Presentation on theme: "Part 3 Markets and Efficiency"— Presentation transcript:
1 Part 3 Markets and Efficiency Concept of economic (allocative) efficiency introduced previouslyDecreasing marginal benefits and increasing marginal costsEfficient allocation where MB = MCThis assumes all costs and benefits are included (including environmental costs)Do competitive markets produce efficient outcomes?
2 Demand and Marginal Benefit People value many different goods and servicesThe total benefit (value) of a good to a person is the benefit gained from the whole of the amount of the good consumedThe marginal benefit (value) of a good to a person is the additional benefit that consuming the last unit providesA person’s relative valuation of a good is expressed in their willingness to pay
3 Willingness to PayPeople have a limited budget so that purchasing one thing for $5 means not purchasing the other things that $5 could have boughtIf I pay $5 for a unit of a good it means I value that unit of that good at least as much as (and maybe more than) the other things I could have bought for $5My willingness to pay for the last unit I purchase is a measure of its marginal benefit to me
4 Willingness to PayWillingness to pay for additional units of a good declines with quantity for each individualPeople vary in their willingness to pay depending on their incomes and preferencesAt the level of the market will find willingness to pay will decline with quantity.
5 Willingness to Pay and Demand Curves Under most circumstances (small or zero income effects from price changes) a demand curve can also be thought of as a marginal benefit curve or as a marginal willingness to pay curveThe area under the demand curve to the left of the last unit purchased can be thought of as measuring total benefit or total willingness to pay
6 Willingness to Pay and Demand Curves Total benefit or total WTP for Q1(green shaded area)P1P1 = MB or marginal WTPat Q1DQ1Q
7 Consumers’ Surplus Given a price of P1 consumers purchase up to Q1. They pay P1 for all unitsalthough previous units are valuedmorePConsumers’ Surplus: excessof total WPT over amount actually paidP1P1 = MB or marginal WTPat Q1DQ1QAmount actually paid (P1 x Q1)
8 Supply and Marginal Cost The cost of production of a good is its opportunity cost--the other goods that could have been produced instead with the resources usedProvided all productive resources are priced in competitive markets, the opportunity cost of producing something will be reflected in the cost of production (cost of the productive resources used)
9 Supply and Marginal Cost The marginal cost of production is the opportunity cost of producing one more unit of the goodMarginal opportunity costs tend to rise with outputProducers will only produce up to the point where the price they receive equals the marginal cost of production (profit max)The supply curve is a marginal cost curve
10 Supply and Marginal Cost MC=S15Marginal opportunity costOf the 10th unit = $15Q10Firm will supply the 10th unit if the price is$15. This is the minimum price that producerswill accept for that unit of production
11 Producers’ Surplus P S=MC Producers’ Surplus 15 Cost of production 10 QProducer would have been willing toProduce units 1-9 for less than $15 butReceives the same price for all units
12 Is the Competitive Market Efficient? S=MCPCSSum of CS andPs is theSocial SurplusE15PSD=MB10QAt E the Social Surplus is maximized.Maximum of total benefit over thetotal opportunity cost.
13 Is the Market Always Efficient? Markets may not result in economic efficiency for a number of reasons- Price floors and ceilings- Taxes, subsidies, quotas- Monopoly- Public goods- External costs or benefitsThese barriers to efficiency are very widespread
14 Inefficiencies: Underproduction and Overproduction Deadweight lossSUnderproductionDQQ’Q*PSDeadweight lossOverproductionDQQ*Q’
15 Efficiency and EquityEfficiency is an allocation of resources where MB=MCAn efficient allocation can only be defined given some initial allocation of resources between individualsWillingness to pay is budget constrainedEfficient markets may well result in very unequal distributions of income
16 Markets with Price or Quantity Regulation Housing markets and rent ceilingsRentSRbDeadweight lossRcShortageDQQsQd
17 Markets with Price or Quantity Regulation Labour Markets with minimum wagesWageUnemploymentSWminW*DQQ*QdQs
18 Markets with Price or Quantity Regulation Agricultural markets--problems of price and income instability due to supply fluctuations and inelastic demandMarkets in inventories and price stabilizationAttempts to raise farm incomes- Price floors- Quotas- Subsidy programs
19 Agricultural Price Floors and Quotas Surplus at P’P’P*DQ”Q’Q*QP’ = price floorQ’ = quota amount