Economics 1021A/B Chapter Notes - Chapter 5: Allocative Efficiency, Demand Curve, Economic Surplus

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Published on 13 Nov 2012
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Chapter 5 Notes
Resource Allocation Methods
resources are scarce, so they must be allocated
allocating can be performed in several ways
o market price
when a market price allocates a scare resource, the people who are
willing and able to pay that price get the resource
there are two kinds of people who decide not to pay the market price:
those who can afford but choose not to buy, and those too poor to buy
for many goods and services, distinguishing between those who
choose not to buy and those who can’t afford to buy doesn’t matter
o command
a command system allocates resources by order of someone in
authority
the 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 monitory the activities being
performed
o majority rule
majority rule allocates resources in a way that a majority of voters
choose
societies use majority rule to elect representative governments that
make economic decisions
works well when the decisions being made affect large numbers of
people and self-interest must be suppressed to use resources most
effectively
o contest
a contest allocates resources to a winner (or a group of winners)
contests do a good job when the efforts of the “players” are hard to
monitor and reward directly
e/x when a manger offers everyone in the company the opportunity to
win a big prize, people are motivated to work harder. Only a few
ending up winning, but many people worked harder, increasing total
output
o first-come, first-served
a first-come, first-served method allocates resources to those who are
first in line
works best when a scarce resource can serve just one user at a time in
a sequence, minimizing the time spent waiting for the resource to
become free
o lottery
span more than just gambling; airlines at airports, fishing rights,
electromagnetic spectrum used by cell phones
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lotteries work best when there is no effective way to distinguish
among potential users a scarce resource
o personal characteristics
o force
force plays a crucial role in allocating resources, as it provides the
state with an effective method of transferring wealth from the rich to
the poor, and it provides the legal framework in which voluntary
exchange in markets takes place
Benefit, Cost, and Surplus
resources are allocated efficiently and in the social interest when they are used in the
ways that people value most highly
we measure marginal benefit by the maximum price that is willingly paid for another
unit of the good or service
o willingness to pay determine demand
o thus, a demand curve is a marginal benefit curve
Individual 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
is called market demand
o the 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
we call the marginal benefit to entire society marginal social benefit
o thus, the market demand curve is also the marginal social benefit curve,
MSB
Consumer Surplus
consumer surplus is the excess of the benefit received from a good over the amount
paid for it
all goods are services have decreasing marginal benefit, so people receive more
benefit from their consumption than the amount they pay
Supply and Marginal Cost
for a firm to make profit, they must sell their output for a price that exceeds the cost
of production
o producers distinguish between cost and price
cost is what a firm gives up when it produces a good
price is what a firm receives when it sells the good or service
the cost of producing one more unit of a good or service is its marginal cost
o the minimum price that producers must receive to induce them to offer one
more unit a good
o the minimum supply price determines supply
thus, a supply curve is a marginal cost curve
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