Market Efficiency

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Market Efficiency

• Section 1.1e in SL syllabus

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1.1e Market efficiency

• The workings of a truly free market guarantee
  that resources will not be used if their value is
  higher as an unused factor (oil in the ground)
  rather than their contribution to a produced good
  or service (plastics).
• Recall that scarcity requires society to make
  choices in terms of what to produce. As each
  decision involves some form of opportunity cost,
  resources take on a value that is related to
  their alternative and intended uses.

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• The market sets a price, which reflects the value
  of a resource (or a final good or service)
  through the interaction of buyers and sellers.
  The price incorporates the opportunity costs
  perceived by buyers.

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• Consequently, the price mechanism performs
  several functions in allocating resources. 
• Prices send a signal to the markets about the
  relative value placed upon a resource. Prices in
  this case tell the market where a particular
  resource is needed/wanted.

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• The rationing function of prices is most apparent
  ion shortages and surpluses. In the case of a
  shortage, if there are tickets for a Foo Fighters
  concert, prices will ration the seats according
  to who is most willing to pay for those seats.
  If the seats are 85, then the seats will be
  allocated to those who are willing to pay 85 or
  more.
• Airplane tickets are another good example based
  upon the time of day one wants to fly.

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• Finally, prices perform an incentive function for
  producers to meet consumer tastes and
  preferences. When consumers increase their demand
  for Smartphones, this sends a signal to Apple to
  produce more iPhone 4s.

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• How do we take into account various gains to
  consumers and producers that demonstrate how
  their utility is maximized?
• Usually, in a market, we can see the collective
  benefits to participants through calculating the
  monetary measure of the increase in total
  utility.

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• Consumer surplus is the difference between the
  maximum price a consumer is willing to pay for a
  product and the price that they actually pay.
• A clue to how this measure will work with changes
  in the market place is to remember that consumer
  surplus and price are inversely related.

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• Note that the consumer surplus is the triangle
  above the equilibrium price representing the
  additional amount that consumers would have been
  willing to pay but retain to spend on other goods
  and services, in this case 5 per unit.

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• Benefits accrue to sellers via the producer
  surplus, which is the difference between the
  actual price received and the minimum price at
  which they would have been willing to sell the
  good or service.
• It is important to note that the producer surplus
  enjoys a positive relationship with the
  equilibrium price.

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• Note that the consumer surplus is the triangle
  above the equilibrium price representing the
  additional amount that consumers would have been
  willing to pay but retain to spend on other goods
  and services, in this case 5 per unit.

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• Note that the producer surplus is the triangle
  below the equilibrium price representing the
  minimum price at which producers would have been
  willing to sell the app being 3. In this case
  the surplus received by sellers is 7 per unit.

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• The combination of the two triangles, CS and PS
  represents community surplus.

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• Equilibrium also indicates that society has used
  its resources to produce the products most wanted
  by society. Consequently, this equilibrium is
  where marginal benefit matches marginal or MB
  MC. This is the lesson that made economics
  relevant to a professor of ethicsAdam Smithback
  in 1776. It is now called allocative efficiency.

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• Equilibrium prices usually connote another
  efficiency, which is called productive
  efficiency.