CH5 Efficiency and Equity
Outline
I.
Efficiency and the Social Interest
A. Recall from Chapter Two that an efficient allocation of resources occurs when we cannot
produce more of one good without giving up the production of some other good that is
valued more highly.
1.
This definition implies that it is not possible to make someone better off without
making someone worse off.
 Efficiency is based on values, which are determined by people’s preferences.
B. Marginal benefit is the benefit a person receives from consuming one more unit of a
good or service.
1.
We can measure the marginal benefit from a good by the dollar value of other goods
that a person is willing to give up to get one more unit.
2.
The concept of decreasing marginal benefit implies that as more of a good is
consumed, its marginal benefit decreases.
3.
Figure 5.1 shows the decreasing
marginal benefit from each
additional slice of pizza, measured in
dollars per slice.
C. Marginal cost is the opportunity cost of
producing one more unit of a good. The
measure of marginal cost is the value of
the best alternative forgone to obtain the
last unit of the good.
1.
We can measure the marginal cost of
a good or service by the dollar value
of other goods and services that a
person is must give up to get one
more unit of it.
2.
The concept of increasing marginal
cost implies that as more of a good
or service is produced, its marginal cost increases.
3.
Figure 5.1 also shows the increasing marginal cost of each additional slice of pizza,
measured in dollars per slice.
D. Efficiency and Inefficiency
1.
If the marginal benefit from a good exceeds its marginal cost, producing and
consuming one more unit of the good uses resources more efficiently.
2.
If the marginal cost of a good exceeds its marginal benefit, producing and consuming
one less unit of the good uses resources more efficiently.
3.
If the marginal benefit from a good equals its marginal cost, producing and consuming
one more unit of the good or one less unit of the good uses resources less efficiently.
4.
When marginal benefit equals marginal cost, we cannot improve on this allocation of
resources. It is efficient. In Figure 5.1, the efficient quantity of pizza is 10,000 pizzas
per day.
II. Value, Price, and Consumer Surplus
A. The value of one more unit of a good or service is its marginal benefit, which we can
measure as maximum price that a person is willing to pay.
1.
A demand curve for a good or service shows the quantity demanded at each price. A
demand curve also shows the maximum price that consumers are willing to pay at each
quantity.
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2.
Figure 5.2 shows two ways of interpreting a demand curve.
3.
Because a demand curve shows the maximum price that consumers are willing to pay
for the last unit of the good at each quantity available, a demand curve is a marginal
benefit curve.
B. Consumer surplus is the value of a good minus the price paid for it, summed over the
quantity bought.
1.
The price paid is the market price, which is the same for each unit bought. The
quantity bought is determined by the demand curve.
2.
Consumer surplus is measured by the area under the demand curve and above the price
paid, up to the quantity bought.
3.
Figure 5.3 shows the consumer
surplus for pizza for an individual
consumer.
III. Cost, Price, and Producer Surplus
A. The cost of one more unit of a good or
service is its marginal cost, which we
can measure as minimum price that a
firm is willing to accept.
1.
A supply curve of a good or service
shows the quantity supplied at each
price. A supply curve also shows the
minimum price that producers are
willing to accept at each quantity.
2.
Figure 5.4 shows two ways of interpreting a supply curve.
3.
Because a supply curve shows the minimum price that producers are willing to accept
for the last unit of the good at each quantity available, a supply curve is a marginal
cost curve.
B. Producer surplus is the price of a good minus the marginal cost of producing it,
summed over the quantity sold.
1.
The price of a good is its market price,
which is the same for each unit sold.
2.
The quantity sold is determined by the
supply curve.
3.
Producer surplus is measured by the area
below the price and above the supply
curve, up to the quantity sold.
4.
Figure 5.5 shows the producer surplus for
pizza for an individual producer.
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IV. The Efficiency of a Market Equilibrium
A. Figure 5.6 shows that a competitive
market creates an efficient allocation of
resources at equilibrium.
1.
The demand curve can be thought
of as the marginal benefit curve for
society, and the supply curve as the
marginal cost curve for society.
2.
In equilibrium, the quantity
demanded equals the quantity
supplied, which means the marginal
benefit to society of the last unit
consumed equals the marginal cost
to society of making the last unit
available for consumption.
3.
The sum of consumer and producer
surplus is maximized at this
efficient level of output. No other
quantity bought and sold will
produce as much consumer or
producer surplus.
B. Adam Smith’s Invisible Hand idea in
his book Wealth of Nations implied that
competitive markets motivate consumers
and producers to send resources to their
highest valued use in society.
1.
Consumers and producers make
decisions in their own self-interest
when they interact in markets.
2.
These market transactions can
generate an efficient allocation of
resources allocated to their highestvalued use in society.
C. Markets are not always efficient. Some obstacles to efficiency include:
1. Price ceilings and floors: Artificial constraints on price.
2. Taxes, subsidies, and quotas: Place a wedge between price received by sellers and
price offered by sellers.
3. Monopoly: A lack of competitive pressure places a wedge between marginal cost and
selling price.
4. Public goods and Common Resources: Marginal benefits (costs) no longer equal social
marginal benefits (costs)
5. External costs and external benefits: The full benefits (costs) do not accrue to the
consumer (producer)
D. Underproduction and Overproduction
1.
Obstacles to efficiency lead to
underproduction or overproduction
and create a deadweight loss—a
decrease in consumer and producer
surplus.
2.
Figure 5.7 shows the dead weight
loss from underproduction and
overproduction.