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 people’s preferences and cost of production.

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 MB>P
The MB curve will be identical to the consumer’s 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
Law of Increasing MC: MC curve is upward sloping.
A firm will produce all units of a product where P>MC
The MC curve is the firm’s supply curve (more details later). MC P Q

7. Allocative Efficiency
Efficiency and Inefficiency
If MB>MC, should produce and consume more of the good.
If MB<MC, should produce and consume less of the good.
If MB=MC, allocative efficiency obtained. MC MB Q*
Quantity

8. Value, Price, and 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
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. Deadweight loss from overproduction.

13. Deadweight loss from underproduction.

14. Obstacles to Efficiency
Externalities
Price ceilings and floors
Taxes, subsidies, and quotas.
Monopoly
Public goods and common resources

15. 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

16. Is the Competitive Market Efficient?
When there are negative externalities,
SMC>PMC
The market produces “too much”
deadweight loss results
Taxes could “fix” market.

17. Is the Competitive Market Efficient?
When there are positive externalities,
SMB>PMB
The market produces “too little”
deadweight loss results
Subsidies could “fix” market.