Economic-Efficiency and Equity

Welcome to Managerial Economics

2
Mich Kimilang
(Jacky)
10751088
Cheam Sokleat
(Sunny)
10751065
Tim Pheakdey
(Kevin)
10751067
Monika Monu Singh
(Monika)
10751018
Emil Amangeldiev
(Li Min)
10751080
Group
Member
Efficiency and
Equity
Na Som Oun
(Same)
10751068

3Chapter 5 : EFFICIENCY AND EQUITY
After studying this chapter, you will be able to:
 Describe the alternative methods of allocating scarce
resources
 Explain the connection between demand and marginal
benefit and define consumer surplus; and explain the
connection between supply and marginal cost and define
producer surplus
 Explain the conditions under which markets are efficient
and inefficient
 Explain the main ideas about fairness and evaluate claims
that markets result in unfair outcomes
Objective:

Jacky (10751088)
Resource Allocation Methods

Scarce resources can be allocated using many
combinations of methods
1. Market price
2. Command
3. Majority rule
4. Contest
5. First-come, first-served
6. Lottery
7. Personal characteristics
8. Force

How does each method work?

• Market Price: When a market allocates a scarce resource, the people who get
the resource are those who are willing to pay the market price. (most used)
• Command System: Allocates resources by the order of someone in authority.
(works well in organizations, but badly in an entire economy)
• Majority Rule: Majority rule allocates resources in the way that a majority of
voters choose. (works well when self-interest needs to be depressed, large
societies)
• Contest: Allocates resources to a winner. (sporting events or the Oscars). When
it is hard to monitor everyone actions and rewards are given directly
• First-come, First-served: Allocates resources to those who are first in line.
(Supermarkets, restaurants). Scarce resources are served one person at a time.
This method minimizes the time spent waiting for the resource to become free.
RESOURCE ALLOCATION METHODS

• Lottery: Allocate resources to those with the winning number, draw the
lucky cards, or come up lucky. (work well when no better way to distinguish
between users).
• Personal characteristics: Allocate resources to those with the “right”
characteristics. Some of the resources that matter most to you are allocated
in this way. (choosing a mate). allocating the best jobs to white males and
discriminating against minorities and women.
• Force: War has played an enormous role historically in allocating resources.
War and theft – taking property of others without consent. Transfer wealth
from the rich to the poor and establish legal framework. (redistribution of
wealth)
RESOURCE ALLOCATION METHODS

Cheam Sokleat
(Sunny)
10751065

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’re now going to see whether competitive
markets produce the efficient quantities. We
begin on the demand side of a market.

Demand, Willingness to Pay, and Value
• In everyday life, we talk about “getting value for money.”
When we use this expression, we are distinguishing
between value and price. Value is what we get, and 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.

• 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.
Individual Demand and Market Demand

Consumer Surplus
• We don’t always have to pay as much as we are willingto pay.
We get a bargain. When people buy something for less than it
is worth to them, they receive a 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.

Supply, Cost, and Minimum Supply-Price
• Firms make a profit when they receive more from the sale of a
good or service than the cost of producing it. Just as consumers
distinguish between value and price, so 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 or service 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.
A supply 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. And 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.

Producer Surplus
•When 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 minimum supply-price),
summed over the quantity sold.
•Consumer surplus and producer surplus can be used to
measure the efficiency of a market.

Tim Pheakdey
(Kevin)
10751067
Is The Competitive
Market efficient

Efficiency of Competitive Equilibrium
 Equilibrium in a competitive market occurs when the quantity
demanded equals the quantity supplied at the intersection of the
demand curve and the supply curve. At this intersection point,
marginal social benefit on the demand curve equals marginal social
cost on the supply curve.
 This equality is the condition for allocative efficiency. So in
equilibrium, a competitive market achieves allocative efficiency.

If production is less than 10,000 pizzas a day, the marginal pizza is valued more highly than it
costs to produce. If production exceeds 10,000 pizzas a day, the marginal pizza costs more to
produce than the value that consumers place on it. Only when 10,000 pizzas a day are produced is
the marginal pizza worth exactly what it costs.
The competitive market pushes the quantity of pizzas produced to its efficient level of 10,000 a day. If
production is less than 10,000 pizzas a day, a shortage raises the price, which increases production. If
production exceeds 10,000 pizzas a day, a surplus of pizzas lowers the price, which decreases production. So a
competitive pizza market is efficient.

The demand curve and the supply curve
intersect

marginal social benefit equals marginal social
cost

Economics in Action
 The Invisible Hand: The unobservable market force that helps the
demand and supply of goods in a free market to reach equilibrium
automatically.
Example: A new technology cuts the cost of producing a smart phone.
With a lower production cost, the supply of smart phones increases and the
price of a smart phone falls. The lower price encourages an increase in the
quantity demanded of this now less-costly tool. The marginal social benefit
from a smart phone is brought to equality with its marginal social cost.

Market Failure
 Markets do not always achieve an efficient outcome. We call a situation
in which a market delivers an inefficient outcome one of market failure.
Market failure can occur because too little of an item is produced
(underproduction) or too much is produced (overproduction).
 It’ll describe these two market failure outcomes and then see why they
arise.

Emil Amangeldiev
(Li Min)
10751080
Source of Market Failure

Source of Market Failure
• Price and quantity regulations
• Taxes and subsidies
• Externalities
• Public goods and common resources
• Monopoly
• High transactions costs

Price and quantity regulations
• Price regulations that put a cap on the rent a
landlord is permitted to charge and laws that
require employers to pay a minimum wage
sometimes block the price adjustments that
balance the quantity demanded and the
quantity supplied and lead to
underproduction.
• Quantity regulations that limit the amount
that a farm is permitted to produce also lead
to underproduction.

Taxes and subsidies
• Taxes increase the prices paid by buyers
and lower the prices received by sellers. So
taxes decrease the quantity produced and
lead to underproduction.
• Subsidies, which are payments by the
government to producers, decrease the
prices paid by buyers and increase the
prices received by sellers. So subsidies
increase the quantity produced and lead to
overproduction.

Externalities
• An externality is a cost or a benefit that affects someone other than the
seller or the buyer.
• An external cost arises when an electric utility burns coal and emits
carbon dioxide. The utility doesn’t consider the cost of climate change
when it decides how much power to produce. The result is
overproduction.
• An external benefit arises when an apartment owner installs a smoke
detector and decreases her neighbor’s fire risk. She doesn’t consider the
benefit to her neighbor when she decides how many detectors to install.
The result is underproduction.

Public goods and common resources
• A public good is a good or service that is consumed simultaneously by
everyone even if they don’t pay for it. National defense is an example.
Competitive markets would underproduce national defense because it is
in each person’s interest to free ride on everyone else and avoid paying
for her or his share of such a good.
• A common resource is owned by no one but is available to be used by
everyone. Atlantic salmon is an example. It is in everyone’s self-interest
to ignore the costs they impose on others when they decide how much
of a common resource to use. The result is that the resource is overused.

Monopoly
• A monopoly is a firm that is the sole
provider of a good or service. Local
water supply and cable television are
supplied by firms that are monopolies.
The monopoly’s self-interest is to
maximize its profit. Because the
monopoly has no competitors, it can set
the price to achieve its selfinterested
goal. To achieve its goal, a monopoly
produces too little and charges too high
a price. It leads to underproduction.

High transactions costs
• Transaction costs are the costs incurred during
trading – the process of selling and purchasing –
on top of the price of the product that is changing
hands. Transaction costs may also refer to a fee
that a bank, broker, underwriter or other financial
intermediary charges.
• The difference between what a dealer and buyer
paid for a security is one of the transaction costs.
• Transaction costs may include legal fees,
communication charges, the information cost of
finding the price, or the labor required to bring a
good or service to market. When deciding
whether to make a product or purchase it,
transaction costs are a critical factor.

Monika Monu Singh
(Monika)
10751018

Is the
Competitive
Market Fair?

◆ Is the Competitive Market Fair.
• The reason is that ideas about fairness are not
exclusively economic ideas. They touch on
politics, ethics, and religion. Nevertheless,
economists have thought about these issues
and have a contribution to make To think
about fairness
• Ideas about fairness can be divided into two
groups:
• It’s not fair if the result isn’t fair.
• It’s not fair if the rules aren’t fair.

It’s Not Fair if the Result Isn’t Fair.
• The idea that “it’s not fair if the result isn’t
fair” began with utilitarianism, which is the
principle that states that we should strive to
achieve “the greatest happiness for the
greatest number .
• ”If everyone gets the same marginal utility
from a given amount of income, and if the
marginal benefit of income decreases as
income increases, taking a dollar from a richer
person and given it to a poorer person
increases the total benefit. Only when income
is equally distributed has the greatest
happiness been achieved.

• Figure 5.7 shows how redistribution increases
efficiency.
• Tom is poor
and has a high
marginal benefit
of income.
Jerry is rich
and has a low
marginal benefit
of income.
.Taking dollars from Jerry and giving them to Tom
until they have equal incomes increases total benefit.

The big Trade off.
• Utilitarianism ignores the cost of making
income transfers.
• Recognizing these costs leads to the big
tradeoff between efficiency and fairness.
• A bigger share of a smaller pie can be less than
a smaller share of a bigger pie
• Because of the big tradeoff, John Rawls
proposed that income should be redistributed
to point at which the poorest person is as well
off as possible.

.it’s Not Fair if the Rules aren’t
Fair.
• It’s Not Fair If the Rules Aren’t Fair.
• The idea that “it’s not fair if the rules aren’t
fair” is based on the symmetry principle,.
• symmetry principle. is the requirement that
people in similar situations be treated similarly.
• In economics, this principle means equality of
opportunity, not equality of income.

• Robert Nozick suggested that fairness is based on two rules,.
• 1.The state must create and enforce laws that establish and protect
private property.
• 2.Private property may be transferred from one person to another only
by voluntary exchange.
• This means that if resources are allocated efficiently, they may also be
allocated fairly.

Case study .
• Market Price Suppose that if the water is
allocated by market price, the price jumps to
$8 People who are willing and able to pay $8 a
bottle get the water. And because most people
can’t afford the$8 price, they end up either
without water or consuming just a few drops a
day.
• You can see that the water is being used
efficiently. There is a fixed amount available,
some people are willing to pay $8 to get a
bottle, and the water goes to those people
who one the sell the water .The out come is
fair, no one is denied the water they are willing
to pay for. In the results view, the outcome
would most likely be regarded as unfair. The
lucky owners of water make a killing, and the
poorest end up the thirstiest.

Market price with taxes
• Suppose water owners are taxed on each
bottle sold and the revenue from these taxes is
given to the poorest people. People are then
free, starting from this new distribution of
buying power, to trade water at the market
price.
• Because the owners of water are taxed on
what they sell, they have a weaker incentive to
offer water for sale and the supply decreases.
The equilibrium price rises to more than $8 a
bottle. There is now a deadweight loss in the
market for water—similar to the loss that
arises from underproduction on pp.

• So the tax is inefficient. In the rules view, the
tax is also unfair because it forces the owners
of water to make a transfer to others. In the
results view, the out-come might be regarded
as being fair.
• This brief case study illustrates the complexity
of ideas about fairness. Economists have a
clear criterion of efficiency but no comparably
clear criterion of fair-ness. Most economists
regard N o zick as being too extreme and want
a fair tax system, but there is no consensus
about what a fair tax system looks like.

Na Som Oun
(Same)
10751068

ECONOMIC ANALYSIS
■ Roses are traded in a global market.
■ Most of the roses sold in the United States come from Columbia and Ecuador, but the
world’s largest cut flower market is in Aalsmeer, Holland, where 75 percent of the world’s
flowers are traded every day.
• On a normal day
■ Figure 1 illustrates the market on a
normal day. The demand and marginal benefit
curve is D0 = MSB0; the supply and marginal cost
curve is S0 = MSC0; and the auction finds the
equilibrium and efficient outcome.

• Was not a normal day.
Figure 2: shows the situation on
April 19. Supply decreased
because the cost of inbound
transportation increased. Demand
decreased because the cost of
outbound transportation increased.

Summary the key points
Resource Allocation Methods (pp. 106–107)
• ■ Because resources are scarce, some mechanism
must allocate them.
• ■ The alternative allocation methods are market price;
command; majority rule; contest; first-come, first-
served; lottery; personal characteristics; and force.

Benefit, Cost, and Surplus (pp. 108–111)
■ The maximum price
willingly paid is marginal
benefit, so a demand curve
is also a marginal benefit
curve.
■ The market demand
curve is the horizontal sum
of the individual demand
curves and is the marginal
social benefit curve.
■ Consumer surplus is the
excess of the benefit
received from a good or
service over the amount
paid for it.
■ The minimum supply-
price is marginal cost, so a
supply curve is also a
marginal cost curve.
■ The market supply curve
is the horizontal sum of
the individual supply
curves and is the marginal
social cost curve.
■ Cost is what producers
pay; price is what
producers receive.
■ Producer surplus is the
excess of the amount
received from the sale of a
good or service over the
cost of producing it.

Is the Competitive Market Efficient?
■ In a competitive equilibrium, marginal social benefit
equals marginal social cost and resource allocation is efficient.
■ Buyers and sellers acting in their self-interest end
up promoting the social interest.
■ Total surplus, consumer surplus plus producer surplus, is maximized.
■ Producing less than or more than the efficient quantity creates
deadweight loss.
■ Price and quantity regulations; taxes and subsidies;
externalities; public goods and common resources;
monopoly; and high transactions costs can lead to market failure.

Is the Competitive Market Fair?
■ Ideas about fairness can be divided into two
groups: fair results and fair rules.
■ Fair-results ideas require income transfers
from the rich to the poor.
■ Fair-rules ideas require property rights and
voluntary exchange.

Economic-Efficiency and Equity

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