C h a p t e r
5
EFFİCİENCY AND
EQUİTY
Outline
More for Less
A. People are constantly striving to get more for less. Could we
get more out of our scarce resources if we used them differently
or is our use efficient?
B. Are market outcomes fair outcomes?
C. This chapter explains the conditions under which competitive
markets yield an efficient outcome, describes the sources of
inefficiency, and explores the concept of fairness.
I.
Efficiency: A Refresher
A. An efficient allocation of resources occurs when we produce the most
highly valued goods and services.
 Resources are allocated efficiently when it is not possible
to produce more of a good or service without giving up some
other good or service that is valued more highly.
 Efficiency is based on values, which are determined by
people’s preferences.
B. Marginal Benefit
1. Marginal benefit is the benefit a person receives from consuming
one more unit of a good or service.
2. We can measure the marginal benefit from a good or service by
the dollar value of other goods and services that a person is
willing to give up to get one more unit of it.
3. The concept of decreasing marginal benefit implies that as
more of a good or service is consumed, its marginal benefit
decreases.
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4. Figure 5.1 (page 102) shows the decreasing marginal benefit
from each additional slice of pizza, measured in dollars per
slice.
C. Marginal Cost
1. Marginal cost is the opportunity cost of producing one more
unit of a good or service. The measure of marginal cost is
the value of the best alternative forgone to obtain the last
unit of the good.
2. 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.
3. The concept of increasing marginal cost implies that as more
of a good or service is produced, its marginal cost
increases.
4. Figure 5.1 (page 102) 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. We cannot
improve on this allocation of resources. It is efficient.
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II. Value, Price, and Consumer Surplus
A. Value, Willingness to Pay, and Demand
1. 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.
2. 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.
3. Figure 5.2 (page 104) shows these two ways of interpreting a
demand curve.
4. Because it 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
1. Consumer surplus is the value of a good minus the price paid
for it, summed over the quantity bought.
a) The price paid is the market price, which is the same for each unit
bought.
b) 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 (page 105) shows the consumer surplus for pizza
for an individual consumer.
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III. Cost, Price, and Producer Surplus
A. Cost, Minimum Supply-Price, and Supply
1. 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.
2. 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.
3. Figure 5.4 (page 106) shows these two ways of interpreting a
supply curve.
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4. Because it 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
1. Producer surplus is the price of a good minus the marginal cost
of producing it, summed over the quantity sold.
2. The price of a good is its market price, which is the same
for each unit sold.
3. The quantity sold is determined by the supply curve.
4. Producer surplus is measured by the area below the price and
above the supply curve, up to the quantity sold.
5. Figure 5.5 (page 107) shows the producer surplus for pizza
for an individual producer.
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IV. Is the Competitive Market Efficient?
A. Figure 5.6 (page 108) shows that a competitive market creates an
efficient allocation of resources at equilibrium.
1. In equilibrium, the quantity demanded equals the quantity
supplied.
2. At the equilibrium quantity, marginal benefit equals marginal
cost, so the quantity is the efficient quantity.
3. The sum of consumer and producer surplus is maximized at this
efficient level of output.
B. The Invisible Hand
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1. Adam Smith’s “invisible hand” idea in the Wealth of Nations
implied that competitive markets send resources to their
highest valued use in society.
a) Consumers and producers pursue their own self-interest and
interact in markets.
b) Market transactions generate an efficient—highest valued—
use of resources.
C. Obstacles to Efficiency
Markets are not always efficient and the obstacles to efficiency
are:
1. Price ceilings and floors
2. Taxes, subsidies, and quotas.
3. Monopoly
4. Public goods
5. External costs and external benefits.
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 (page 111) shows the dead weight loss from
underproduction and overproduction.
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V. Is the Competitive Market Fair?
A. Ideas about fairness can be divided into two groups:
1. It’s not fair if the result isn’t fair
B.
2. It’s not fair if the rules aren’t fair
It’s Not Fair if the Result Isn’t Fair
1. 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.”
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2. 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.
3. Utilitarianism ignores the cost of making income transfers.
Recognizing these costs leads to the big tradeoff between
efficiency and fairness.
4. 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.
C. It’s Not Fair If the Rules Aren’t Fair
1. The idea that “it’s not fair if the rules aren’t fair” is
based on the symmetry principle, which is the requirement that
people in similar situations be treated similarly.
2. In economics, this principle means equality of opportunity,
not equality of income. Robert Nozick suggested that fairness
is based on two rules:
a) The state must create and enforce laws that establish and
protect private property.
b) Private property may be transferred from one person to
another only by voluntary exchange.
3. Pages 114–115 present an extended illustration of two
proposals for achieving a fair and efficient use of
resources.
Reading Between the Lines
Two October 2001 news articles about efficiency and equity in
the production and use of Cipro (the anthrax antibiotic)
provides an opportunity to show how we can use the concepts of
efficiency and fairness to deepen our understanding of a real
world issue.