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
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
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.
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