‘Market Efficiency’ PowerPoints and Activities
2008/20144[2]
‘Market efficiency’ PowerPoints and activities
1
Content
The documents in this section provide support material for the stage 2 units.
2
Document
Covers
1.
A sample program for stage 2 which covers unit 2AECO in the contexts of options
from Economics D304
2.
Sample lesson outlines for Business firms and markets–Unit 2AECO
3.
Notes and PowerPoint slides on Market efficiency and equity—Unit 2AECO
4.
A range of teaching and learning materials covering the concepts of Market
efficiency and equity for the 2AECO unit and some applications of these
concepts:
4.1
The Sundance film festival—A case study with suggested answers
4.2
PowerPoint slides—Efficiency and equity, concepts and applications
4.3
PowerPoint companion—Efficiency and equity, concepts and applications
4.4
Extension activities—The concepts of efficiency and equity
4.5
Extension activities discussion topics
4.6
Emissions trading schemes (ETS)
4.7
Review Questions—Efficiency and Equity, with suggested answers
‘Market efficiency’ PowerPoints and activities
Document 1: Sample program for Stage 2
The purpose of this document is provide an example of how the Stage 2 units can be programmed by
drawing on four of the Options from the Economics D304 subject and using them as contexts for unit
2AECO. In this sample program the options from D304 drawn on to provide contexts are Australian
market forms, Firms and production and Environmental economics.
While options from D304 can be used to provide contexts for the 2AECO unit, they will not be covered
in their entirety (in terms of D304).
Programming of Stage 2 Units using optional units from the D304 as contexts
Week
Content
Concepts
Assessment
Contexts: Australian market forms, Firms and production, and Environmental economics
1&2
Markets and prices
The Economic problem
Macroeconomics and Microeconomics
Scarcity. Economic system
2
Opportunity Cost
Choices. PPF.
3
Nature of markets
Markets in the circular flow. Product
and Factor markets. Returns accruing
to factors of production. Competitive
and non competitive markets
4
Demand
Law of demand. Demand schedule.
Demand curve, Factors affecting
demand. Normal and inferior goods.
Changes in demand
5
Supply
Law of supply. Supply schedule.
Supply curve. Factors affecting supply.
Changes in supply
5/6
Price mechanism
Equilibrium, Surpluses and shortages,
Market clearing
7&8
Elasticity
Types of elasticities. Revenues.
Importance to consumers Firms and
government.
‘Market efficiency’ PowerPoints and activities
3
Week
Content
Concepts
Context: Firms and production
9&10
Business firms and
markets
Role of the firm. Economic cost and
economic profit. Costs and revenue.
Derived demand. Product
differentiation. Barriers to entry. Price
taking and price making firms.
Marketing and advertising.
Specialisation. Characteristics of
market structures (perfect competition,
monopolistic competition, oligopoly,
monopoly.
(Note: Product and cost curves/models
are not required)
Context: Australian market forms
11&12
Market efficiency and
equity
Efficiency. Consumer and producer
surplus (marginal cost). Total surplus.
Deadweight loss. Trade-off between
equity and efficiency.
Context: Environmental economics
13&14
Market failure and
government policies
Strengths and weaknesses of the price
mechanism. Market failure. Price
ceilings and price floors. Taxation.
Positive and negative externalities.
Social costs. Social benefits. Public
goods and private goods. Free goods.
Market power. Imperfect information.
Income inequality. Role of government.
15
Revision
16&17
Examinations
4
‘Market efficiency’ PowerPoints and activities
Assessment
PROGRAM
Week
Objective
Content
Assessment
Context: The Australian economy
1,2&3
Macroeconomic activity
Macroeconomics and Microeconomics,
Circular flow model. Aggregates O Y &
E. Leakages. Injections. Equilibrium.
Inventories. Components of AE and
factors affecting AE.
4
Macroeconomic
concepts
and Issues
Business cycle
Business/trade cycle. Characteristics of
phases.
Turning points.
5&6
Economic Growth
Meaning, Measurement. Causes. Costs
and benefits. GDP as a measure of
welfare. PPF.
6&7
Inflation
Meaning. Headline. Underlying.
Measurement. Types. Costs of
inflation/benefits of low inflation
7&8
Unemployment
Meaning, Participation rate. Natural
rate. Full employment.
Underemployment. Measurement.
Types. Effects of unemployment.
Implications of full employment. Phillips
curve.
9
International trade
Importance of trade. Composition and
direction. Balance of payments. CAD.
10
Distribution of Income
and wealth
Lorenz curve. Income. Wealth.
Inequality. Trends.
11&12
The government’s role
The role of government. Modified
market economy. Relative size of the
public (government) sector in Australia.
Spending and revenue of the three
levels of government. Taxes—
meaning, types and examples.
Macroeconomic objectives.
‘Market efficiency’ PowerPoints and activities
5
Week
Objective
Content
13&14
Macroeconomic
performance
Types of economic indicators.
Measuring economic performance.
Recent trends in inflation,
unemployment, economic growth and
the CAD. Impact of domestic and
international events on the economy.
15&16
Revision
17&18
Examinations
6
‘Market efficiency’ PowerPoints and activities
Assessment
Document 2: Sample lesson outlines—Business firms and markets
Unit 2AECO
The purpose of this document which was prepared by Bob Miller is to illustrate how optional units from
the D304 Economics course can be used to provide contexts for unit 2AECO. It also provides a guide
as to the appropriate depth and scope of content for this section of Unit 2AECO. It contains a series of
lesson outlines that a teacher might typically plan in delivering this part of the unit.
These notes cover the following knowledge content from Unit 2AECO:
Business firms and markets
 discuss the role of the business firm
 explain the concepts of economic cost and economic profit
 explain the concepts of a business firm’s total revenue and total costs
 discuss the factors influencing a business firm’s revenue and costs
 outline strategies to raise a business firm’s revenue and lower its costs
 explain why some business firms in a particular market thrive, while others in the same market fail
e.g. efficiency of operations, motivation and productivity of staff, quality of management, product
development and innovation, pricing policies, marketing and advertising
 outline the factors that affect the level of competition in a market e.g. number of buyers, number of
sellers, barriers to entry, product differentiation
 distinguish between price taking and price setting business firms
 compare the characteristics of market structures including competitive markets, monopolies and
oligopolies.
Business firms and markets
The essence of the Business firms and markets section is to convey to the students the feel of how
business firms go about the job of making a profit and staying in business. The first task is to ensure
that revenue exceeds costs. Thereafter, the firm can choose to expand revenue, reduce costs or a
combination of each.
Students should develop an understanding that the nature of business firms as entities varies from the
likes of a single person lawnmower operator, a couple running a deli, to mid-sized private companies
and finally to giant public companies, such as BHP Billiton.
A number of students will one day be either managers or owners of business firms. They should
understand why some firms in a particular market thrive, and others fail. The concepts of efficiency of
operations, staff productivity and quality of management can be clarified and made meaningful by
discussion of real life business firms, familiar to the students. An obvious starting point would be the
firms in which students have already worked.
Ultimately, the students should be able to view business firms from a consumer’s position and a
manager’s position. In the case of the former, it’s a case of considering: “What I like/dislike about
dealing with this firm?” and with the latter: “What can be done to improve the profitability of this firm?”
This section can be completed in 6 one-hour lessons and the suggested teacher program is based on
such a time allocation
‘Market efficiency’ PowerPoints and activities
7
Lesson 1


Discuss the role of the business firm
Explain the concepts of economic cost and economic profit
Business firms, while varying enormously in size and scope, have the same objective; to make a profit.
At the very least, the firm must ensure that revenue exceeds costs. Obviously, most firms try to make
more than the bare minimum (or ‘normal’ profit) to stay in the industry.
Models of profit maximisation, marginal revenue and marginal cost analysis are not required.
For the purposes of this section, ‘Economic Cost’ simply refers to any cost experienced by a business
firm in the production of a good or the provision of a service. The sum of all these costs is termed ‘total
costs’.
For the purposes of this section, ‘Profit’, in economics terms requires the students to consider the
opportunity cost of the time spent by the owner(s) of the business.
For example, a person who previously earned $60, 000 p.a. as an office worker, starts a lawn mowing
business. The business receives $130 000 in revenue with expenses of $50 000 in its first year. The
accounting profit would be $80 000 (i.e.$130 000 - $50 000) but the profits in economics terms would
only be $20 000. This is because the opportunity cost of the office job needs to be taken into
account.(i.e. $130 000 - $50 000 - $60 000).
The reason for the introduction of Profit is to sharpen the focus on small owner-operator businesses.
Many such businesses make a relatively small Accounting Profit, but an Economic Loss. Simply put,
the owner must ask himself/herself: Is this a sensible use of my expertise?
Students should be able to relate real life instances where there are Accounting Profits but Economic
Losses.
8
‘Market efficiency’ PowerPoints and activities
Lesson 2:


Explain the concepts of a business firms total revenue and total costs
Discuss the factors influencing a firm’s revenue and costs
Students should be able to make a broad distinction between a firm’s fixed (or overhead) costs and
variable costs. Fixed costs do not vary with changes in output. They include interest on the loan for the
building and equipment, rates on the land and management salaries.
Variable costs increase as production increases. They include payments for new materials,
fuel/electricity and wages. Critically, a firm must aim to achieve an outcome where at least total revenue
exceeds total costs (i.e. an Accounting Profit).
A firm’s costs can be affected in a number of ways. Interest rate rises adversely affect firms carrying
considerable debt. The cost of raw materials may also rise substantially and squeeze a firm’s profits
(especially when the firm cannot easily raise its own prices). ‘Boom’ conditions in an economy can
make it tough for a business to attract workers. For example, during a minerals boom, restaurants and
cafes in Perth may have to pay significantly more to keep existing staff, much less attract new staff.
Management efficiency/inefficiency has a lot to do with a firm’s productivity (and hence its costs).
Business management must ensure that productivity remains high. Productivity essentially examines
the output from a firm’s inputs. Labour productivity measures the output of each unit of labour.
Regardless of whether the person is making burgers, laying bricks or typing a letter, the concept of
productivity arises. Clearly, there is a close correlation between a worker’s efficiency and productivity.
But adding an additional, efficient, worker to an already crowded office space may even serve to reduce
total output. In that case the ‘efficient worker’ turns out to be a non-productive additional unit of labour.
Students should be encouraged to examine the physical layout of businesses they know and consider
whether there are ways in which management could change things so that labour productivity rose.
Capital productivity should also be considered. Just how productive is the machinery used by the
business firm? Students should also consider factors such as air conditioning. Teachers may pose the
question: Can you think of an example where the provision of air conditioning would contribute to a
relatively large increase in labour productivity? Students should then be encouraged to find out the cost
of such an air conditioning unit. Thereafter, they could estimate the productivity gains (i.e. give a dollar
amount).
The students are then in a position to arrive at a conclusion (i.e. can management really justify such an
expenditure?)
A firm’s revenue is largely dependant upon the general state of the world, national and regional
economy. A slowdown in the economy doubtlessly affects the quantity of goods or services purchased
by customers/clients.
The concepts of price and income elasticity of demand should be considered. For example, in a sharp
economic downturn, certain discretionary spending in businesses, no matter how well they are run, will
be adversely affected.
Once again, in considering a business firm’s costs and revenues, students should relate to real
examples in the community. Provided students don’t ask direct questions about the size of profits,
proprietors of small business firms are likely to be happy to discuss factors affecting their costs and
revenue.
‘Market efficiency’ PowerPoints and activities
9
Lesson 3

Outline strategies to raise a firm’s revenue and profits
Following the previous lesson, students should be able to outline their own strategies on a particular
firm of their own choice. Thereafter, the teacher could nominate a couple of well known firms and
request that the students, in small groups, discuss and report on ways to raise revenue and lower the
costs of those firms.
The subject on advertising is interesting. While advertising can succeed in shifting the demand curve to
the right, it can also be a quite significant cost for the firm.
Lesson 4

Explain why some firms in a particular market thrive, while others in the same market fail.
The two most important issues here are efficiency of operations (no matter what type of business firm)
and the driver of such efficiency—the quality of management.
Each student could be asked to do the following:
1. Imagine a business that you would consider to be efficient.
2. List the efficient attributes of this firm.
3. If you were in charge of this firm, is there anything you would do to make it even more efficient? Give
reasons.
4. What do you consider are the qualities of a “good business manager?” (This could be the basics of a
class discussion).
Another issue relates to the way a firm can stand out from its competitors in the market place. The
concepts of product development and innovation become relevant in certain industries. So too are
pricing policies, marketing and advertising in other industries.
On a national level, students may examine the motor vehicle market. Here the issues of product
development, innovation and pricing appear to be very important. So too are marketing and advertising
campaigns (which may be the subject of conjecture and debate among students).
10
‘Market efficiency’ PowerPoints and activities
Lessons 5 and 6




Outline the factors that affect the level of competition in the market.
Outline the factors that affect the level of competition in a market e.g. number of buyers, number
of sellers, barriers to entry, product differentiation
Distinguish between price taking and price setting business firms
Compare the characteristics of market structures including competitive markets, monopolies
and oligopolies.
The content for this lesson could be sourced from a text such as Pathways in Economics, Greg Parry
th
and Steven Kemp; Tactic: 6 Edition. Chapter 3 (Australian Market Forms)
For example:
‘Market structures’ figure 3.2 is important. So too is the first part of 3.1 ‘The perfect market and
equilibrium’ down to, but not including ‘Profit maximisation’.
The first part of 3.5 ‘Oligopoly’ down to, but not including ‘Models of Oligopoly’, should be considered.
A key issue of monopoly is encapsulated in figure 3. 14. The monopolist’s choice. The first part of 3.6
Monopoly down to, but not including “comparing monopoly with perfect competition’ is appropriate. (i.e.
figure 3.15 is not required).
Students are not required to use graphs to explain the relevant concepts.
The goal of the section ‘Business firms and markets’ is to give students a practical appreciation of the
firms they see around them and those they know through the media.
The students should see business firms as dynamic organisations that can thrive or die, … and to come
to an understanding of the forces that can lead to both outcomes.
‘Market efficiency’ PowerPoints and activities
11
Document 3: Notes and PowerPoint slides on Market efficiency and
equity
Unit 2AECO
This document includes notes for teachers on a ‘new’ area of content in stage 2—Market
efficiency and equity, and a printed copy of slides from a PowerPoint presentation covering the
concept of market efficiency, which was given by Steven Kemp at the Curriculum Council’s
professional development day on 15th October 2007. The PowerPoint will be made available for
downloading via the Council’s website
These notes and the PowerPoint cover the following knowledge content from Unit
2AECO:
Market efficiency and equity
 explain the concept of efficiency
 demonstrate and explain the benefits to consumers from participating in a market by
applying marginal benefit and consumer surplus
 demonstrate and explain the benefits to producers from participating in a market by applying
marginal cost and producer surplus
 demonstrate and explain the efficiency of market equilibrium i.e. maximising total surplus
 demonstrate and explain how under and overproduction results in a deadweight loss
 explain the concept of equity (fairness)
 discuss the trade-off between efficiency and equity.
12
‘Market efficiency’ PowerPoints and activities
Market efficiency and equity
Microeconomics is concerned with the efficient allocation of scarce resources. Markets (demand
and supply) are one way to allocate resources and economists would argue that they are the
‘best’ or most efficient way for most goods and services.
“If there is one thing that separates economists from mere mortals, it is an appreciation of the
power of markets as a mechanism for allocating scarce resources . . . it explains the biggest
economic event of the 20th century— the victory of capitalism over communism” (G. Mankiw)
Does the market provide the socially optimal quantities of goods and services? This topic
investigates that question, using the tools of welfare economics. Welfare economics is the study
of how society’s allocation of resources affects economic wellbeing. Welfare economics
measure the benefits that buyers and sellers receive from taking part in a market. Why is the
free market said to be efficient? Because the equilibrium price and quantity in a market is the
only price/output combination that maximises the net benefits received by buyers and sellers.
This is the economist’s definition of efficiency.
Consumer surplus
Consumer surplus measures the net benefits received by buyers from participating in a market.
Consumer surplus is the amount that a buyer is willing to pay for a good minus the amount
actually paid. That is, consumer surplus is the additional amount that the buyer would have
willingly paid to get the product beyond the market price that he or she actually paid. For
example if you are willing to pay $20 for a new CD by your favourite music artist and you are
able to purchase it for just $15, then your consumer surplus is $5 ($20-$15).
The demand curve represents buyers’ willingness to pay. The area underneath the demand
curve is the total value that consumers get from consumption. Part of this area is consumer
expenditure (price x quantity), while the remaining part is consumer surplus. The area under the
demand curve but above the market price represents consumer surplus. Consumer surplus is to
the consumer what profit is to the producer. If market price falls, consumer surplus will
increase—the area under the demand curve and above the price will increase. A rise in
consumer surplus means that consumers’ economic welfare has increased.
Producer surplus
Producer surplus measures the net benefits received by sellers from participating in a market.
Producer surplus is the amount that a seller is paid for a good minus the marginal cost of
production. That is, producer surplus is the excess that the seller receives beyond his or her
opportunity cost of providing the good or service. For example, if a musician can produce a CD
for a cost of $10 and sell it for a price of $15, the musician receives a producer surplus of $5
($15 - $10).
The supply curve reflects the seller’s marginal costs of production—the area below the supply
curve. Producer surplus is the area above the supply curve and below the price of the good.
Producer surplus is similar to profit. If market price rises, producer surplus increases—the area
above the supply curve and below the price will increase. A rise in producer surplus means that
sellers’ economic welfare has increased.
‘Market efficiency’ PowerPoints and activities
13
Market efficiency
We measure economic wellbeing with total surplus - the sum of consumer and producer surplus.


Total Surplus = value to buyers - cost of sellers
Total Surplus = consumer surplus + producer surplus
Total surplus is the area below the demand curve and above the supply curve. Resource
allocation is said to be efficient if total surplus is maximised. The free market equilibrium price
and quantity is efficient because it maximises total surplus:



Free markets allocate the output of goods to the buyers who value them the most.
Free markets allocate production to the sellers who can produce them at the lowest
opportunity cost.
Free markets produce the quantity of goods that maximises the sum of consumer and
producer surplus.
Underproduction - if society produces less than the equilibrium quantity, we fail to produce
goods where the value to buyers exceeds the cost to producers.
Overproduction - If society produces more than the equilibrium quantity, we produce goods
where the cost to sellers exceeds the value to buyers.
When output or prices are restricted, consumer and producer surplus are reduced. The amount
by which total welfare (total surplus) is reduced is known as the deadweight loss. At the
competitive, free market output, deadweight loss is zero, and benefits to consumers and
producers are maximised. This is the argument that is often used by economists to advocate
completely free markets.
The concepts of consumer and producer surplus can be used to analyse a wide range of policy
issues:

How do taxes affect market efficiency?

How do price controls affect market efficiency?

How do quantity restrictions affect market efficiency?

Who wins and who loses when a country opens itself to international trade?

How do externalities, such as pollution, affect the efficiency of market outcomes?
Economics is also concerned with the objective of equity— the fairness of the distribution of
wellbeing among the members of society. Efficiency concerns maximising the size of the
economic pie, while equity is concerned with distributing the pie fairly. One of the fundamental
trade-offs in economics is the efficiency/equity trade-off. Economists can define and measure
efficiency and state the conditions under which it can be achieved. However, the issue of equity
is more problematic - there is no simple definition or easily stated condition for equity. The issue
of equity requires normative judgements and is usually resolved through the political system.
Market efficiency and market failure
When markets work efficiently, they maximise total social wellbeing. However, market failure
may occur when market power allows some of the buyers or sellers to control price to some
extent, or when there are externalities - costs or benefits that affect social welfare but are not
considered by buyers or sellers because they are borne by someone else.
Reference:
Steven Kemp, 2005, Principles of Microeconomics Study Guide, 3rd edition, Nelson Thomson
Publishers.
14
‘Market efficiency’ PowerPoints and activities
PowerPoint slides
Market efficiency
Market Efficiency
Unit 2A
• Microeconomics is concerned with
the efficient allocation of scarce
resources.
• Markets (demand & supply) are just
one way to allocate resources
Market Efficiency
Steven Kemp
Does the market achieve an
efficient allocation of resources?
1
2
Resource Allocation Methods
Market Efficiency
• Resources might be allocated by:
“If there is one thing that separates
economists from mere mortals, it is an
appreciation of the power of markets as a
mechanism for allocating scarce resources
. . . it explains the biggest economic event
of the 20th century – the victory of
capitalism over communism” (G. Mankiw)
– Market price
Economists would
– Command
argue that markets
– Majority rule
are the ‘best’ or
most efficient way
– Contest
– First-come, first-served
– Lottery
– Personal characteristics
– Force
3
4
Demand, Marginal Benefit,
and Consumer Surplus
Market Efficiency
• How much benefit do producers and
consumers receive from the existence of
a market?
• How is the welfare of consumers and
producers affected by changes in market
prices?
• The demand curve reflects your
willingness to pay - the maximum
price that a person is willing to pay for a
good
• A demand curve is a marginal benefit
curve – the area under the D curve
represents the total benefits from
consumption
• Does the market equilibrium
maximise the total welfare of
buyers and sellers?
5
6
Demand & Consumer Surplus
P
10
9
8
7
6
5
4
Qd
1
2
3
4
5
6
7
P
10
Demand & Consumer Surplus
P
Demand reflects
the maximum
price consumers
are willing to pay
10
• How much value (benefit)
does the consumer receive?
• Notice that total benefits are
more than what you pay
6
6
D
D
5
Q
5
7
8
‘Market efficiency’ PowerPoints and activities
Q
15
Demand & Consumer Surplus
P
10
9
8
7
6
Qd
1
2
3
4
5
Total
$ Paid
6
6
6
6
6
30
Consumer Surplus
• Consumer surplus is equal to the
difference between the buyer’s willingness
to pay and the actual price paid
• Consumer surplus measures the net
benefits from consumption
• If consumer surplus increases, then
consumers are better off
Con Surplus
4
3
2
1
0
+ 10
9
10
How a change in Price affects
consumer surplus
Consumer Surplus
Consumer surplus is the
area below the demand
curve and above the
market price ($10)
P
Price
A
Supply
Initial
consumer
surplus
6
P1
Amount paid ($30)
C
B
D
Demand
5
Q
0
11
• Do producers receive a similar
surplus?
Supply
S
Increase in consumer
surplus
C
P1
B
P2
D
• The cost of one more unit of a good or
service is its marginal cost, which
reflects the minimum price that a firm
is willing to accept.
• A supply curve is a marginal cost
curve.
E
Demand
0
Q1
Q2
Quantity
13
14
Supply & Producer Surplus
P
1
2
3
4
5
6
7
Qs
0
1
2
3
4
5
6
Quantity
Supply, Marginal Cost, and
Producer Surplus
A
Initial
consumer
surplus
Q2
12
How a change in Price affects
consumer surplus
Price
Q1
Supply & Producer Surplus
P
S
6
5
Q
15
16
P
Qs
1
0
2
1
3
2
4
3
5
4
6
5
Total
Price
Received
6
6
6
6
6
$30
Producer
Surplus
4
3
2
1
0
$10
Supply & Producer Surplus
Supply & Producer Surplus
P
Producer surplus
= $10
• Producer surplus is the price of a
good minus the marginal cost of
producing it
• Producer surplus is measured by the
area below the price and above the
supply curve.
• If producer surplus increases, then
producers are better off
6
Cost of
production = $20
5
17
16
S
18
‘Market efficiency’ PowerPoints and activities
Q
How a change in price affects
producer surplus
How a change in price affects
producer surplus
Price
Price
Increase in producer
surplus
Supply
B
P1
Initial
producer
surplus
F
B
P1
C
E
D
P2
Supply
C
Initial
producer
surplus
D
Demand
Demand
A
0
A
Q1
Q2
Quantity
0
19
Market Efficiency
Total
Surplus
Quantity
=
Consumer
Surplus
+
Producer
Surplus
or
Total
Surplus
21
=
Total
Benefits
_ Total
Costs
22
Total Surplus
Is the
Competitive
Market
Efficient?
Price
Consumer Surplus
Supply
• TS = MAX
only at EQUIL !
Producer Surplus
Demand
0
Q2
Economic well-being and
total surplus
• Consumer surplus and producer surplus are
the basic tools that economists use to study
the welfare of buyers and sellers in a market.
• The economic well-being of a society is
measured as the sum of consumer surplus
and producer surplus - total surplus.
• Market efficiency is attained when the
allocation of resources maximises total
surplus.
Equilibrium
price
Q1
20
Quantity
Equilibrium
quantity
23
24
Sources of Inefficiency
Market Inefficiency
• Price & quantity restrictions
• Deadweight Loss
• Taxes & subsidies
– The decrease in total surplus that results
from an inefficient allocation of
resources
• Monopoly – market power
• Externalities
These lead to either underproduction
or overproduction.
25
26
Market Efficiency
Under & Overproduction
Price
Deadweight
loss
• The concepts of consumer and producer
surplus can be used to analyse a wide range
of policy issues:
– How do taxes affect market efficiency?
– How do price controls affect market efficiency?
– How do quantity restrictions affect market
efficiency?
– Who wins and who loses when a country opens
itself to international trade?
– How do externalities, such as pollution, affect the
efficiency of market outcomes?
overproduction
Demand
underproduction
0
Supply
Qe
Quantity
27 28
‘Market efficiency’ PowerPoints and activities
17
Review
Review
Maria decides that she would pay as much
as $3000 for a new laptop computer. She
buys the computer and realises a consumer
surplus of $700. How much did Maria pay for
her computer?
A. $700
B. $2300
C. $3000
D. $3700
Tony Bird values watching Legally Blonde
for the fourth time at $20. He finds a
cinema showing Legally Blonde for $5.
Tony’s willingness to pay is ___ and his
consumer surplus is ___
A. $5; $15
B. $5; $20
C. $20; $5
D. $20; $15
29
30
Review
•
Tariffs raise prices, increase domestic
production and lower domestic consumption.
They cause consumer surplus to ____,
producer surplus to ____, and total surplus to
____
a. decrease, decrease, decrease
b. increase, decrease, increase
c. decrease. increase, decrease
d. increase, increase, increase
31
18
‘Market efficiency’ PowerPoints and activities
Document 4: Teaching and learning materials—Market efficiency and
equity
Unit 2AECO
This document includes a range of teaching and learning material prepared by Andrew Tibbitt covering
the concepts of market efficiency and equity, and some applications of these.
Knowledge content from Unit 2AECO
Market efficiency and equity
 explain the concept of efficiency
 demonstrate and explain the benefits to
consumers from participating in a market by
applying marginal benefit and consumer
surplus
 demonstrate and explain the benefits to
producers from participating in a market by
applying marginal cost and producer surplus
 demonstrate and explain the efficiency of
market equilibrium i.e. maximising total surplus
 demonstrate and explain how under and
overproduction results in a deadweight loss
 explain the concept of equity (fairness)
 discuss the trade-off between efficiency and
equity.
Market failure and government policies
 demonstrate and explain the effects of price
and quantity restrictions in markets by
applying consumer and producer surplus e.g.
price ceilings and price floors, quotas and
licences
 demonstrate and explain the impact and
incidence of taxes on goods and services
 explain the concept of market failure
 analyse the causes of market failure e.g.
positive and negative externalities, public
goods and common resources, market power
(monopoly), imperfect information, income
inequality
 discuss the link between market failure and
the role of government
 evaluate government policy options to correct
market failure e.g. the use of taxes and
subsidies, assigning property rights and
regulating the use of common resources,
providing public goods and services
Teaching and learning activity
4.1 The Sundance film festival – A case study
4.2 PowerPoint slides – Efficiency and equity,
concepts and applications
4.3 PowerPoint companion – Efficiency and
equity, concepts and applications
4.4 Extension activities
The concepts of efficiency and equity
4.5 Extension activities
Discussion topics
4.7 Efficiency and equity
Review Questions
4.2 PowerPoint slides – Efficiency and equity,
concepts and applications
4.3 PowerPoint companion – Efficiency and
equity, concepts and applications
4.4 Extension activities
The concepts of efficiency and equity
4.5 Extension activities
Discussion topics
4.6 Emissions trading schemes (ETS)
4.7 Efficiency and equity
Review Questions
.
‘Market efficiency’ PowerPoints and activities
19
4.1 The Sundance film festival
A Case study
Part 1
The Sundance Film Festival is the largest independent cinema festival in the United States. The festival
was named by Robert Redford after his character ‘The Sundance Kid’ from the movie Butch Cassidy
and the Sundance Kid, probably because this is his favourite character among those he played.
Held in January in Park City, Salt Lake City, and Ogden, Utah as well as the Sundance Resort, the
festival is the premier showcase for new work from American and international independent filmmakers.
The festival comprises competitive sections for American and international dramatic and documentary
films, and a group of non-competitive showcase sections, including the Sundance Online Film Festival.
(See www.sundancechannel.com/home/ for more information and some movie clips).
The festival has changed over the decades from a low-profile venue for small-budget, independent
creators from outside the Hollywood system to a media extravaganza for Hollywood celebrity actors,
directors from studios that are subsidiaries of the major studios, paparazzi, and luxury-goods company
sponsors giving gifts to the attendees.
Attending the festival to see films can be difficult. Essentially the allocation of tickets involves a three
stage process; stage 1 involves interested ticket buyers registering their interest on the festival website
within a set time period; stage 2 is the random selection through a ballot of people who have registered
giving them the opportunity to buy a ticket (successful people are then allocated a 30 minute time slot
when they will be able to buy their tickets); and stage 3 is the actual purchase of the ticket by those who
take up the offer and manage to get on-line in the right half-hour time slot.
For the 2008 festival, the film festival eliminated a $5 fee registration fee for a time slot to buy festival
passes and ticket packages. This resulted in a flood of applications, and several thousand were
rejected without receiving any time slot at all. In addition the festival organisers give locals a shot at
purchasing tickets before they go on sale nationally. For the 2008 festival more than 2460 Utah
residents were selected at random for a chance to buy up tickets at a ‘locals-only’ sale.
Activity
 Assume that market research suggests that demand for tickets
for a film premiere at the festival is as shown in table 1.
 The price of a double ticket is set at $125 by the festival
organisers.
 The cinema in which the film will be shown seats 1000 people
(that is, 500 double tickets will be issued).
(a) Draw on the axes provided the demand curve based on the
demand schedule in table 1.
Market research suggests that 100 double tickets would be sold if the
price of a double ticket was $300. People who are successful in obtaining
a double ticket only have to pay $125.
(b) What can be inferred about the value of a double ticket to these
100 potential purchasers?
Table 1
Ticket price
per double
($)
300
275
250
225
200
175
150
125
100
75
50
25
0
Quantity
demanded
100
200
300
400
500
600
700
800
900
1000
1100
1200
1300
(c) What is the consumer surplus for each of the 100 people prepared to pay $300 for a double
ticket?
20
‘Market efficiency’ PowerPoints and activities
Film premiere demand curve
The cinema has a capacity of 1000 (500 double tickets). Add the supply curve to the diagram
above. (It will be a vertical line at quantity 500).
(d) Shade in the area on the diagram below that represents the total amount of consumer
surplus in this market. Calculate or estimate the dollar value of the total consumer surplus
in this situation.
(e) What is the market clearance price in this situation (that is the ticket price where ticket
demand equals the fixed ticket supply of 500)?
(f) Given the price of tickets is set below the market clearance price of $200, will there be a
shortage or a surplus of tickets for the film premiere? What is the size of the shortfall or
surplus?
Remember that the allocation of tickets involves a three stage process; stage 1 involves interested
ticket buyers registering their interest; stage 2 is the random selection through a ballot of people who
have registered giving them the opportunity to buy a ticket; and stage 3 is the actual purchase of the
ticket by those who take up the offer. Some may not take up the offer even though their names have
been picked out in the ballot, with any unsold tickets are sold on a first come first served basis at the
on-line box office.
The ballot system does not reflect the different values placed on a double ticket by different people.
Some people who really wanted to buy a ticket to the premiere, because they believed they would
receive up to $300 or more benefit from attending the premiere, were not given the chance to buy a
ticket as a result of the festival organisers’ ballot.
(g) Discuss the options of a person who is unsuccessful in the ticket ballot but who places a
high value on obtaining a ticket?
(h) In what circumstances might some people who are successful in the ballot and who buy a
double ticket for $125 be prepared to sell their ticket to others?
(i) There are some positive, negative and interesting aspects about this system of ticketing.
Complete the table below by identifying at least two positive, two negative and two
interesting aspects of the ticket process.
(j)
Positive or goods points
Negative or bad points
1
1
Interesting points – other
thoughts about the process
1
2
2
2
Overall, do you think the ticketing system at the Sundance Film Festival is efficient and
fair?
‘Market efficiency’ PowerPoints and activities
21
Part 2
People who are desperate for tickets to see their favourite stars at the Sundance Film Festival premiere
may be able to pick up tickets on eBay. Some people who have been lucky enough to be allocated the
chance to buy a ticket at face value will take a chance to make a profit by offering the prized tickets on
the on-line auction website.
However, reselling tickets online is prohibited in the US. Sundance officials say they are scanning the
San Jose, California based online auction site and cracking down on people re-selling tickets.
Sundance officials warn that tickets resold online can be remotely deactivated before the film's
showing.
Despite this threat, two tickets to the first screening of Waitress, staring Keri Russell, sold for over
$300. The high number of hits from a search on eBay for ‘Sundance tickets’ suggested that people
were trying to get around the re-sale prohibition. Several sellers were giving away ‘free’ tickets with the
‘purchase’ of festival venue instructions or a film guide, which are given to ticket holders. Several venue
instructions and film guides were selling for around $150 while a film guide with two ‘free’ tickets to
Waitress sold for $225 in an auction.
All manner of items can be bought and sold on eBay. It is said that if you can’t find it on eBay you are
pretty unlucky. eBay is an on-line auction and market place.
Sellers can sell items by auction setting a closing time and a reserve price for their item. No sale can be
made below the reserve price. Some items are not sold by auction on eBay but are offered on a ‘buy it
now’ basis.
For items being sold by auction, buyers search through the offers, make a bid and wait to see if they
are successful. They can make multiple bids during an auction process, reacting to the bids of other
potential buyers. This can be quite time consuming so buyers can indicate a maximum price they are
prepared to pay and eBay automatically increases the bid as new offers come in up to a limit set by the
buyer.
EBay has proved very popular claiming up to 75m registered users. Since 2005, however, activity has
slipped back a little as new competing auction sites have come on-line, stories about ‘ugly traders’ are
circulated and sellers find that they get 20 to 30% less on eBay that on some other sites.
(More information about eBay can be found at www.ebay.com or Money.cnn.com (company code =
EBAY)
Activity
(a) What in general terms is ‘a market’? What happens in a market?
(b) Briefly explain how eBay creates a market ‘for all manner of items’
Tickets for the Sundance Film Festival can be purchased on eBay, despite regulations
preventing the re-selling of tickets obtained in the ticket ballot.
(c) Discuss the factors that will influence the minimum or reserve price placed by people
selling their festival tickets by auction on eBay. Try to build in economic concepts such as
opportunity cost and marginal benefit into your answer.
(d) Suppose a buyer (let’s call her Katherine Ross) was bidding in an eBay auction to get a
double ticket for a film premiere and she had indicated that she was prepared to bid up to
$310 in the auction process. What does this reveal about Katherine Ross?
(e) Assume that Katherine Ross ‘won’ the auction with a final bid of $285 (a ticket that the
seller had presumably obtained for $125). What is the level of consumer surplus of
Katherine Ross?
(f) Assuming the seller did obtain the ticket for $125, what was their bonus (producer or
supplier surplus) from the eBay auction?
(g) How, in general then, does eBay increase welfare?
(h) Do you think selling tickets for prices above their face value (scalping) should be illegal?
Try to consider whether scalping is an efficient and/or fair process?
22
‘Market efficiency’ PowerPoints and activities
Some commentators suggest that eBay is struggling to maintain its peak level of activity and profit.
(i)
Look at eBay’s share price performance over the last 3 years. Describe the movements in
the share price and suggest two reasons for the dip in the share price.
The prices people can get from eBay auctions reflect the relative numbers of buyers and sellers
participating. Too many sellers and too few buyers mean overall prices will be soft. Although eBay has
recently raised the price for ‘selling’ on eBay it still remains a relatively cheap process. The underlying
problem that buyers experience when trading on eBay is that the seller has the advantage over the
buyer in terms of information. Markets don’t work well when there is asymmetric (or one-sided)
information. Critics of eBay suggest the there is a lack of effective seller certification and a performance
guarantee mechanism.
Do you agree that information is ‘asymmetric’ on eBay? Who has the information
advantage? Explain why, and why this is a problem?.
(k) Suggest two steps that eBay can take to raise the general level of prices for items traded.
(l) Overall is eBay efficient and fair?
(j)
Part 3
Economists like auctions. When auctions are genuinely competitive, they pair the buyer with the
greatest utility or marginal benefit (the buyer who values the product highest) and has effective demand
(has the money to back up their bids) with items offered at the lowest price sellers will take for them
(the reserve price is equal or close to cost).
The following websites provide information about auctions.
www.shannons.com.au/ www.sothebys.com www.bonhams.com www.christies.com
(a) List five types of goods that are commonly sold in an auction?
(b) In general what do these auctioned goods have in common?
(c) Suggest two things a potential buyer at an auction should decide or determine before the
bidding starts. Use appropriate economic terms and concepts in your answer where
possible.
(d) Suggest two things a potential seller at an auction should decide or determine before the
bidding starts. Use appropriate economic terms and concepts in your answer where
possible.
Look at www.youtube.com and do a search for videos under ‘auctions’. Select three video clips.
Prepare a presentation that uses the video clips to identify things that can happen at an auction that
result in the auction process becoming inefficient and unfair.
Part 4
Many products are sold in South East Asia without a fixed price being displayed. The prospective buyer
and seller barter to establish the price for the sale.
(a) Write a 10 line script for an imaginary bartering exchange between a prospective buyer and
seller in a market where clothes or textiles are traded. If you have been to South East Asia
you may remember some of the ‘lines’ that are used in the process.
(b) How does the seller determine their opening (ambit) price? What economic concept or
concepts underpin this opening offer?
(c) What conditions need to exist for this price discrimination between customers (charging
different buyers different prices) to operate?
(d) In 75 words, using the economic concepts of consumer surplus, producer surplus and net
economic welfare, compare the process of bartering and buying in a fixed-price market in
terms of its efficiency and fairness.
‘Market efficiency’ PowerPoints and activities
23
The Sundance film festival
A Case study
Answer suggestions
Part 1
(a) Draw a demand curve.
(b) The benefit they receive must be at least $300 otherwise it would be irrational to pay this amount.
(c) If they get a ticket for $125 they are getting a bonus (consumer surplus) of $175.
(d) The area between the demand curve and the $125 price level up to quantity 500.
(e) $200 (demand = fixed supply at this price).
(f) There is a shortage of 300 tickets.
(g) Try to buy a ticket on the black market. Try eBay. Go to another film.
(h) If the benefit they receive from going to the film is less than the value they place on boosting their
spending power. Alternatively the opportunity cost (or sacrifice) of selling the ticket will be less
than the benefit they receive from the extra money they now receive.
(i) Positive—equitable, locals get preferential treatment (to compensate them for inconvenience?)
Negative—inefficient, tickets don’t go to those who value them the highest
Interesting—festival organisers are not profit maximisers, paying a small fee to register may cut
down registrations from people who are not that interested in seeing the films.
Part 2
(a) A market brings buyers and sellers together for trade or exchange.
(b) It is an on-line facility that links sellers and buyers. (See website for more information).
(c) The reserve price will reflect the seller’s opportunity cost – what they sacrifice by offering a ticket
for sale. The marginal benefit they receive from keeping the ticket and going to the film will be
equal or less than the reserve price.
(d) Her marginal benefit is $310. If she wins the auction at less than this she will receive consumer
surplus.
(e) She paid $285, $25 less than her marginal benefit. Consumer surplus for Katherine was therefore
$25.
(f) They paid only $125 and made a profit of $160. Assuming their opportunity cost was $125 their
surplus was $160.
(g) It creates a market, which in turn generates consumer and producer welfare.
(h) Tickets bought on the black market or through eBay go to those who get most benefit from having
a ticket. This suggests a high level of allocative efficiency. If the organisers are not maximising
profits why can’t others get a share of the consumer surplus that is generated?
(i) The share price dropped somewhat after 2005. They have lost market share to new on-line
auction sites. Prices received by sellers on eBay have dropped. Stories about problems
encountered by traders on eBay may have reduced consumer confidence.
(j) The basic problem with many auctions is that the buyer has less information than the seller. The
trade becomes one-sided. The result is market failure.
(k) Prices on eBay will rise if there are fewer sellers (charge people more to sell on the site?) and
more buyers (increase buyer confidence by guaranteeing reputation of sellers, and reducing risks
of making on-line payments (see PenPal)).
(l) eBay provides is a popular market place. It increases welfare, even though sellers might have an
advantage.
Part 3
(a) Houses, paintings, cars, livestock, antiques.
(b) Differentiated goods – items which have special or individual features. Products where there is not
a strong concept of a ‘right’ or ‘correct’ market price.
(c) The level of marginal benefit the buyer expects to receive—the opportunity cost of paying this
amount of money—the quality of the product—the status of the seller.
(d) A reserve price—the opportunity cost of selling the product.
(e) There were some good clips about phoney auctions, lack of information, people buying irrationally
and in a emotional atmosphere, people who have not considered their marginal benefit or the
opportunity cost of the purchase.
24
‘Market efficiency’ PowerPoints and activities
Part 4
(a) ‘Best price’, ‘I have to feed my family’, ‘special price for first sale of the day’, ‘take another for your
wife (husband)’ and so. The exchange should ensure both parties work out the other’s marginal
benefit and opportunity cost.
(b) The seller makes an instant assessment of price, income and cross price elasticity. A rich looking
tourist will be prepared to pay more than a backpacker.
(c) Resale is difficult, information about prices charged to each customer is not known by other
customers, customers are kept apart, and customers have different levels of elasticity.
(d) Fixed price market places tend to lead to a more even distribution of producer and consumer
surplus. Auctions tend to reduce consumer surplus because buyers reveal the level of their
marginal benefit to the seller. There is a growing body of economic analysis that studies the impact
of auctions on buyers and sellers—if the sale is not competitive and information is not shared
evenly the results can be quite unfair.
‘Market efficiency’ PowerPoints and activities
25
4.2 PowerPoint slides
Efficiency and equity—concepts and applications
A rationing system to deal with the
economic problem
Because economic resources are relatively scarce
(resources are limited, wants are unlimited) a society
can’t have everything they want. There must be a
system that rations both resources and products.
Efficiency and Equity
The rationing system must answer the following
questions:
1. What, and how much, to produce
2. How to produce
3. For whom to produce
1
2
Efficiency and Equity (c) Andrew Tibbitt 2008
Tests for a rationing system
Slide 2
Efficiency and equity
1.
The two basic tests for any rationing system are:
 Is the system efficient?
 Is it fair?
2.
3
Efficiency and Equity (c) Andrew Tibbitt 2008
4
Slide 3
Efficiency – is the economy getting the most of out its
scarce resources (or are they being wasted)?
1. Technical efficiency – is production being done at
lowest unit cost?
2. Allocative efficiency – are resources being used to
make products that people want?
Equity – how fair is the distribution of products between
different members of society?
1. Horizontal equity – no discrimination between
people whose economic characteristics and
performance are equal
2. Vertical equity – different treatment of different
people in order to reduce the differences between
people
Efficiency and Equity (c) Andrew Tibbitt 2008
Slide 4
Different rationing systems
Different rationing systems
The world’s dominant rationing system is the price
mechanism.
But markets are not the only way to resolve
 what and how much to produce,
 how to produce, and
 for whom to produce
Prices are determined in markets (as a result of the
interplay of demand and supply).
Given the correct economic conditions, advocates of
market economies believe they lead to the best
allocation of resources and the highest level of net
economic welfare.
5
Efficiency and Equity (c) Andrew Tibbitt 2008
6
Slide 5
How else can economic activity be co-ordinated?
How can the necessary economic choices be made
and on what grounds?
Will the resulting pattern of production, distribution
and consumption be efficient?
Will it be fair?
Efficiency and Equity (c) Andrew Tibbitt 2008
Slide 6
The world’s dominant rationing
system.
Some options
– Ballot (lanes in Melbourne Cup)
– Central directives (in Cuba, North Korea)
– Allocate to members (finals tickets, some wine
vintages)
– Rules and regulations (water restrictions by
street number)
– Queues – first come first served (public
hospitals)
– Priority allocation (AFL draft)
– Merit – university selection
It has already be said that the world’s dominant
rationing system is the price mechanism.
The circular flow of income model illustrates some
of the markets that operate in the economy.
7
Efficiency and Equity (c) Andrew Tibbitt 2008
8
Slide 7
Efficiency and Equity (c) Andrew Tibbitt 2008
Markets in the circular flow
Markets in the circular flow
Price
Consumption =
demand
Supply
Goods and
services
= supply
HOUSEHOLDS
Price
Slide 8
Demand
Quantity
PRODUCERS
HOUSEHOLDS
PRODUCERS
Supply
Resources (e.g. labour)
= supply
Demand
9
Quantity
Efficiency and Equity (c) Andrew Tibbitt 2008
26
Slide 9
10
Demand for resources =
demand
Efficiency and Equity (c) Andrew Tibbitt 2008
‘Market efficiency’ PowerPoints and activities
Slide 10
The super-computer network
Prices as a signalling mechanism
In a competitive free market economy the market for
each product and economic resource is connected to
the market for all other products and resources
through an ultra-complex network of prices.
The free-market super computer operates through an
ultra-complex network of prices. The prices provide
a messaging or signalling service for producers and
consumers in the economy.
Normally, a rise in price reflects an increase in relative
scarcity. The higher price signals
– Consumers to reassess their buying choices (are
they still getting value for money – some will buy
less)
– Producers to reassess their production choices
(could they increase profits by supplying more?)
This network operates ‘invisibly’ as if driven by a giant
free-market super-computer.
What is the operating system for this free-market
super-computer?
11
Efficiency and Equity (c) Andrew Tibbitt 2008
12
Slide 11
Efficiency and Equity (c) Andrew Tibbitt 2008
Slide 12
Prices as a signalling mechanism
The correct economic conditions
The system only works if consumers and producers
– get the right message
– make a rational choices when they act on the
message
What are the correct economic conditions that allow
markets to maximise welfare?
1.
2.
Prices send the right message given the right economic
circumstances. The right circumstances create ‘a
truthful world’ where the demand curve reflects value
or benefit and the supply curve reflects costs.
3.
4.
5.
13
Efficiency and Equity (c) Andrew Tibbitt 2008
No information gaps / no asymmetrical
information
No side-effects (externalities) / no effect on
bystanders
No monopoly (or scarcity power)
Good motives and incentives
No free riders or non-exclusion products
14
Slide 13
Efficiency and Equity (c) Andrew Tibbitt 2008
Markets increase trade and trade
increases welfare
Given the right conditions markets
maximise welfare.
Consumers only buy things if
the value of the product to
them is equal or greater than
their opportunity cost.
In these economic conditions:
Price = marginal social benefit
Price = marginal social cost
Price
Consumer
surplus
Supply
Consumers get what they want
Producers don’t waste resources
If these conditions do not exist the market becomes
distorted (price does not reflect value and cost).
Demand and supply curves are in the wrong place.
Welfare is reduced. There is a deadweight loss.
Efficiency and Equity (c) Andrew Tibbitt 2008
Demand
Quantity
15
16
Slide 15
Supply
Producers only supply things if
the price they can get is equal or
greater than the cost of
production.
Price
Consumer
surplus
This bonus is called producer
surplus. It increases their
welfare or profit.
Slide 17
Supply
Demand
Quantity
17
18
Efficiency and Equity (c) Andrew Tibbitt 2008
Supply
Price
Competitive markets
create a WORLD OF TRUTH.
Consumer
surplus
Demand
Quantity
Producer
surplus
The supply curve is a true
indicator of the cost of
production for producers.
Slide 19
Competitive markets are,
therefore efficient because:
Demand
 producers make the
right things in the right
quantities.
Quantity
19
Efficiency and Equity (c) Andrew Tibbitt 2008
Supply
 consumers get what
they want
The demand curve is a true
indicator of the value of
the product to consumers.
Producer
surplus
Slide 18
The world of truth
This is only good if the
world of truth exists
Consumer
surplus
The sum of consumer and
producer surplus indicates the
total increase in welfare from
this market.
Producer
surplus
The world of truth
Price
Slide 16
So markets create trade and
trade increases welfare.
When a sale is made they get a
bonus – the money they receive
is greater than their costs of
Demand
production.
Quantity
Efficiency and Equity (c) Andrew Tibbitt 2008
This bonus is called consumer
surplus. It increases their
welfare or satisfaction.
Trade increases welfare
Efficient producers can supply
for less than the clearance price.
Producer
surplus
So, people that buy something
in a market at the ruling price
are getting a bonus – the value
they receive is greater than the
price they pay.
Efficiency and Equity (c) Andrew Tibbitt 2008
Markets increase trade and trade
increases welfare
Price
Slide 14
20
Efficiency and Equity (c) Andrew Tibbitt 2008
‘Market efficiency’ PowerPoints and activities
Slide 20
27
Welfare is maximised at the clearance
price.
Price
Supply
Trade increases consumer
and producer welfare up to
quantity Q1. If the aim is to
maximise benefits and
profits trade should rise to
Q1.
Demand
Q1
If the market clearance price
is not charged welfare falls.
People will opt out of
trading if they are going to
reduce their welfare. They
will lose if cost is greater
than benefit.
Cost greater
than benefit
– trade
stops at Q1
P1
The world of truth
Quantity
Efficiency and Equity (c) Andrew Tibbitt 2008
Price
Consumer
surplus
Deadweight
loss
Producer
surplus
Q2
21
Supply
Deadweight
loss
Producer
surplus
Demand
Quantity
If the market clearance price
is not charged welfare falls.
If a price is set above the
clearance price consumers
reduce demand.
There is excess supply.
Consumer surplus is low
(the red area).
Producers who make a sale
get a big bonus (the orange
area), but some production
is left unsold.
It is easy to show that overall
welfare rises if trade between
countries is increased.
23
24
RISE IN
WELFARE
Overseas
supply
Domestic
Demand
Quantity
25
Efficiency and Equity (c) Andrew Tibbitt 2008
26
Slide 25
Producer
surplus
Domestic
Demand
Quantity
However, overall welfare
increases .
Slide 24
Domestic
Supply
There has been a
redistribution effect
though, some producers
gain, some lose,
consumers gain if they
buy some products and
lose if they buy others. Is
this fair?
RISE IN
WELFARE
Overseas
supply
Domestic
Demand
Quantity
Efficiency and Equity (c) Andrew Tibbitt 2008
Slide 26
Market failure
When there are externalities
Markets sometimes fail to produce efficient results
because the necessary conditions do not exist.
Bystanders (third parties) can be affected by economic
decisions made by others. These spin-off or side
effects of an economic decision are called
externalities.
They fail, for example when :
1. Externalities are not taken into account (and
bystanders suffer collateral damage)
2. Producers have scarcity or monopoly power (and
they dominate the market, raise prices and earn
excessive profits
3. Key information is not known or shared evenly
4. Income distribution is unfair.
Bystanders can be affected in a good or positive way
(e.g. your neighbour has nice garden). These positive
externalities create social benefits.
27
28
Slide 27
Efficiency and Equity (c) Andrew Tibbitt 2008
Efficiency and Equity (c) Andrew Tibbitt 2008
Quantity
Greenhouse Gases are emitted by planes.
So do free markets create too many flights
at too low a price?
Slide 29
Public transport S
private
es
s
co
ng
es
tio
n
S total
So
D
Too much will be
produced and
consumers will pay too
low a price.
Price
of
l
c ia
lc
os
to
f5
%
of
cli
m
at
e
ch
an
ge
In a similar way, if market
players do not take
positive externalities or
social benefits into
account (do not include
them in their demand and
supply decisions) the
market will not work
efficiently.
S
airlines
So
If market players do not
take these negative
externalities or social
costs into account (do
not include them in
their demand and
supply decisions) the
market will not work
efficiently.
Ignoring externalities leads to inefficiency
S total
Air travel
Slide 28
ef
it
Ignoring externalities leads to inefficiency
Price
Bystanders can be harmed or affected in a negative
way (e.g. people become sick from factory pollution).
These negative externalities create social costs.
c ia
lb
en
Efficiency and Equity (c) Andrew Tibbitt 2008
28
Overseas
supply
RISE IN
WELFARE
Taken together more
Price
exports and more imports
lead to higher welfare.
Domestic
Supply
However, overall welfare
increases.
Domestic
Supply
Applying the concept to international
trade
Consumer
surplus
Producer
surplus
Consumer
surplus
Efficiency and Equity (c) Andrew Tibbitt 2008
Applying the concept to international
trade
Consumers can buy goods at
cheaper prices (we are less
efficient than the overseas
country). Our producers lose
out as competition from
imports increases.
Price
Exporters can get higher
prices for their products (we
are more efficient than the
overseas country) and sell
more. Some supply is
diverted from domestic sales
so consumers lose out.
Slide 23
Price
Slide 22
Applying the concept to international
trade
Efficiency and Equity (c) Andrew Tibbitt 2008
It is easy to show that overall
welfare rises if trade between
countries is increased.
If a price is set below the
clearance price producers
reduce supply (to Q2).
There is excess demand.
Producer surplus is low (the
orange area).
The consumers who can get
the product get a big bonus
(the red area), but some
potential buyers go without.
Efficiency and Equity (c) Andrew Tibbitt 2008
The world of truth
Consumer
surplus
Demand
Quantity
22
Slide 21
Price
Supply
Too little will be supplied
and consumers will pay
too high a price.
29
30
Efficiency and Equity (c) Andrew Tibbitt 2008
‘Market efficiency’ PowerPoints and activities
D
Quantity
Free market public transport could be
too expensive if it forces people to
use their cars and cause congestion
Slide 30
Monopolists restrict supply and push up
prices.
Scarcity or monopoly power
If one of the players in a market has power over the
other then the market outcome becomes distorted
and the result can be inefficient. If a producer has
monopoly power in a sense they have scarcity power.
Consumer
surplus
Price
Supply
(competitive)
Monopoly power comes from a lack of competition.
Deadweight
loss
Producers can deliberately minimise competition (e.g.
by branding, innovation, take overs). Producers with
monopoly power can restrict supply or push up prices.
The price no longer reflects the costs of production.
The result is inefficiency.
Producer
surplus
Demand
Quantity
31
Efficiency and Equity (c) Andrew Tibbitt 2008
Monopolists have the
power to control supply
in the market. This can
lead to prices that are
higher than those set in
competitive markets.
New Supply
(monopoly)
32
Slide 31
Efficiency and Equity (c) Andrew Tibbitt 2008
Slide 32
Information gaps
Other problems for the market economy
Competitive free markets only produce efficient
outcomes if
 Demand curves reflect the true level of consumer
value or marginal benefit
 Supply curves reflect true costs of production
(the opportunity of using the resource inputs)
Income distribution
Demand curves reflect effective demand.
Effective demand exists if a need or want can be
backed up by the ability to pay for it.
If income distribution is unfair (lacks equity) the
pattern of effective demand will be unfair.
If producers don’t know the cost of production (like
insurance companies) and consumers don’t know the
value of the product they are buying (like health care
and second hand cars) then the market can’t operate
efficiently.
Efficiency and Equity (c) Andrew Tibbitt 2008
33
34
Slide 33
Efficiency and Equity (c) Andrew Tibbitt 2008
Modified market economies
Other problems for the market economy
As a result of market failure, nearly all economies are not
pure free market economies but mixed economies.
Public and collective goods
Products
– that are non-rival products (one person using the
good doesn’t prevent another for using it as well)
– where the exclusion principle does not operate
(the supplier or owner can’t prevent non-payers or
free-riders from using the product)
– where individual demand is unrealistic (such as
national defence)
Government’s modify markets or override the market
altogether by influencing:
 the allocation of resources (e.g. through taxes, subsidies,
or directives) – allocative role
 business behaviour (e.g. through regulations and
legislation) – regulatory role
 the distribution of household incomes (e.g. through
taxation and welfare) – redistribution role
will not be efficiently produced in a free market
economy.
Efficiency and Equity (c) Andrew Tibbitt 2008
Slide 34
 the overall level of aggregate demand (e.g. through fiscal
and monetary policy) – demand management role
Slide 35
35
36
Efficiency and Equity (c) Andrew Tibbitt 2008
Slide 36
Government modifications
Government failure
Policy measures to fix up or prevent market failure
include:
In some situations government intervention does prevent or
fix up market failure. But overall central planning does not
provide a more efficient and fairer rationing system.
Government run economies suffer from:
1. Taxing bad behaviour, taxing high income earners
2. Subsidising good behaviour, paying welfare to low
income earners.
3. Regulating or legislating against bad behaviour
4. Regulating or legislating good behaviour
5. Establishing markets to trade ‘permits to behave
badly’
1.
2.
3.
4.
5.
The trick is to intervene only when necessary.
37
Efficiency and Equity (c) Andrew Tibbitt 2008
38
Slide 37
Efficiency and Equity (c) Andrew Tibbitt 2008
Taxing a competitive market reduces
net economic welfare.
Supply with
tax
Price
Slide 38
A difference of emphasis
When to intervene and modify a market is a matter of
judgement for governments. Economists can use the
concepts of consumer surplus, producer surplus and net
economic welfare to inform the policy debate.
Taxing a
competitive market
reduces welfare.
Supply
without tax
REDUCTION IN NET
WELFARE =
DEADWEIGHT LOSS
Demand
Quantity
39
Efficiency and Equity (c) Andrew Tibbitt 2008
Bureaucratic and cumbersome allocation processes
Moral hazard
Rent seeking behaviour (corruption)
Lack of incentive – bottomless pots, feather bedding,
no competition
Lack of consumer freedom or sovereignty
Slide 39
40
LEFT
RIGHT
Responsibilities
Rights
Entitlements
Choice
Equity
Efficiency
Market failure
Incentives
Government intervention
Government failure
Efficiency and Equity (c) Andrew Tibbitt 2008
‘Market efficiency’ PowerPoints and activities
Slide 40
29
4.3 PowerPoint Companion
Efficiency and equity—concepts and applications
Efficiency and Equity
Slide 2
a) Economic resources are _________ __________.
b) Resources are ________, while wants are
_________.
c) A society can’t have everything they want. There
must be a system that ________both resources and
products.
d) The rationing system must answer the following
questions:
1.
Slide 5
a) The world’s dominant rationing system is the
__________ ______________.
b) Prices are determined in _________ (as a result of
the interplay of ______ and ______).
c) Given the ___________________________,
advocates of market economies believe they lead to
the best allocation of resources and the highest level
of net economic welfare.
Slides 6 and 7
a) The price mechanism is not the only rationing
system. Other alternative approaches include:
1.
2.
3.
2.
Slide 3
a) Two basic tests for a rationing system are:
1.
3.
4.
5.
2.
Slide 4
a) __________ is a concept related to the use of
resources.
b) Two types of efficiency are:
1.
2.
c) ____________ efficiency refers to the cost of
production
d) ____________ efficiency assesses whether
resources are being used to make products that
people want
e) ____________ is a concept related to the
distribution of products between different members of
society.
f) _______________ equity occurs where there is no
discrimination between people whose economic
characteristics and performance are equal
g) _______________equity occurs where there is
different treatment of different people in order to
reduce the differences between people
30
b) Alternatives are used because markets are not
always _____________ and they are not always
__________________.
Slides 8 and 9
Markets are used to ration products in product
markets and resource markets.
Slide 10 and 11
a) In a competitive free market economy the market
for each product and economic resource is
connected to the market for all other products and
resources through an ultra-complex
______________________.
b) This network operates ____________ as if driven
by a giant free-market super-computer.
c) The operating system for this free-market supercomputer is the ________ ___________.
Slide 12
a) Prices provide a messaging or _________ service
for producers and consumers in the economy.
b) Normally, a rise in price reflects an increase in
__________________.
c) The higher price signals consumers to buy
__________________.
d) The higher price signals producers to supply
__________________.
‘Market efficiency’ PowerPoints and activities
PowerPoint Companion
Slide 13
a) The system only works if consumers and
producers
1.
2.
b) Price messages will only be right in certain
economic circumstances. The right circumstances
create ‘a truthful world’ where
1. Demand reflects __________ .
2. SS reflects ______________________.
Slide 14
There are five key conditions required for the
effective operation of the price mechanism.
Efficiency and Equity
Slide 16
a) Markets promote _______ and trade increases
__________________.
b) Consumers only buy things if the value of the
product to them is equal or greater than their
___________________.
c) So, people that buy something in a market at the
ruling price are getting a ________.
d) The value or benefit they receive is greater than
(or for one consumer equal to) the price they pay.
e) This bonus is called ___________________. ) It
adds to their welfare or satisfaction because they are
receiving more benefit than the opportunity cost they
incur.
g) The total amount of consumer surplus generated
in a market is:
Price
Supply
1.
2.
3.
4.
5.
Slide 15
a) In these economic conditions prices reflect
1.
of consumers
2.
Demand
Quantity
of producers
b) __________ get what they want and _________
don’t waste resources
c) If these conditions do not exist the market
becomes ____________ and price does not reflect
_________ and ________.
d) Markets are distorted because the demand and
supply curves are ___________________.
e) Overall ___________is reduced.
f) The loss of overall welfare is referred to as
___________________.
Slide 17
a) Producers only supply products if the price they
can get is equal or greater than the ______ of
__________________.
b) Efficient producers can supply for less than the
_______________ price.
c) When a sale is made they get a _____________
— the money they receive is greater than their costs
of production.
d) This bonus is called ___________________.
e) It increases their ___________ or profit.
‘Market efficiency’ PowerPoints and activities
31
PowerPoint Companion
Slide 17 continued
The total amount of producer surplus received by
producers is:
Price
Efficiency and Equity
Slide 20
Competitive markets are efficient because:
1.
2.
Supply
Demand
Slide 21
a) People will _________ of trading if they are going
to reduce their welfare.
b) If extra costs of production (as shown by the
______ curve) greater than extra benefits gained (as
shown by the ______ curve) from a trade they will
lose out and total welfare will ______.
c) Trade increases consumer and producer welfare
up to quantity Q1 because extra ________ are
greater than costs of production. d) If the aim is to
maximise benefits and profits trade should rise to Q1.
Quantity
Slide 18
a) The sum of _________ and _________surplus
indicates the total increase in __________ from this
market.
b) So markets promote _______ and trade promotes
_________.
c) The total welfare promoted in this market is the
sum of consumer and producer surplus and can be
illustrated as follows:
Slide 22
a) If the market clearance price is not charged
welfare falls.
b) If a price is set below clearance price producers
_________ supply.
c) There is excess _________.
d) Producer surplus is low (the _______ area).
e) The consumers who can get the product get a big
bonus (the _____ area), but some potential buyers
go without.
Price
Price
Supply
Supply
Demand
Demand
Quantity
Slide 19
a) Remember markets only work efficiently if the
‘world of truth’ exists.
b) The demand curve must be a true indicator of the
___________ of the product to consumers.
c) The supply curve must be true indicator of the
______________________ for producers.
32
‘Market efficiency’ PowerPoints and activities
Quantity
PowerPoint Companion
Slide 23
a) If the market clearance price is not charged
welfare ______.
b) If a price is set above clearance price consumers
_________ demand.
c) There is excess _________.
d) Consumer surplus is ____ (the _______ area).
e) Producers who make a sale get a big bonus (the
_____ area), but some production is left unsold.
Price
Supply
Demand
Efficiency and Equity
Slide 25
a) Welfare also increases because we can import
goods.
b) Consumers can buy goods at ________ prices (we
are _____ efficient than the overseas country at
making these products).
c) Our producers ________ as competition from
imports increases.
d) However, overall the extra imports ________
welfare.
Slide 26
a) Taken together more exports and more imports
lead to _______ welfare.
b) There has been a redistribution effect though,
some producers gain, some lose, consumers gain if
they buy some products and lose if they buy others.
Is this fair?
Slide 27
a) Markets sometimes ______ to produce efficient
results because the conditions required do not exist.
b) They fail, for example when :
1.
Quantity
2.
Slide 24
a) It is easy to show that overall welfare ______ if
trade between countries is increased.
b) Exporters can get _______ prices for their
products (we are more efficient than the overseas
country) and sell ______.
c) Some supply is diverted from domestic sales so
consumers ________.
d) However, overall the extra exports lead to
increased welfare _________.
Price
Supply
3.
4.
Slide 28
a) _____________ (or third parties) can be affected
by economic decisions made by others.
b) These spin-off or side effects of an economic
decision are called _____________.
c) Bystanders can be affected in a good or positive
way (e.g. your neighbour has nice garden). These
are _________ externalities and create _________
benefits.
d) Bystanders can be harmed or affected in a
negative way (e.g. people become sick from factory
pollution). These are _____________ externalities
and crate ________ costs.
Demand
Quantity
‘Market efficiency’ PowerPoints and activities
33
PowerPoint Companion
Slides 29 and 30
a) If market players do not take these social costs
and benefits into account (do not include them in
their demand and supply decisions) the market will
not work __________.
b) Too much or too little will be produced at too low
or too high a price.
c) If negative externalities are ignored, free markets
lead to over-supply, and consumers pay too low a
price.
Efficiency and Equity
Slide 32
a) Monopolists have the power to control supply in
the market. This can lead to prices that are higher
than those set in competitive markets.
The result is inefficiency.
Price
Supply
Price
Supply
Demand
Quantity
Demand
Quantity
d) If positive externalities are ignored, free markets
lead to under-supply, and consumers pay too high a
price.
Price
Supply
Slide 33
a) Competitive free markets only produce efficient
outcomes if
1) Demand curves reflect ….
2) Supply curves reflect ….
b) If producers don’t know the cost of production (like
insurance companies) and consumers don’t know
the value of the product they are buying (like health
care and second hand cars) then the market can’t
operate efficiently.
Slide 34 - Income distribution
Demand curves reflect effective demand.
Effective demand exists if a need or want can be
backed up by the ability to pay for it.
If income distribution is unfair (lacks equity) the
pattern of effective demand will be unfair.
Demand
Quantity
Slide 31
a) If one of the players in a market has power over
the other then the market outcome becomes
___________ and the result can be inefficiency. b) If
a producer has ______________ in a sense they
have scarcity power.
c) Monopoly power creates a lack of _________.
d) Producers with monopoly power can _______
supply or _______ prices. The price no longer
reflects the costs of production.
34
Slide 35 - Public and collective goods
Products
1) that are ____________ products (one person
using the good doesn’t prevent another for using it
as well)
2) where the _____________ does not operate (the
supplier or owner can’t prevent non-payers or freeriders from using the product)
3) where ___________demand is unrealistic (such
as national defence) will not be efficiently produced
in a free market economy because a market demand
curve and market supply will not exist or will be in
the wrong place.
‘Market efficiency’ PowerPoints and activities
PowerPoint Companion
Slide 36
a) As a result of market failure, nearly all economies
are not pure free market economies but ______
______________.
b) Government’s modify markets or override the
market altogether by influencing:
1.
Efficiency and Equity
Slide 39
a) Taxing competitive markets ___________ net
economic welfare.
b) The tax results in a ________ price and
___________ quantity traded.
c)
Price
Supply
2.
3.
4.
Slide 37
a) Policy measures to fix up or prevent market failure
include:
1. Taxing bad behaviour, taxing high income
earners
2. Subsidising good behaviour, paying welfare to
low income earners.
3. Regulating or legislating against bad behaviour
4. Regulating or legislating good behaviour
5. Establishing markets to trade ‘permits to behave
badly’
Slide 38
a) In some situations government intervention does
prevent or fix up market failure.
b) But overall central planning does not provide a
more efficient and fairer rationing system than the
market system.
c) Government run economies suffer from:
1.
Demand
Quantity
Slide 40
a) When to intervene and modify a market is a
matter of judgement for governments.
b) Economists can use the concepts of consumer
surplus, producer surplus and net economic welfare
to inform the policy debate.
2.
3.
4.
5.
The trick is to intervene only when necessary.
‘Market efficiency’ PowerPoints and activities
35
PowerPoint Companion
Efficiency and equity-— concepts and applications
(answers)
PowerPoint Companion
Slide 2
a) Economic resources are RELATIVELY SCARCE
b) Resources are LIMITED, while wants are
UNLIMITED.
c) A society can’t have everything they want. There
must be a system that RATIONS both resources and
products.
d) The rationing system must answer the following
questions:
1. WHAT AND HOW MUCH TO PRODUCE
Efficiency and Equity
Slide 5
a) The world’s dominant rationing system is the
PRICE MECHANISM
b) Prices are determined in MARKETS (as a result
of the interplay of DEMAND and SUPPLY).
c) Given the CORRECT ECONOMIC CONDITIONS,
advocates of market economies believe they lead to
the best allocation of resources and the highest level
of net economic welfare.
Slides 6 and 7
a) The price mechanism is not the only rationing
system. Other alternative approaches include:
1. DIRECTIVES, COMMANDS
2. HOW TO PRODUCE
3. FOR WHOM TO PRODUCE
2. BALLOTS
Slide 3
a) Two basic tests for a rationing system are:
1. IS IT EFFICIENT?
3. MEMBERSHIP, PREFERENTIAL TREATMENT
4. QUEUES
5. ON BASIS OF NEED, GOVERNMENT
2. IS IT FAIR?
PROVIDES
Slide 4
a) EFFICIENCY is a concept related to the use of
resources.
b) Two types of efficiency are:
1. PRODUCTIVE
2. ALLOCATIVE
c) PRODUCTIVE efficiency refers to the cost of
production
d) ALLOCATIVE efficiency assesses whether
resources are being used to make products that
people want
e) EQUITY is a concept related to the distribution of
products between different members of society.
f) HORIZONTAL equity occurs where there is no
discrimination between people whose economic
characteristics and performance are equal
g) VERTICAL equity occurs where there is different
treatment of different people in order to reduce the
differences between people
36
b) Alternatives are used because markets are not
always EFFICIENT and they are not always FAIR
(EQUITABLE).
Slides 8 and 9
Markets are used to ration products in product
markets and resource markets.
Slide 10 and 11
a) In a competitive free market economy the market
for each product and economic resource is
connected to the market for all other products and
resources through an ultra-complex NETWORK OF
PRICES.
b) This network operates INVISIBLY as if driven by a
giant free-market super-computer.
c) The operating system for this free-market supercomputer is the PRICE MECHANISM.
Slide 12
a) Prices provide a messaging or SIGNALLING
service for producers and consumers in the
economy.
b) Normally, a rise in price reflects an increase in
RELATIVE SCARCITY.
c) The higher price signals consumers to buy LESS.
d) The higher price signals producers to supply
MORE.
‘Market efficiency’ PowerPoints and activities
PowerPoint Companion
Slide 13
a) The system only works if consumers and
producers
1. GET CORRECT PRICE SIGNALS
2. RESPOND RATIONALLY (LOGICALLY)
b) Price messages will only be right in certain
economic circumstances. The right circumstances
create ‘a truthful world’ where
1. Demand reflects VALUE OR MARGINAL
BENEFIT.
2. SS reflects COSTS OF PRODUCTION.
Slide 14
There are five key conditions required for the
effective operation of the price mechanism.
1. NO INFORMATION GAPS
Efficiency and Equity
Slide 16
a) Markets promote TRADE and trade increases
WELFARE.
b) Consumers only buy things if the value of the
product to them is equal or greater than their
OPPORTUNITY COST.
c) So, people that buy something in a market at the
ruling price are getting a BONUS.
d) The value or benefit they receive is greater than
(or for one consumer equal to) the price they pay.
e) This bonus is called CONSUMER SURLUS.
f) It adds to their welfare or satisfaction because they
are receiving more benefit than the opportunity cost
they incur.
g) The total amount of consumer surplus generated
in a market is:
Price
Supply
2. NO EXTERNALITIES
3. NO MONOPOLY POWER
4. RATIONAL RESPONSE TO ECONOMIC
INCENTIVES (as apposed to political ones)
5. NO FREE RIDERS OR EXCLUSION ISSUES
Slide 15
a) In these economic conditions prices reflect
1. MARGINAL BENEFIT of consumers
Demand
Quantity
2. MARGINAL COST OF PRODUCTION of
producers
b) CONSUMERS get what they want and
PRODUCERS don’t waste resources
c) If these conditions do not exist the market
becomes DISTORTED and price does not reflect
BENEFITS and COSTS.
d) Markets are distorted because the demand and
supply curves are IN THE WRONG PLACE.
e) Overall WELFARE is reduced.
f) The loss of overall welfare is referred to as
DEADWEIGHT LOSS.
Slide 17
a) Producers only supply products if the price they
can get is equal or greater than the COST of
PRODUCTION
b) Efficient producers can supply for less than the
MARKET or CLEARANCE price.
c) When a sale is made they get a BONUS – the
money they receive is greater than their costs of
production.
d) This bonus is called PRODUCER SURPLUS.
e) It increases their WELFARE or profit.
‘Market efficiency’ PowerPoints and activities
37
PowerPoint Companion
Slide 17 continued
The total amount of producer surplus received by
producers is:
Price
Supply
Demand
Quantity
Slide 18
a) The sum of CONSUMER and PRODUCER
surplus indicates the total increase in WELFARE
from this market.
b) So markets promote TRADE and trade promotes
WELFARE.
c) The total welfare promoted in this market is the
sum of consumer and producer surplus and can be
illustrated as follows:
Price
Efficiency and Equity
Slide 20
Competitive markets are efficient because:
1. CONUMERS GET WHAT THEY WANT AND
VALUE
2. PRODUCERS MAKE THE RIGHT THINGS AT
THE RIGHT PRICE
Slide 21
a) People will OPT OUT of trading if they are going
to reduce their welfare.
b) If extra costs of production (as shown by the
SUPPLY curve) greater than extra benefits gained
(as shown by the DEMAND curve) from a trade they
will lose out and total welfare will FALL.
c) Trade increases consumer and producer welfare
up to quantity Q1 because extra BENEFITS are
greater than costs of production. d) If the aim is to
maximise benefits and profits trade should rise to
Q1.
Slide 22
a) If the market clearance price is not charged
welfare falls.
b) If a price is set below clearance price producers
REDUCE supply.
c) There is excess DEMAND.
d) Producer surplus is low (the ORANGE area).
e) The consumers who can get the product get a big
bonus (the RED area), but some potential buyers go
without.
Price
Supply
Demand
Quantity
Slide 19
a) Remember markets only work efficiently if the
‘world of truth’ exists.
b) The demand curve must be a true indicator of the
BENEFIT of the product to consumers.
c) The supply curve must be true indicator of the
COST OF PRODUCTION for producers.
38
‘Market efficiency’ PowerPoints and activities
Supply
Demand
Quantity
PowerPoint Companion
Slide 23
a) If the market clearance price is not charged
welfare FALLS.
b) If a price is set above clearance price consumers
REDUCE demand.
c) There is excess SUPPLY.
d) Consumer surplus is LOW (the RED area).
e) Producers who make a sale get a big bonus (the
ORANGE area), but some production is left unsold.
Price
Supply
Demand
Efficiency and Equity
Slide 25
a) Welfare also increases because we can import
goods.
b) Consumers can buy goods at LOWER prices (we
are LESS efficient than the overseas country at
making these products).
c) Our producers LOSE OUT as competition from
imports increases.
d) However, overall the extra imports INCREASE
welfare.
Slide 26
a) Taken together more exports and more imports
lead to INCREASE welfare.
b) There has been a redistribution effect though,
some producers gain, some lose, consumers gain if
they buy some products and lose if they buy others.
Is this fair?
Slide 27
a) Markets sometimes FAIL to produce efficient
results because the conditions required do not exist.
b) They fail, for example when :
1. EXTERNALITIES AREN’T INTERNALISED
Quantity
2. PRODUCERS HAVE MONOPLOY POWER
Slide 24
a) It is easy to show that overall welfare RISES if
trade between countries is increased.
b) Exporters can get HIGHER prices for their
products (we are more efficient than the overseas
country) and sell MORE.
c) Some supply is diverted from domestic sales so
consumers PAY MORE.
d) However, overall the extra exports lead to
increased welfare WELFARE.
Price
Supply
3. THERE ARE INFORMATION GAPS
4. INCOME DISYRIBUTION IS UNFAIR
Slide 28
a) BYSTANDERS (or third parties) can be affected
by economic decisions made by others.
b) These spin-off or side effects of an economic
decision are called EXTERNALITIES.
c) Bystanders can be affected in a good or positive
way (e.g. your neighbour has nice garden). These
are POSITIVE externalities and create SOCIAL
benefits.
d) Bystanders can be harmed or affected in a
negative way (e.g. people become sick from factory
pollution). These are NEGATIVE externalities and
crate SOCIAL costs.
Demand
Quantity
‘Market efficiency’ PowerPoints and activities
39
PowerPoint Companion
Slides 29 and 30
a) If market players do not take these social costs
and benefits into account (do not include them in
their demand and supply decisions) the market will
not work EFFICIENTLY.
b) Too much or too little will be produced at too low
or too high a price.
c) If negative externalities are ignored, free markets
lead to over-supply, and consumers pay too low a
price.
Efficiency and Equity
Slide 32
a) Monopolists have the power to control supply in
the market. This can lead to prices that are higher
than those set in competitive markets.
The result is inefficiency.
Price
Supply
Price
Supply
Demand
Quantity
Demand
Quantity
d) If positive externalities are ignored, free markets
lead to under-supply, and consumers pay too high a
price.
Price
Supply
Slide 33
a) Competitive free markets only produce efficient
outcomes if
1) Demand curves reflect MARGINAL BENEFIT OF
CONSUMERS
2) Supply curves reflect MARGINAL COSTS OF
PRODUCTION OF PRODUCERS
b) If producers don’t know the cost of production (like
insurance companies) and consumers don’t know
the value of the product they are buying (like health
care and second hand cars) then the market can’t
operate efficiently.
Slide 34 - Income distribution
Demand curves reflect effective demand.
Effective demand exists if a need or want can be
backed up by the ability to pay for it.
If income distribution is unfair (lacks equity) the
pattern of effective demand will be unfair.
Demand
Quantity
Slide 31
a) If one of the players in a market has power over
the other then the market outcome becomes
DISTORTED and the result can be inefficiency. b) If
a producer has MONOPLY POWER in a sense they
have scarcity power.
c) Monopoly involves a lack of COMPETITION.
d) Producers with monopoly power can REDUCE
supply or RAISE prices. The price no longer reflects
the costs of production.
40
Slide 35 - Public and collective goods
Products that are
1) NON-RIVAL products (one person using the good
doesn’t prevent another for using it as well)
2) where the EXCLUSION PRINCIPLE does not
operate (the supplier or owner can’t prevent nonpayers or free-riders from using the product)
3) where INDIVIDUAL demand is unrealistic (such
as national defence) will not be efficiently produced
in a free market economy because a market demand
curve and market supply will not exist or will be in
the wrong place.
‘Market efficiency’ PowerPoints and activities
PowerPoint Companion
Slide 36
a) As a result of market failure, nearly all economies
are not pure free market economies but MODIFIED
MARKET ECONOMIES
b) Government’s modify markets or override the
market altogether by influencing:
1. RESOURCE ALLOCATION
Efficiency and Equity
Slide 39
a) Taxing competitive markets REDUCES net
economic welfare.
b) The tax results in a HIGHER price and LOWER
quantity traded.
c)
Price
Supply
2. BUSINESS BEHAVIOUR
3. INCOME DISTRIBUTION
4. AGGREGATE DEMAND
Slide 37
a) Policy measures to fix up or prevent market failure
include:
6. Taxing bad behaviour, taxing high income
earners
7. Subsidising good behaviour, paying welfare to
low income earners.
8. Regulating or legislating against bad behaviour
9. Regulating or legislating good behaviour
10. Establishing markets to trade ‘permits to behave
badly’
Slide 38
a) In some situations government intervention does
prevent or fix up market failure.
b) But overall central planning does not provide a
more efficient and fairer rationing system than the
market system.
c) Government run economies suffer from:
1. Bureaucracy
Demand
Quantity
Slide 40
a) When to intervene and modify a market is a
matter of judgement for governments.
b) Economists can use the concepts of consumer
surplus, producer surplus and net economic welfare
to inform the policy debate.
2. Moral hazard
3. Rent-seeking behaviour
4. Lack of incentives
5. Lack of consumer sovereignty
The trick is to intervene only when necessary.
‘Market efficiency’ PowerPoints and activities
41
42
‘Market efficiency’ PowerPoints and activities
4.4 Extension activities
The concepts of efficiency and equity
1. Efficiency and equity
(a) Explain the difference between the concepts of efficiency and equity.
Option
A
B
C
D
E
(b) An economy has used its resources to make
10 units of a product. The resources are to
be allocated between two people. Complete
the table by placing a tick or a cross in the
efficiency and equity columns in the table
provided.
Distribution
10,0
7,2
5,5
3,6
0,10
Efficiency
Equity
Note: In the distribution column 10.0 means person A gets 10 units and person B gets 0 units.
(c)
Is option D better or worse than C?
2. An economy has units of a product available for distribution between two people, you and me.
(a) Option 1 is 10 units to you and 10 units to
me and is shown on the graph. Place
options 2 to 8 on the graph as well.
Option 2 is 15 you, 5 me.
Option 3 is 5 you, 5 me
Option 4 is 20 you, 10 me.
Option 5 is 5 you, 10 me.
Option 6 is 15 you, 15 me.
Option 7 is 5 you, 15 me.
Option 8 is 10 you, 20 me.
F
or
20
y
o
u
15
10
1
5
(b) For society (you and me) as a whole:
i) which options are better than option 1?
ii) which options are worse than option 1?
iii) which options can’t be judged to be
better or worse?
(c)
25
5 10 15 20 25
For Me
If there were only 20 units available, which of the above options is:
i) efficient
ii) inefficient
iii) impossible
iv) equitable
3.
Suppose an economy only produces books and food. The price of a book is $20 and the price of a
unit of food is $10.
(a)
(b)
(c)
(d)
(e)
What is the marginal social benefit from the last book purchased?
What is the marginal social benefit from the last unit of food purchased?
What is the marginal social cost of producing the last book?
What is the marginal social cost of producing the last unit of food?
Suppose a $5 tax is placed on books. Describe what happens in the book and food markets
and predict what happens to the welfare in the economy as a whole.
‘Market efficiency’ PowerPoints and activities
43
4. (a) Based on the data in the table 1 what is the equilibrium price for their potting mix?
Table 1 Potting Mix
(b) What is the equilibrium level of sales of potting mix
Price ($)
Quantity
Quantity
each week?
demanded per
supplied per
(c) What is the equation of the demand curve for
week
week
potting mix?
0
40
0
(d) What is the equation for the supply curve of potting 1
34
4
mix?
2
28
8
(e) Show how these equations can be used to verify
3
22
12
that the answers given in questions 1 and 2 are
4
16
16
correct.
5
10
20
(f) What would happen to the garden centre’s stock of 6
4
24
potting mix if they set the price at $3 per bag?
Explain your answer.
(g) According to this data, state, with reasons, whether or not the demand for potting mix
conforms to the law of demand.
(h) Draw the demand and supply curves for the garden centre’s potting mix. Label axes correctly.
Show the equilibrium position clearly.
(i) Use the diagram to indicate the total level of (i) consumer surplus and (ii) producer surplus in
this situation. (2 marks)
(j) What must be true for all consumers who buy potting mix at the equilibrium price? Why do
they buy potting mix at this price? Why do they gain from participating in this market?
5. What indicators, evidence or signs would indicate that a specific market was operating efficiently
or inefficiently?
6. The Car Auction
A car dealer has three demonstrator models that it wishes to sell. Experience shows that these
models in good condition and with low kilometres sell for between $14,000 and $15,500. It has
already had some customers enquiring about buying similar cars second hand. As it happens (and
unknown to the dealer) there are 10 people interesting in buying one of these cars.
Alan will only buy if he can get a car for $12,000, Bob if he can get one for $12,500, Chris will pay
up to $13,000, David $13,500, Evan $14,000, Fred $14,500, George $15,000, Harry $15,500, Ian
$16,000 and James $16,500.
The sales manager has three main options:
i) Put the three up for sale at $15,500 (and be prepared to negotiate if necessary)
ii) Hold an open auction for the cars one Saturday morning (with a reserve price of $14,000)
iii) Invite people to put in sealed bids for the cars by a given date and sell to the three highest
bids (with a reserve set again at $14,000).
(a) Draw a demand curve for the cars.
(b) What is the equilibrium price for these cars?
(c) If option a is chosen who gets the cars and which of these get the car for less than were
prepared to pay? What is the total consumer surplus?
(d) How much does the dealer receive from option (i)?
(e) Which of the options is best for the dealer?
(f) What might the consumers do if options (ii) or (iii) were used?
44
‘Market efficiency’ PowerPoints and activities
Answers to Extension activities
The concepts of efficiency and equity
1.
(a) Explain the difference between the concepts of efficiency and equity.
Efficiency – is the economy getting the most of out its scarce resources
Equity – how fair is the distribution of products
Option
Distribution
between different members of society?
A
10,0
B
7,2
Efficiency
Yes
No
Yes
No
Yes
Equity
No
No
Yes
No
No
(b) An economy has used its resources to make
C
5,5
D
3,6
10 units of a product. The resources are to
E
0,10
be allocated between two people. Complete
the table by placing a tick or a cross in the efficiency and equity columns in the table
provided.
Note: In the distribution column 10,0 means person A gets 10 units and person B gets 0 units.
(c)
Is option D better or worse than C?
Depends on value placed on product by
each consumer.
2.
An economy has units of a product available
for distribution between two people, you and
me.
(a) Option 1 is 10 units to you and 10 units to
me and is shown on the graph. Place
options 2 to 8 on the graph as well.
25
F
or
20
y
o
u
15
4
2
6
10
1
8
5
Option 2 is 15 you, 5 me.
Option 3 is 5 you, 5 me
Option 4 is 20 you, 10 me.
Option 5 is 5 you, 10 me.
Option 6 is 15 you, 15 me.
Option 7 is 5 you, 15 me.
Option 8 is 10 you, 20 me.
3
7
5
5 10 15 20 25
For Me
(b) For society (you and me) as a whole:
i) which options are better than option 1? 4, 6, 8
ii) which options are worse than option 1? 3, 5
iii) which options can’t be judged to be better or worse? 2, 7
(c)
If there were only 20 units available, which of the above options is:
i) efficient 2,1,7
ii) inefficient 3,5
iii) impossible 4,6,8
iv) equitable 3,1,6
3.
Suppose an economy only produces books and food.
The price of a book is $20 and the price of a unit of food is $10.
(a)
(b)
(c)
(d)
What is the marginal social benefit from the last book purchased? $20
What is the marginal social benefit from the last unit of food purchased? $10
What is the marginal social cost of producing the last book? $20
What is the marginal social cost of producing the last unit of food? $10
‘Market efficiency’ PowerPoints and activities
45
(e) Suppose a $5 tax is placed on books. Describe what happens in the book and food markets
and predict what happens to the welfare in the economy as a whole. Price of books rises,
welfare in this market drops, extra sales of food.
4.
(a) Based on the data in the table 1 what is the equilibrium price for their potting mix? $4
Table 1 Potting Mix
(b) What is the equilibrium level of sales of potting mix
Price ($)
Quantity
Quantity
each week? 16 units
demanded
per
supplied
per
(c) What is the equation of the demand curve for
week
week
potting mix? Qd = 40 – 6P
0
40
0
(d) What is the equation for the supply curve of potting
1
34
4
mix? Qs = 4P
2
28
8
(e) Show how these equations can be used to verify
3
22
12
that the answers given in questions 1 and 2 are
4
16
16
correct.
5
10
20
40 – 6P = 4P
6
4
24
40 = 10P
4=P
(f) What would happen to the garden centre’s stock of potting mix if they set the price at $3
per bag? Explain your answer. Due to excess demand the would run out mid-week
(g) According to this data, state, with reasons, whether or not the demand for potting mix
conforms to the law of demand. Yes, as price rises, quantity demanded falls
(h) Draw the demand and supply curves for the garden centre’s potting mix. Label axes correctly.
Show the equilibrium position clearly.
Consumer
surplus
4
Producer
surplus
16
(i)
Use the diagram to indicate the total level of (i) consumer surplus and (ii) producer surplus in
this situation.
(j)
What must be true for all consumers who buy potting mix at the equilibrium price? Why do
they buy potting mix at this price? Why do they gain from participating in this market?
Consumers are getting consumer surplus. They value the product more than the opportunity
cost of spending their money on it.
5.
What indicators, evidence or signs would indicate that a specific market was operating efficiently
or inefficiently? Absence of conditions that lead to market failure.
46
‘Market efficiency’ PowerPoints and activities
6. The Car Auction
A car dealer has three demonstrator models that it wishes to sell. Experience shows that these
models in good condition and with low kilometres sell for between $14,000 and $15,500. It has
already had some customers enquiring about buying similar cars second hand. As it happens (and
unknown to the dealer) there are 10 people interesting in buying one of these cars.
Alan will only buy if he can get a car for $12,000, Bob if he can get one for $12,500, Chris will pay
up to $13,000, David $13,500, Evan $14,000, Fred $14,500, George $15,000, Harry $15,500, Ian
$16,000 and James $16,500.
The sales manager has three main options:
i) Put the three up for sale at $15,500 (and be prepared to negotiate if necessary)
ii) Hold an open auction for the cars one Saturday morning (with a reserve price of $14,000)
iii) Invite people to put in sealed bids for the cars by a given date and sell to the three highest
bids (with a reserve set again at $14,000).
(a) Draw a demand curve for the cars.
(b) What is the equilibrium price for these cars? $15,500
(c) If option a is chosen who gets the cars and which of these get the car for less than were
prepared to pay? What is the total consumer surplus? Harry, Ian and James
(d) How much does the dealer receive from option (i)? $46,500
(e) Which of the options is best for the dealer? Auction – he reduces consumer surplus
(f) What might the consumers do if options (ii) or (iii) were used? Collude, buy and resell.
‘Market efficiency’ PowerPoints and activities
47
4.5 Extension activities
Discussion topics
1.
How could the concept of consumer surplus help make a decision about the building of a new
by-pass through an area of outstanding beauty or area of special interest?
2.
How might an analysis or consumer and producer surplus help us understand why
companies who exercise market power can be accused of ‘operating against the public
interest?
3.
How might a government justify paying subsidies to a car producer such as Mitsubishi, or
other business or industry?
4.
What is the justification for government intervention in the tobacco industry?
5.
What are some of the limitations in using consumer surplus for government decision-making?
Think of some relevant examples.
6.
Should people have to pay an entrance fee to visit a museum or public art gallery?
7.
Why are ticket prices for ‘finals’ set below the market clearance price?
8.
Is the current rationing system of university places fair and efficient?
9.
If BHP is successful in its takeover of RTZ what might this do to the efficiency and fairness of
market for iron ore?
10. Discuss the merits of a proposal to double the registration fees for 4-wheel drive vehicles or
SUV’s.
48
‘Market efficiency’ PowerPoints and activities
Extension activities
Discussion topics (responses)
1.
How could the concept of consumer surplus help make a decision about the building of a new
by-pass through an area of outstanding beauty or area of special interest?
What is the marginal benefit of the area? What are the opportunity costs involved?
2.
How might an analysis or consumer and producer surplus help us understand why
companies who exercise market power can be accused of ‘operating against the public
interest?
Consumer surplus is reduced, producer surplus is increased, total welfare falls. The
producers may do something beneficial with their profit however.
3.
How might a government justify paying subsidies to a car producer such as Mitsubishi, or
other business or industry?
Positive externalities (e.g. employment in local area)
4.
What is the justification for government intervention in the tobacco industry?
Negative externalities — cost to hospital service — but consumer sovereignty is reduced.
5.
What are some of the limitations in using consumer surplus for government decision making?
Think of some relevant examples.
Subjective — benefit is difficult to assess in dollar terms
6.
Should people have to pay an entrance fee to visit a museum or public art gallery?
It would reduce consumer surplus (people benefit from seeing pictures). Does price reflect
costs of operating gallery?
7.
Why are ticket prices for ‘finals’ set below the market clearance price?
Equity — not wanting to exploit loyal fans?
8.
Is the current rationing system of university places fair and efficient?
Do the people who benefit from the education able to get in? Is it equitable?
9.
If BHP is successful in its takeover of RTZ what might this do to the efficiency and fairness of
market for iron ore?
Will it increase monopoly power and raise the price of iron ore?
10. Discuss the merits of a proposal to double the registration fees for 4-wheel drive vehicles or
SUV’s.
Negative externalities should be internalised.
‘Market efficiency’ PowerPoints and activities
49
4.6 Emissions trading schemes (ETS)
Part A: Background
 There is agreement between scientists and environmentalists that the emission of Greenhouse
Gases (GHGs) is leading to climate change. Two important GHGs are carbon dioxide and
methane.
 There has been a shift in society’s attitude to climate change and this changed attitude is now
increasingly reflected by politicians and in government policy.
 The first multilateral agreement to reduce GHG emissions was signed by many developed
countries in Kyoto in Dec 1997. The United States and Australia did not sign the agreement,
although the Rudd Labor Government plans to do so early in its first term of office.
 Countries that signed up to Kyoto agreed to aim for a 5% reduction below 1990 levels of GHG
emissions by 2012.
Question 1
List 2 examples of changes in consumer behaviour that provide evidence of a shift in attitude
towards more environmentally friendly purchases.
Question 2
List 2 ways businesses are changing the nature of their operations to be more environmentally
friendly? Why might they be changing their ways?
Part B: Major polluters
Production of goods and services can create GHGs:
 as part of the production process (e.g. electricity)
 from the use of fossil fuel energy used in the manufacturing process (e.g. aluminium)
 from the use of resources or components which are energy intensive to make (concrete,
transportation)
Consumption of goods and services also generates GHGs:
 when products that create pollution are used (e.g. SUV’s, plastic bags)
One major source of GHG emissions comes from energy production. There are a number of
options for reducing the impact of fossil fuel energy.
 Switch energy production to renewable sources or nuclear power.
 Clean up energy production from traditional sources (carbon capture, clean coal)
 Make production less energy-intensive
Question 3
Source of energy
% of total
(a) List 5 economic actions that cause Greenhouse
Oil
35%
gases to be emitted into the atmosphere.
Coal
41%
(b) Why do the producers or consumers act in this way,
Natural Gas
19%
knowing that they are contributing to climate
Renewable
5%
change?
(c) What are wind farms built of? What are photovoltaic solar panels made with? Is concrete,
steel and silicon environmentally friendly?
Source of renewable
% of total
(d) Draw a pie chart (or two pie charts) to illustrate the
Hydro
21%
following data about the sources of Australia’s
Biomas
71%
energy
Solar/Wind
3%
(e) What economic incentives or government direction
Biogas
5%
might be needed to decrease our dependence on
energy sourced from fossil fuels?
50
‘Market efficiency’ PowerPoints and activities
Part C: Negative externalities
Greenhouse Gas emissions are a spin-off or side-effect of economic decisions taken by others.
Economists call these side-effects ‘externalities’. Costs imposed by climate change are referred to
as negative externalities. Bystanders are negatively affected by the decisions taken by other
consumers and by producers. The welfare of the bystanders suffers.
The economic decisions of the people causing the negative externalities need to change. Ways
have to be found to force polluters to take into account the overall costs of their actions. Taking
into account the external costs is said to be a process of ‘internalising the externalities’.
The overall objective, in the case of GHG emissions, is to find a way to reduce negative
externalities with least damage to the economy (for example to economic growth and national
competitiveness)
Question 4
Suppose the supply curve on the diagram on the right
reflects the private costs of production for a producer
of concrete. Production of concrete is energy intensive
so production creates negative externalities
associated with GHG emissions.
(a) Show on the diagram a supply curve that
represents total costs of production (the private
and the social costs).
(b) What can be inferred about the price of concrete
and the quantity of concrete produced if negative
externalities are ignored?
(c) Suggest three ways the government can ensure
that the externalities are internalised by the
concrete producers.
Price
Supply
Demand
Quantity
There are three main approaches to dealing with the
problem of negative externalities.
1. Regulation, command and control
This approach has the advantage of dealing with the problem directly and is a common sense
approach. But enforcement may be difficult and expensive, and the regulations may be inflexible.
2. Suasion—Education and information
This approach can produce powerful long term results but may appear wimpish. Even though
people understand that what they are doing is harmful they still may not change their behaviour.
3. Economic instruments
There are five main types of economic instrument that can be used to internal external costs or
benefits. Economists like them because they are based on providing people with an incentive to
change. Even though the principle may be simple, supporting the economic instrument with
appropriate regulations and legislation may be complex.
 Taxes (noise tax at Sydney Airport, carbon tax)
 Subsidies (e.g. public transport, solar hot water schemes)
 Enforcement incentives (e.g. performance bonds paid by mining companies – repayable when
rehabilitation successful undertaken)
 Deposit refund systems (e.g. bottles and cans in South Australia)
 Property rights and market creation (e.g. an emissions trading scheme)
‘Market efficiency’ PowerPoints and activities
51
Question 5
Using demand and supply diagrams show how paying a subsidy to a producer or consumer can
be used to reduce GHG emissions.
Part D: Property Rights and Market Creation
How does an emissions trading scheme work?
Step 1—Create something (property) that people can own
People can own ‘property rights’. These are permits, allowances or licences that allow the owner
to emit GHGs.
Step 2—Define and control the supply of the property rights
As with money, the property rights have to be carefully defined in law. If there is to be international
trade of these rights to pollute there has to be an exchange rate established or international permit
established.
Step 3—Set up a market
The property rights are tradable. They can be bought and sold in a market. The market establishes
the value of the property through the establishment of the market clearance price. Experience from
Europe suggests that trade on the ‘climate exchange’ will shift to ‘forward contracts’ so that
industry can hedge or manage future exposure to risk of having to pay unanticipated high prices
for their permits. Forward trades are agreements to buy or sell an asset (which can be of any kind)
at an agreed price at a future point in time)
Step 4—Decide who has to have a permit and who does not
Small polluters can be made exempt from the scheme. The aim is to get the big polluters to
internalise the negative externalities they cause by increasing their costs.
Step 5—Establish offsets
Firms that can’t easily cut their emissions may offset their pollution by investing in activities which
reduce emissions in other ways, for example by planting trees or by investing in carbon reducing
initiatives in less developed economies.
Step 6—Decide how many permits to issue
If too many permits are issued, the price will be too low. There will be little incentive to change
polluting behaviour. If too few permits are issued the price will be too high, and the profits of key
TEEI industries will be hit.
Step 7—Allocate or distribute permits
Some permits can be simply allocated free of charge to ‘trade-exposed energy-intensive’
industries (TEEI’s) such as the aluminum industry). These industries will initially face a significant
loss of profits. However it is not easy to identify which industries are TEEI industries and which are
not. Some permits can be sold by the government at a fixed initial price or by auction.
Step 8—Plan to reduce the number of permits year by year in line with emission reduction
targets
Emission reduction targets, either set unilaterally by a single government, or as a result of a
multilateral agreement such as the Kyoto Protocol, provide a supply constraint. Over time they
move the supply curve for permits to the left, pushing up the price.
Step 9—Have a price cap to stop the price going too high
The government proposes to allow firms to pay a fee to the government to pollute without a permit.
This essentially creates an ‘emissions cap’ and provides safety valve. Depending on the
relationship between the market price and the price cap, the government essentially can set the
price of an emissions permit. The cap system is designed to provide confidence for industry out
into the future (say to 2020).
How will system change choices and reduce GHG emissions?
Markets create a price (within controls established by government (e.g. offsets, allocations,
reduction targets, price cap systems). The price level depends on demand and supply for the
permits.
52
‘Market efficiency’ PowerPoints and activities
The price is a signalling mechanism. The price creates incentives to change decision making or
economic choices.
 If industry can reduce GHG emissions at less than the permit price then they should do it (it
saves buying a permit, or provides opportunity to sell un-needed permits)
 If industry can’t reduce GHG emissions then they have to buy a permit to emit carbon. This
costs money and reduces profits. Steps will be taken to reduce costs. They may, for example,
invest in cleaner electricity production, invest in projects that generate carbon credits or
offsets.
Question 6
Draw a graphic that shows the basic principles behind an emissions trading scheme.
Question 7
Using a supply and demand diagram to support your answer, predict what will happen to the price
of an emissions trading permit over time (say 30 years).
Question 8
Source: http://www.carbonneutral.com.au or other websites
Identify and explain three ways that consumers can be motivated or provided with an incentive to
internalise the externalities they cause through their consumption choices. Each of the three main
ways of dealing with externalities outlined above should be included.
Question 9
Assess the fairness of emissions trading schemes (i) within the Australian economy and (ii)
internationally. What provisions are being made to help less developed economies make the
transition?
Advantages of the emissions trading scheme
1. Better than no system or a voluntary system relying on goodwill.
2. Based on incentive and choice—why is this better than rules?
3. Allows for a flexible response—people can react to incentive in different ways
4. Allows for innovation and new technology—not locked into one solution (e.g. subsidies for
solar panels)
5. Raises revenue for government—can be used to …
6. Regulation too complex
Disadvantages of the emissions trading scheme
1. Effectively government sets the price (they control of supply of permits and set the emissions
price cap). Government’s may not get the price right.
2. The market needs complex rules and regulations to make it work
3. Definitions used in setting up the schemes are somewhat arbitrary.
4. Incentives and choices only work if people behave rationally. People can only make rational
decisions of they have the full information available in order to make the decision. Need to be
educated to get information. Does anybody know the impact of climate change in 2050? Will
there be technological advances (e.g. in carbon capture) and when will they happen?
Question 10
(a) Identify the most important argument for an emissions trading system. Explain why you
believe it is a powerful argument.
(b) Identify the most important argument against an emissions trading system. Explain why you
believe it is a powerful argument.
‘Market efficiency’ PowerPoints and activities
53
4.7 Efficiency and equity
Review Questions
1.
An economy has the resources and technology to produce a maximum of 50 units of a product.
There are only two consumers in the economy, Person A and Person B. If as a result of economic
activity in the economy Person A is able to consume 10 units of the product and Person B 30 units
of the product the rationing or allocation system in the economy can best be described as:
(a) efficient and equitable
(b) efficient and inequitable
(c) inefficient and equitable
(d) inefficient and inequitable
Price
2.
The diagram shoes the market for hats. Which of the
following is a correct statement about this market?
Supply
A
(a) Area A indicates the level of producer surplus
and Area B the level of consumer surplus.
(b) Area B indicates the level of producer surplus
and Area A the level of consumer surplus.
(c) Area A indicates the level of producer surplus
and Area C the level of consumer surplus.
(d) Area B indicates the level of producer surplus
and Area C the level of consumer surplus.
B
C
Demand
Quantity
3.
A market operates with maximum economic
efficiency when:
(a) the demand curve reflects the marginal benefits received by consumers and the supply curve
reflects the marginal cost of production.
(b) the supply curve reflects the marginal benefits received by consumers and the demand curve
reflects the marginal cost of production.
(c) the demand curve reflects the income of consumers and the supply curve reflects the profit
levels of producers.
(d) the supply curve reflects the income of consumers and the demand curve reflects the profit
levels of producers.
4.
Suppose the Australian Government reduced tariffs (import taxes) on imported cars and, as a
result, the price of cars in Australia falls. Which of the following describes the most likely impact on
consumer surplus, producer surplus and net economic welfare on the Australian car market?
5.
Suppose a shopper is prepared to pay $150 for a
particular brand and model of sport shoes. At a
store in Harbour Town they find these shoes on
special for $100. If they buy the shoes from the
Harbour Town store the shopper’s:
(a)
(b)
(c)
(d)
54
consumer surplus will be $100
opportunity cost will be $150
consumer surplus will be $50
producers’ surplus will be $50
A
B
C
D
Consumer
surplus
Producer
Surplus
Rise
Rise
Fall
Rise
Rise
Fall
Fall
Fall
‘Market efficiency’ PowerPoints and activities
Net
economic
welfare
Rise
Rise
Fall
Fall
6.
Rational consumers will opt out of trading in the
market shown in the diagram after the quantity
traded reaches Q1 because after this quantity:
Price
(a) the marginal benefit received by a consumer
is greater than the marginal cost of producing
the good
(b) the marginal benefit received by the
consumer is less than the opportunity cost of
buying the good
(c) the marginal costs of production are less than
the payment received by the producer who is
supplying the product
(d) net economic welfare will begin to fall.
Supply
Demand
Q1
Quantity
7.
Which of the following government measures is most likely to increase equity in the Australian
economy?
(a) Market deregulation which leads to increased productivity
(b) Reduction of the power of trade unions to influence wages
(c) A progressive income tax system
(d) Imposition of a consumption tax (GST) on food and clothes.
8.
Which of the following is most likely to create an efficient market?
(a) An unfair distribution of incomes in the economy
(b) Producers who are able to wield monopoly power
(c) Absence of positive or negative externalities
(d) Asymmetrical information resulting in consumer uncertainty about the need for the product.
9.
Which of the following are likely to lead to an inefficient allocation of resources and products in a
command or centrally planned economy?
1.
2.
3.
(a)
(b)
(c)
(d)
Goods are not allocated to the people who will gain most benefit from consuming them
Resources are wasted in the production process because workers lack the motivation to work
hard.
A change in consumer preferences is not matched by a change in the government’s plan for
resource allocation.
Statements 1 and 2 are correct
Only statement 1 is correct
Statements 2 and 3 are correct
All the statements are correct.
10.
Which of the following outcomes from the introduction of a carbon emissions trading scheme is
likely to bring the most satisfactory reduction in greenhouse gas emissions?
(a) a trading scheme where the price remains low so economic growth is unaffected
(b) a trading scheme where the price is very high, causing inflation and a loss of profits for
producers
(c) a scheme where offsets or credits can be gained by firms investing in low emissions projects
in less developed countries
(d) a trading scheme where prices rise to moderate level to provide sufficient incentive for
business to reduce emissions but without slowing economic growth too much.
‘Market efficiency’ PowerPoints and activities
55
Part B
Price
Cameras
Supply
$200
$100
Demand
40
80
Quantity
Assume the diagram represents the demand and supply of cameras in a town, and that the
demand curve accurately reflects the consumers’ marginal benefit from buying cameras and the
producers marginal cost of supplying cameras.
(a) Calculate for this market:
(i) the total outlay of consumers
(ii) the total benefit received by consumers
(iii) the amount of consumer surplus
(iv) the total revenue received by producers
(v) the total costs of production
(vi) the amount of producer surplus
(vii) the total net economic welfare produced by this market
(b) Estimate what will happen in this market if the government imposes a $20 tax on cameras
to:
(i) the price of cameras
(ii) the quantity of cameras traded
(iii) the net economic welfare produced by the market
(c)
Explain why, despite the likely fall in net economic welfare, the government might feel
justified in introducing a tax in this market.
Part C
(a) Explain why is important for a society to have an economic system that leads to an efficient
use of its resources and an equitable distribution of goods and services.
(b) Why do modified market economic systems dominate the world’s economies?
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Economics: Section 9 Additional
Efficiency and equity
Review questions
(Suggested answers)
Part A
Q
1
2
A
D
B
3
A
4
B
5
C
6
B
7
C
8
C
9
D
10
D
Part B
(a) (i)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)
Comment
Production is less than maximum capacity. Distribution is uneven.
Consumer surplus is difference between market price and consumers’ marginal
benefit (as indicated by demand curve). Producer surplus is difference between
market price and costs of production (as indicated by supply curve).
If the demand and supply curves are in the ‘right’ place they lead to the ‘right’
price. In turn the ‘right’ signals are sent to producers and consumers.
When import tariffs are cut, consumers gain but local producers miss out on
sales (until they become more competitive). Overall welfare rises (consumers
gain more than producers lose.
Consumer surplus is the difference between what they had to pay and what they
were prepared to pay (because they associated this level of benefit from the
purchase of the shoes).
There is no trade after Q1. Consumers have to pay more for the product than
they marginal benefit they expect to receive. Producers are not interested either
because marginal costs of production exceed marginal revenue after Q1.
A progressive income tax system addresses issues of vertical equity. It provides
a ‘Robin Hood’ style redistribution of disposable income.
Demand and supply curves that do not reflect all benefits and costs lead to a
distorted market.
These, amongst others, are all possible problems with a command or centrally
planned rationing system.
The price of emissions permits must be high enough to bring about change, but
not too high to dent business confidence and investment.
Total consumer outlay = 4000
Total consumer benefit = 6000
Consumer surplus = 2000
Producers’ revenue = 4000
Total costs of production = 2000
Producers’ surplus = 2000
Net economic welfare = 4000
(b) Supply curve shifts upwards (by $20).
Price rises, quantity traded falls. Net economic welfare falls.
(c)
The government may want to raise revenue to pay for welfare programs (but there would be
more efficient ways of raising revenue than this). There may been some negative
externalities involved with the disposal of cameras (although I’m not sure what they might
be).
Part C
(a) The greater the level of efficiency the more needs and wants that can be satisfied.
It is probably morally unfair that some people (for no fault of their own) are able to
participate in an economy while others are excluded.
(b) Market economies dominate because competitive markets provide greatest economic
welfare (they maximise consumer and producer surplus). Modifications are made to
markets that fail. If there is too much government intervention a new set of ‘government
failure’ problems are introduced.
Economics: Section 9 Additional
57