Those who don‟t pay the market price are those who cannot afford it, or those who do not want the resource  Command: Someone in authority orders the allocation of resources o Used extensively inside firms and government departments (authority is the line of command) o Makes it easy to monitor activities and separate responsibilities, but only to a certain extent  Majority Rule: Allocates resource in the way that a majority of voters choose o Works well when the decision is being made affect many people and self-interest is suppressed for effectively  Contest: Resource is allocated to a winner o Works well when the efforts of the competitors are hard to monitor and reward directly, as the total output produced by them is much greater than it would be without a contest  First-Come, First-Served: Resource is allocated to those who are first in line o Works well when a scarce resource can serve limited users in a time sequence, as it minimizes the time spent waiting for the resource to become free  Lottery: Resource is allocated to those who comes up lucky in a gaming (gambling) system o Works well when there is no effective way to distinguish among potential users of a scarce resource  Personal Characteristics: Resource is allocated on the basis of personal characteristics  Force: Resource is allocated forcefully by those in power, even without the consent of the owners o Ill Use: War, organized crimes o Beneficial Use: Transferring wealth from rich to poor, necessary power of law in general Demand and Marginal Benefit  Demand & Willingness to Pay & Value o Value: What we get; measured as the maximum price that a person is willing to pay o Price: What we pay; measured as the number of dollars‟ worth of other goods willingly forgone o Marginal Benefit: Value of one more unit of a good or service o Demand: Determined by willingness to pay (demand curve = marginal benefit curve)  Individual Demand & Market Demand o Individual Demand: Relationship between the price of a good and the quantity demanded by one person o Market Demand: Relationship between the price of a good and the quantity demanded by all buyers o Market Demand Curve: Horizontal sum of the individual demand curves and is formed by adding the quantities demanded by all the individuals at each price (Also marginal social benefit curve)  Consumer surplus: The value of a good minus the price paid for it summed over the quantity bought o Assuming that all goods and services have decreasing marginal benefit. th o EX: Pizza is sold for $1 per slice. Lisa buys 30 slices, because the 30 slice is worth $1 to her. However, Lisa is willing to pay $2 for the 10 slice, so her marginal benefit from that piece is $1 more than she pays for it. Supply and Marginal Cost  Supply, Cost & Minimum Supply-Price o Cost: What a producer gives up o Price: What a producer receives; the dollars‟ worth of other goods and services that must be forgone o Marginal Cost: The minimum price that a producer is willing to accept in return for goods or services o Supply: Determined by minimum supply-price (supply curve = marginal cost curve)  Individual Supply & Market Supply o Individual Supply: The relationship between the price of a good and the quantity supped by one producer o Market Supply: The relationship between all the producers at each price o Market Supply Curve: The horizontal sum of the individual supply curves and is formed by adding the quantities supplied by all the producers at each price (Also marginal social cost curve)  Producer Surplus: The price received for a good minus its minimum supply price, summed over the quantity sold o Assuming that all goods have increasing marginal benefit o EX: Max sells pizza at $15 per slice, and Max sells 100 slices for $15 dollars. However, Max is willing to sell the 50 slice for his marginal cost ($10) and therefore he receives a surplus of $5 on the slice. Is Competitive Market Efficient?  Efficiency of Competitive Equilibrium o In equilibrium (all resources are used efficiently), MSC = MSB o In equilibrium, the total surplus (consumer and producer) is maximized, therefore ending up promoting the social interest o Marginal Social Benefit: Marginal benefit of the entire society; MSB curve = Demand curve o Marginal Social Cost: Marginal cost of the entire society; MSC curve = Supply curve  Underproduction & Overproduction o Inefficiency can occur because too little or too much of an item is produced. This results in total surplus that is smaller than its maximum possible level. o Underproduction: If too little items are produced, there aren‟t enough products compared to customers o Overproduction: If too much item is produced, there are too much products compared to customers o Deadweight Loss: The decrease in total surplus that results from an inefficient level of production  Measures the scale of inefficiency with a loss that is borne by the entire society  Obstacles to Efficiency o Obstacles to efficiency that bring underproduction (under) or overproduction (over): o Price and Quantity Regulation  Price Regulations: Law that limi
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