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Chapter 5

Economics 1021A/B Chapter Notes - Chapter 5: Social Cost, Avoidance Speech, Externality


Department
Economics
Course Code
ECON 1021A/B
Professor
Michael Parkin
Chapter
5

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Economics Chapter 5 Notes
October 4, 2010
Resource Allocation Methods
Resources must be allocated by:
1. Market Price
When a market price allocates a scarce resource, the people hwo are willing
and ale to pay that price get the resource
Two kinds of people decide not to pay that price:
Those who can afford it but choose not to buy it
Those who can’t afford it
Because poor people can’t afford items that most people consider to be
essential, these items are usually allocated by one of the other methods
1. Command
Command system: allocates resources by order (command) of someone in
authority
in Canada, used inside firms and government departments
E.g. if you have a job, most likely someone tells you what to do. Your labour
is allocated to specific task by a command
Works well in organizations in which the lines of authority are clear and it is
easy to monitor activities, but works bad when the range of activities to be
monitored is large and when it is easy for people to fool those in authority
1. Majority rule
Allocates resources in the way that a majority of voters choose
Societies use this rule to elect representative governments that make some
of the biggest decisions
Works well when the decisions being made affect large numbers of people
and self-interest must be suppressed to use resources most effectively
1. Contest
Allocates resources to a winner or group of winners
Used by sporting events
Do a good job when the efforts of the “players” are hard to monitor and
reward directly
E.g. when a manager offers everyone in the company an opportunity to win a
big prize, everyone works hard to get it even though only one or few people
win

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1. First-Come, First-Served
Allocates resources to those who are first in line
1. Lottery
Allocates resources to those who pick the winning number, draw the lucky
card etc.
Work best when there is no effective way to distinguish among potential
users of a scarce resource
1. Personal Characteristic
Allocates resources on the basis of personal characteristics
Good- choosing a marriage partner
Bad- best jobs to white guys
1. Force
Plays a crucial role for both good and ill
Ill – war and theft
Good – transferring wealth from rich to poor
Demand and Marginal Benefit
Resources are allocated efficiently when they are used in the ways that
people value most highly
This outcome occurs when marginal benefit equals marginal cost
To determine whether a competitive market is efficient, we need to see
whether, at the market equilibrium quantity, marginal benefit equals
marginal cost
Value: of one more unit of a good or service is its marginal benefit
We measure marginal benefit by the maximum price that is willingly paid for
another unit of the good or service
Willingness to pay determines demand
Demand curve is a marginal benefit curve
Individual Demand: the relationship between the price of a good and he quantity
demanded by one person
Market demand: the relationship between the pice of a good and the quantity
demanded by all buyers
E.g.
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Lisa is willing to pay $1 for the 30th slice of pizza and $1 is her marginal
benefit
Nick is willing to pay $1 for the 10th slice of pizza and $1 is his marginal
benefit
But what quantity is the market willing to pay $1 for the marginal slice?
Consumer Surplus
Consumer surplus: when people buy something for less than it is worth
the value (or marginal benefit) of a good minus the price paid for it, summed
over the quantity bought
Supply and Marginal Cost
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