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Chapter 5

Chapter 5

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Western University
Economics 1021A/B
Michael Parkin

Chapter 5- Efficiency and Equity Resource Allocation Methods • evaluate the ability of markets to allocate resources efficiently and fairly • we must compare it with its alternative • resources are scare, must be allocated • trading in markets i just one of several alternative methods MARKET PRICE • when a market price allocates a scarce resource, the people who are willing and able to pay that price get the resource • those who can afford to pay but choose not to buy and those who are too poor and simply can’t afford to buy • for many goods, distinguishing between those who choose to buy and those who can’t afford to doesn’t matter • but for a few items, it does matter i.e. school or doctors’fees COMMAND • command system- allocates resources by the order of someone in authority • in Canada, command system is used extensively inside firms and government departments works well in organizations in which the lines of authority and responsibility are clear and it is • easy to monitor the activities being performed • works badly when the range of activities to be monitored is large MAJORITY RULE • allocates resources in the way that a majority of voters choose societies use majority rule to elect representative governments that make some of the biggest • decisions i.e. tax rates • majority rule works well when the decisions being made affect large numbers of people and self-interest must be suppressed to use resources most effectively CONTEST • allocates resources to a winner i.e. sporting events • contests do a good job when the efforts of the “players” are hard to monitor and reward directly FIRST-COME, FIRST-SERVED • allocates resources to those who are first in line i.e. casual restaurants won’t accept reservations • works best when a scarce resource can serve just one user at a time in a sequence • by serving the user who arrives first, this method minimizes the time spent waiting for the resource to become free LOTTERY • allocate resources to those who pick the winning number, draw the lucky cards i.e. lotteries and casinos reallocate millions of dollars worth of goods and services every year lotteries are used to allocate landing slots to airlines at some airports • • works best when there is no effective way to distinguish among potential users of a scarce resource PERSONAL CHARACTERISTICS • allocated on the basis of personal characteristics, people with the “right” characteristics get the resources • some of the resources that matter most to you are allocated this way FORCE • force plays a crucial role, for both good and ill, in allocating scarce resources • war has played an enormous role historically in allocating resources • theft also plays a large role • large-scale organized crime and petty crime collectively allocate billions of dollars worth of resources annually • force plays a crucial positive role in allocating resources, it provides the state with an effective method of transferring wealth from the rich to the poor • a legal system is the foundation on which our market economy functions, courts to enforce contracts • courts could not enforce contracts without the ability to apply force if necessary • force of the state is essential to uphold the principle of the rule of law with the rule of law upheld, people can go about their daily economic lives with the assurance • that their property will be protected • free from the burden of protecting their property, people can get on with focusing on the activity at which they have a comparative advantage and trading for mutual gain Demand and Marginal Benefit • resources are allocated efficiently when they are used in the ways that people value most highly • marginal benefit equals marginal cost • determine whether a competitive market is efficient see whether, at the market equilibrium quantity, marginal benefit equals marginal cost DEMAND, WILLINGNESS TO PAY,AND VALUE • value is what we get, price is what we pay • measure marginal benefit by the maximum price that is willing paid for another unit of the good or service • willingness to pay determines demand • a demand curve is a marginal benefit curve • at what quantity is the market willing to pay $1 for the marginal slice, market demand curve INDIVIDUAL DEMANDAND MARKET DEMAND • relationship between the price of a good and the quantity demanded by one person is called individual demand • relationship between the price of a good and the quantity demanded by all buyers is called market demand • market demand curve is the horizontal sum of the individual demand curves and is formed by adding the quantities demanded by all the individuals at each price market demand curve is the marginal social benefit (MSB) curve • • think of the price as the number of dollars’worth of other goods willingly forgone to obtain one more CONSUMER SURPLUS • when people buy something for less than it is worth to them, they receive a consumer surplus consumer surplus- the value (or marginal benefit) of a good minus the price paid for it, • summed over the quantity bought • consumers surplus is the sum of the surpluses on all of the slices she buys • all goods and services have decreasing marginal benefit, so people receive more benefit from their consumption than the amount they pay Supply and Marginal Cost • firms must sell their output for a price that exceeds the cost of production SUPPLY, COSTAND MINIMUM SUPPLY-PRICE • producers distinguish between cost and price • cost is what a producer gives up, and price is what a producer receives • marginal cost is the minimum price that producers must receive to induce them to offer one more unit of a good or service for sale • supply curve is a marginal cost curve INDIVIDUAL SUPPLYAND MARKET SUPPLY • relationship between the price of a good and the quantity supplied by one producer is called individual supply • relationship between the price of a good and the quantity supplied by all producers is called market supply • market supply curve is the horizontal sum of the individual supply curves and is formed by adding the quantities supplied by all the producers at each price • market supply curve is the marginal social cost (MSC) curve • think of the price as telling us the number of dollars’worth of other goods and services that must be forgone to produce one more PRODUCER SURPLUS when price exceeds marginal cost, the firms receives a producer surplus • • producer surplus- the price received for a good minus its minimum supply-price (or marginal cost), summed over the quantity sold • producer surplus is the sum of the surpluses • consumer surplus and producer surplus can be used to measure the efficiency of a market Is the Competitive Market Efficient? EFFICIENCY OF COMPETITIVE EQUILIBRIUM • we call the marginal benefit to the entire society, marginal social benefit, MSB • we call the marginal cost to the entire society, marginal social cost, MSC • where the demand curve and supply curve intersect, marginal social benefit equals marginal social cost • if production is less than equilibrium quantity, the good is valued more highly than it costs to produce • if production exc
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