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Chapter 7

Economics 1021A/B Chapter Notes - Chapter 7: Externality

Course Code
ECON 1021A/B
Terry Biggs

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Economics 1021A Chapter 5 2013-10-02
Scare resources might be allocated by:
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 system allocates resources by the order (command) of someone in authority.
A command system works well in organizations with clear lines of authority but badly in an entire economy.
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, government decides the allocations of 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.
A contest allocates resources to a winner (or group of winners).
The CEO is the winner of a contest as is the winner of The Masters
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.

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Supermarkets use first-come, first-served at checkout.
First-come, first-served works best when scarce resources can serve just one person at a time in a
Lotteries allocate resources to those with the winning number, draw the lucky cards, or come up lucky on
some other gaming system.
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 minorities and women.
Force plays a role in allocating resources.
For example, war has played an enormous role historically in allocating resources.
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.
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.
The relationship between the price of a good and the quantity demanded by one person is called
individual demand.
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