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Chapter 5

Chapter 5.docx

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Department
Economics
Course
ECON 1000
Professor
All Professors
Semester
Winter

Description
1 Chapter 5 – Efficiency and Equity Resource Allocation Methods Resources are scarce, so they must be allocated somehow. Trading in markets is just one of the several alternative methods. Resources might be allocated by: • Market Price. When a market price allocates a scarce resource, the people who are willing and able to pay that price get the resource. Two kinds of people decide not to pay the market price: those who can afford to pay but choose not to buy and those who are too poor and simply cannot afford to buy. • Command. Acommend system allocates resources by the order of someone in authority. In the Canadian economy, the command system is used extensively inside firms and government departments.Acommand system works well in organizations in which the lines the lines of authority and responsibility is clear and it is easy to monitor the activities being performed. • Majority Rule. Majority rule allocates resources in the way that a majority of voters choose. 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.Acontest allocates resources to a winner. Contests do a good job when the efforts of the “players” are hard to monitor and reward directly. • First-Come, First-Served.Afirst-come, first-served method allocates resources to those who are first in line. First-come, first-served works best when a scares 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. 2 • Lottery. Lotteries works best when there is no effective way to distinguish among potential users of a scares resource • Personal characteristics. People with the “right” characteristics get the resource • Force. 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. Demand, Willingness to Pay and Value 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 marginal benefit by the maximum price that is willingly paid for another unit of the good or service. But willingness to pay determines demand. A demand curve is a marginal benefit curve. Individual Demand and Market Demand The relationship between the price of a good and the quantity demanded by one person is called individual demand.And the relationship between the price of a good and the quantity demanded by all buyers is called market demand. 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. For private person individual demand curve is the marginal benefit curve. For society, the market demand curve is the marginal benefit curve. We call the marginal benefit to the entire society marginal social benefit. So the market demand curve is also marginal social benefit curve, MSB curve. 3 Consumer Surplus Consumer surplus is the excess of the benefit received from a good over the amount paid for it. We can calculate consumer surplus as the marginal benefit (or value) of a good minus its price, summed over the quantity bought. All goods and services have decreasing marginal benefit, so people receive more benefit from their consumption than the amount they pay. 4 Supply, Cost, and Minimum Supply-Price Producers distinguish between cost and price. Cost is what a firm gives up when it produces a good or service and price is what a firm receives when it sells the good or service. The cost of producing one more unit of a good is its marginal cost. 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. But the minimum supply-price determines supply.Asupply curve is a marginal cost curve. Individual Supply and Market Supply The relationship between the price of a good and the quantity supplied by one producer is called individual supply. The relationship between the price of a good and the quantity supplied by all producers is called market supply. The 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. 5 For society, the market supply curve is the marginal cost curve. We call society’s marginal cost marginal social cost. So the market supply curve is marginal social cost curve. Producer Surplus When the price exceeds marginal cost, the firm receives a producer surplus. Producer surplus is the excess of the amount received from the sale of a good or service over the cost of producing it. It is calculated as the price received minus the marginal cost (or minimu
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