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

2. The Logic of Maximizing Behavior (Tregarthen & Rittenberg, 2000, p
Economists assume that decisionmakers make choices in a way that maximizes the value of some objective.
Maximization involves determining the change in total benefit and the change in total cost with each unit of an activity. These changes are called marginal benefit and marginal cost, respectively.

3. The Logic of Maximizing Behavior (Tregarthen & Rittenberg, 2000, p
IF the marginal benefit of an activity exceeds the marginal cost, the decisionmaker will gain by increasing the activity.
IF the marginal cost of an activity exceeds the marginal benefit, the decisionmaker will gain by reducing the activity.

4. The Logic of Maximizing Behavior (Tregarthen & Rittenberg, 2000, p
The area under the marginal benefit curve for an activity gives its total benefit; the area under the marginal cost curve gives the activity’s total cost.
Net benefit equals total benefit less total cost (NB=TB-TC).
The marginal decision rule states that the net gain from an activity is maximized at the point at which the marginal benefit of the activity equals the marginal cost.

5. Maximizing the Marketplace (Tregarthen & Rittenberg, 2000, p. 136)
In a competitive system in which demand and supply determine prices, the demand and supply curves can be considered as marginal benefit and marginal cost curves respectively.

6. Maximizing the Marketplace (Tregarthen & Rittenberg, 2000, p. 136)
An efficient allocation of resources is one that maximizes the net benefits of each activity. We expect it to be achieved in markets that satisfy the efficiency condition, which requires a competitive market and well-defined, transferable property rights.

7. Maximizing the Marketplace (Tregarthen & Rittenberg, 2000, p. 136)
Consumer surplus is the amount by which the total benefit to consumers from some activity exceeds their total expenditure for it.
Producer surplus is the amount by which the total revenues of producers exceed their total costs.

8. Maximizing the Marketplace (Tregarthen & Rittenberg, 2000, p. 136)
An efficient allocation of resources doesn’t necessarily mean an equitable allocation of resources.
An inequitable allocation of resources implies that the distribution of income and wealth is inequitable. Judgments about equity in the distribution of income and wealth are normative judgments.

9. The Logic of Maximizing Behavior
In order to achieve efficiency:
Markets must be competitive
Property rights must be exclusive and transferable.
Exclusivepossible for owner of property to exclude others from using the resource
Transferablethe owner of the resource must be allowed to sell or lease it to someone else (if it isn’t transferable, exchange can’t occur).
Efficiency conditionrequires a competitive market with well-defined and transferable property rights

10. Economic Systems Traditional Economies Market Economies
Allocation decisions will be based on how previous generations have done it; continuity and stability valued
Market Economies
Individuals and privately owned firms answer the three economic questions; market prices signal to producers what to produce; goods and services allocated based on price
Command Economies
An authority such as the government, feudal lord or central planners answer the three economic questions

11. Characteristics of a Market Economy
Private Property
Individual control and ownership of resources and products
Property rights-set of rules that specify the ways in which an owner can use a resource
What types of incentives do well defined property rights provide?
Free Enterprise
Within legal limits, individuals are free to open businesses, work where they want, and buy what they want

12. Characteristics of a Market Economy
Self-Interest
Drives people to get the best job they can, get the most for their money, and to earn the most profit in their businesses
1776 Wealth of Nations invisible hand
Competition
Keeps prices in line with the costs of production

13. Characteristics of a Market Economy
System of Markets and Prices
Forces of supply and demand (not government) determine prices
Surplus versus shortage
Limited Government
Government intervention needed in some circumstances (where goods and services are not efficiently provided by markets)

14. Brainstorm What functions should the government perform?
Remember one characteristic of a market economy is limited government

15. Role of Government in Market Economy
Provide a legal system to make and enforce laws and to protect private property rights
Provide public goods that individuals or private businesses wouldn’t provide
Correct market failures such as external costs and benefits

16. Role of Government in Market Economy
Maintain competition by regulating monopolies
Redistribute income by taxing those with larger incomes and helping those in need
Taxes
Social welfare programs

17. Role of Government in Market Economy
Stabilize the economy by reducing unemployment and inflation and promoting economic growth
Fiscal policy
Monetary policy

18. Private Goods
Most goods and services produced in market economies are private goods and services. The consumers who purchase these goods consume these goods.
Private goods are goods for which exclusion is possible and for which the marginal cost of another user is positive
Examples:

19. Public Goods
Public goods differ from private goods because they have the following characteristics:
Shared consumption: When one person consumes a public good, it does not prevent others from also consuming the good
Nonexclusion: Once a public good is produced it is difficult or impossible to exclude others from consuming the good even if they didn’t pay for it.

20. Public Goods
Because people can consume public goods without paying for them (the free rider problem), private businesses do not have incentives to produce enough public goods. Therefore, the government provides them, through tax dollars, if people want them.

21. More on Public Goods
Few examples of pure public goods, but many goods have some public good characteristics and are therefore provided by the government
How do the following illustrate shared consumption and/or non-exclusion?
Fire protection, police protection, lighthouses, weather forecasts etc.
Public goods are examples of positive externalities

22. Externalities Externalities are an example of market failure
Market prices usually reflect the costs producers pay to produce goods and the benefits consumers receive from the good. A kind of market failure occurs when market prices fail to reflect all the costs and all the benefits involved. This kind of market failure is called an externality problem.

23. Externalities
Externalities exist when some of the costs or benefits associated with the production or consumption of a product spill over to third parties, who do not produce or pay to consume the product.
Markets fail when markets “are not competitive and/ or when property rights are not well defined and fully transferable” (Tregarthen & Rittenberg, 2000, p. 137).

24. Positive Externalities
Positive: benefits enjoyed by someone who does not produce or pay to consume a product
Examples:
Government usually subsidizes the production of externalities or provides them

25. Negative Externalities
Negative externalities: costs paid by someone who does not produce or pay to consume a product
Example:
Because of these costs the government provides incentives (laws/fines) to reduce production of these goods or services