1. Markets, Maximizers, and Efficiency
Chapter 6
Markets, Maximizers, and Efficiency

2. 1. THE LOGIC OF MAXIMIZING BEHAVIOR
Learning Objectives
Explain the maximization assumption that economists make in explaining the behavior of consumers and firms.
Explain and illustrate the concepts of marginal benefit and marginal cost and supply them to understanding the marginal decision rule.

3. Utility and Human Nature
Economists assume that:
Tastes and preferences are fixed and given, and play a large role in decision making.
Consumers make choices that give them the greatest , satisfaction —they maximize their satisfaction or benefit.
Utility is the technical term in economics for benefit, satisfaction, or usefulness, so consumers MAXIMIZE Utility.

4. Marginal Utility
Marginal benefit or Marginal utility: the extra utility derived from consuming one more unit of a good or service.
The same formula for “marginal benefit”

5. The difference between total revenue and total cost
Economic Profit

6. 1.1 The Analysis of Maximizing Behavior
Net benefit is the total benefit of an activity minus its opportunity cost.
Marginal benefit is the amount by which an additional unit of an activity increases its total benefit.
Marginal cost is the amount by which an additional unit of an activity increases its total cost.
The marginal decision rule states that if the marginal benefit of an additional unit of an activity exceeds the marginal cost, the quantity of the activity should be increased. If the marginal benefit is less than the marginal cost, the quantity should be reduced.
A constraint is a boundary that limits the range of choices that can be made.

7. Diminishing Marginal Benefit
At some point the marginal benefit of any activity or any product diminishes as we continue doing one more
Eating 1 burger when hungry
2nd burger
3rd burger
4th burger……
1 hour STATS study vs 2nd hour,
3rd, 4th, 20th ????

8. The Benefits of Studying Economics
Note: On Marginal benefit and marginal cost curves we mark the value at the midpoint.
The marginal benefit of 1 hour of study here is shown at 18 points
Notes: 5 hours budgeted for study of both Econ and Accounting. MB of both given as expected gains for each hour allotted to each subject.

9. The Marginal Benefits of Studying Accounting

10. The Marginal Benefits and Marginal Costs of Studying Economics
Reminder: On Marginal benefit and marginal cost curves we mark the value at the midpoint.
The marginal benefit of 1 hour of study here is shown at 18 points
The marginal cost of 1 hour is 0 points

11. The Benefits and Costs of Studying Economics

12. The Marginal Benefit Curve and Total Benefit

13. The loss in net benefits resulting from a failure to carry out an activity at the most efficient level
Deadweight Loss

14. Using Marginal Benefit and Marginal Cost Curves to Determine Net Benefit

15. Using Marginal Benefit and Marginal Cost Curves to Determine Net Benefit

16. Using Marginal Benefit and Marginal Cost Curves to Determine Net Benefit

17. 2. MAXIMIZING IN THE MARKETPLACE
Learning Objectives
Explain what is meant by an efficient allocation of resources in an economy and describe the market conditions that must exist to achieve this goal.
Define consumer and producer surplus.
Discuss the relationship between efficiency and equity.

18. 2. MAXIMIZING IN THE MARKETPLACE
Efficient allocation of resources is when the net benefits of all economic activities are maximized.

19. 2.1 Achieving Efficiency The role of property rights
Property rights are a set of rules that specify the ways in which an owner can use a resource.
An exclusive property right is a property right that allows its owner to prevent others from using the resource.
A transferable property right is a property right that allows the owner of a resource to sell or lease it to someone else.

20. Demand and Supply and the Efficiency Condition

21. 2.2 Producer and Consumer Surplus
Consumer surplus is the amount by which the total benefits to consumers from consuming a good exceed their total expenditures on the good.
Producer surplus is the difference between the total revenue received by sellers and their total cost.

22. Consumer and Producer Surplus

23. Net Benefit: The Sum of Consumer and Producer Surplus

24. 2.3 Efficiency and Equity
In a market that satisfies the efficiency condition, an efficient allocation of resources will emerge from any particular distribution of income
Different income distributions will result in different, but still efficient, outcomes
Whatever distribution society chooses, an efficient allocation of resources is still preferred to an inefficient one

25. 3. MARKET FAILURE Learning Objectives
Explain what is meant by market failure and the conditions that may lead to it.
Distinguish between private goods and public goods and relate them to the free rider problem and the role of government.
Explain the concepts of external costs and benefits and the role of government intervention when they are present.
Explain why a common property resource is unlikely to be allocated efficiently in the marketplace.

26. Occurs when private decision makers in the marketplace fail to achieve an efficient allocation of scarce resources
Market Failure

27. The Government’s Role Market Failures
As Explanation of roles for Government in the economy
Imperfect Information
Externalities
Public Goods
Lack of Competition
Business Cycles

28. Imperfect Information
Imperfect information leads to market failures that cause inefficiency.
False information
Asymmetric information
Either the buyer or seller has
more or better information
than the other
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29. Imperfect Information
Some solutions:
Market Based Solutions: Brand names, franchises, and product warranties
Government Solutions: Requiring full and correct disclosure. (Food labels, stock prospectuses, etc.)
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30. Externalities
Externalities are the costs or benefits of a transaction that are borne by someone not directly involved in the transaction.
Real efficiency occurs only when all the costs and all the benefits accrue to the buyer and seller
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31. Externalities
External Benefits (Positive externalities) when someone outside the transaction is receiving benefits from the transaction.
If buyers are not receiving all benefits, they will demand less than is optimal.
If sellers are not receiving all the benefits from the sale, they will not produce as much as is optimal.
Examples: New large business in a declining neighborhood, Education, Landscaping and painting a formerly unkempt property, Immunizations
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32. Externalities External costs (Negative Externalities): when
someone outside the transaction is incurring costs related to the transaction.
If buyers are not bearing all the costs of the purchase, they will demand too much.
If producers are not bearing all the
costs of production, then they will
produce too much.
Example: Pollution by a manufacturer,
Second hand tobacco smoke, Smog
and traffic congestion from my choice
to drive alone.
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33. External Costs

34. Solutions to the External Cost Problem?
Government imposes costs
Government regulates to internalize external costs.
Examples: Smog fees, mandated pollution controls, banns on indoor smoking etc
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35. Solutions to the External Benefits Problem?
Government produces or subsidizes the production/consumption of the good.
Government requires the consumption of the good
Examples: required immunizations, public education, student aid, tax breaks to businesses that locate in run-down areas
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36. Public Goods*
Public Goods are goods whose consumption by one person does not diminish the quantity or quality available to other consumers. Specifically, they:
Can be jointly consumed (jointness) Individuals can simultaneously enjoy consumption of same product or service.
Are non-excludable (non-exclusion) Consumption of the good cannot be restricted to the customers who pay for it.
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37. Characteristics of a Public Good
Non-excludability
If it is produced for some, it is available to all. There is no way to exclude non-payers.
No one enjoys a private property right to the public good.
Functioning Private Property Rights require:
Exclusivity
Transferability
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38. Characteristics of a Public Good
Without private property rights:
People have an incentive to try free ride:
Free rider: a person who receives the benefits of the good without helping to pay for it.
Because of the Free Rider Problem, too little will be produced; efficiency is not achieved.
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39. Examples of Public Goods
National defense
Forest fire protection
Broadcast radio and television stations
Clean air
Unpolluted ground water
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40. Public Goods and Market Failure

41. Solutions to the Public Goods Problem?
Government production
Government subsidized production
Marketization: Sometimes markets develop ways of providing public goods (e.g. use of advertising to support radio and television).
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42. Common Property Goods Goods owned collectively or not owned at all.
Examples: Public Parks, Public highways and roads, Wildlife, River water or underground water.
Common Property Goods DO NOT have Jointness or Non-exclusivity.
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43. Common Property Goods
Common Property goods tend to be under-produced & over-consumed.
Solutions:
Marketize them like buffalo in the Midwest
Regulate their use like wildlife
Government production & maintenance like city streets and city parks
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44. Lack of Competition
Sellers may gain by restricting output and raising price.
Too few units will be produced.
Consumers may not be able to get needed goods.
Monopoly: a market with only one producer
Example: utility companies
Oligopoly: a market with only few producers (who may operate jointly as a monopolist through a cartel).
Example: OPEC
Monopsony: a market with only one buyer
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45. Restricting Supply to Raise Prices2 D S 1 P2 P1 Q2 Q1
Quantity
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46. Solutions for Lack of Competition
Anti-trust laws; ban collusion and anti- competitive behavior
License and regulate monopolies
Government provision of the good
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47. Business Cycles
Cycles of Expansion and Contraction create inefficient outcomes:
Expansion, when too rapid or extreme leads to over-production or over-consumption of certain types of goods
Contraction, especially when they lead to recession lead to unemployment of Capital and Labor. Unemployment is not efficient.

48. Business Cycles
Market Response: natural market responses correct for business cycles in time.
Government Responses to Recession:
Stimulate demand by Fiscal Stimulus – ie; cut taxes or increase spending
Monetary Stimulus – ie; increase money supply or decrease interest rates

49. Business Cycles
Government Responses to Excessive Expansion: Reign in inflation
Fiscal Contraction – ie; increase taxes or reduce government spending
Monetary Contraction – ie; reduce the money supply or increase the interest rate

50. Public Choice Analysis
Public Choice Theory: Proposes that government activity in the economy has little to do with market failures.
Public Choice theory suggests that government may be brought in to benefit specific individuals or groups.
People may seek government intervention to improve their own profit in comparison to the market outcome.
This is referred to as rent-seeking—the use of resources to transfer wealth from one individual to another without increasing production or total wealth.
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51. Public Choice Conclusions
Self-interest directs public sector activity, just as it directs market activity.
Government actions (like price ceilings or floors) are often enacted for political gain, not as a remedy for economic inefficiency.
Government action is likely to create market failure or reduce efficiency.
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52. 3.2 Public Goods
A public good is a good for which the cost of exclusion is prohibitive and for which the marginal cost of another user is zero.
A private good is a good for which exclusion is possible and for which the marginal cost of another user is positive.
Free riders are people or firms that consume a public good without paying for it.

53. 3.4 Common Property Resources
Common property resources are resources for which no property rights have been defined
The difficulty with common property resources
Individuals may not have adequate incentives to engage in efforts to preserve or protect them