Ch. 5: EFFICIENCY AND EQUITY

1
Ch. 5 EFFICIENCY AND EQUITY

• Allocative Efficiency
• Consumer surplus
• Producer surplus
• Market failures.
• Corrections for market failure.

2
Efficiency and the Social Interest

• Allocative efficiency
• occurs when it is not possible to produce more
  of a good or service without giving up some other
  good or service that is valued more highly.
• depends on peoples preferences.

3
Allocative Efficiency

• Marginal Benefit (MB)
• the benefit a person receives from consuming one
  more unit of a good or service.
• the dollar value of other goods and services
  that a person is willing to give up to get one
  more unit of it.
• decreasing marginal benefit implies that as more
  of a good or service is consumed, its MB
  decreases.

4
Allocative Efficiency

• For any given price, a consumer will buy all
  units of the good where MBgtP
• The MB curve will be identical to the consumers
  demand curve.
• Market demand curve is summation of individual MB
  curves

P
MB
Q
5
Allocative Efficiency

• Marginal Cost
• the opportunity cost of producing one more unit
  of a good or service.
• the dollar value of other goods and services
  required to produce one more unit of the good.
• increasing marginal cost implies that as more of
  a good or service is produced, its marginal cost
  increases.

6
Allocative Efficiency

• The MC curve is upward sloping.
• A firm will produce all units of a product where
  PgtMC
• The MC curve is the firms supply curve (more
  details later).

MC
P
Q
7
Allocative Efficiency

• Efficiency and Inefficiency
• If MBgtMC, should produce and consume more of the
  good.
• If MBltMC, should produce and consume less of the
  good.
• If MBMC, allocative efficiency obtained.

MC
MB
Q
Quantity
8
Value, Price, and Consumer Surplus

• Consumer Surplus
• Difference between maximum amount consumers are
  willing to pay and the price of a good.
• Measured by the area under the demand curve (MB
  curve) and above the price paid, up to the
  quantity bought.

9
Value, Price, and Consumer Surplus
10
Cost, Price, and Producer Surplus

• Producer Surplus
• the price of a good minus the marginal cost of
  producing it, summed over the quantity sold.
• measured by the area below the price and above
  the supply curve, up to the quantity sold.

11
Cost, Price, and Producer Surplus
12
Is the Competitive Market Efficient?

• At the equilibrium quantity,
• MBMC, so the quantity is the allocatively
  efficient quantity.
• The sum of consumer and producer surplus is
  maximized at this efficient level of output.

13
Deadweight loss from overproduction.
14
Deadweight loss from underproduction.
15
What are the additional costs to producers of
increasing pizza production from 5,000 to 10,000
per day? (keep in mind that quantity is measured
in 1000s in the diagram below).
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Obstacles to Efficiency

• Externalities
• Price ceilings and floors
• Taxes, subsidies, and quotas.
• Monopoly
• Public goods and common resources

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Externalities

• When there are negative externalities
• Social MC Private MC per unit negative
  externality
• When there are positive externalities
• Social MB Private MB per unit positive
  externality
• Regardless of whether there are externalities, in
  a competitive market
• Supply Private MC
• Demand Private MB

18
Is the Competitive Market Efficient?

• When there are negative externalities,
• SMCgtPMC
• The market produces too much
• deadweight loss results
• Taxes could fix market.

19
Is the Competitive Market Efficient?

• When there are positive externalities,
• SMBgtPMB
• The market produces too little
• deadweight loss results
• Subsidies could fix market.