Module 6

Positive economics

describes what is — objective, testable, based on facts and data

Normative economics

deals with what ought to be — value judgments, opinions, policy goals.

Positive economics example

A rise in the minimum wage causes unemployment

Normative economics example 

The government should raise the minimum wage

Economists often begin with positive analysis

then use normative reasoning to recommend policy

Demand curve

= marginal benefit = willingness to pay

Supply curve

= marginal cost = willingness to accept

Equilibrium

where MB = MC (no tendency to change)

Voluntary exchange

makes both buyer and seller better off

Consumer Surplus (CS)

difference between what consumers are willing to pay and what they actually pay

Consumer Surplus Example

willing to pay $7, price = $3 → CS = $4

Consumer Surplus Graphically

area between demand curve and price line = ½ × base × height

Price goes down

Larger consumer surplus

Price goes up 

Smaller consumer surplus 

Diamond-Water Paradox

total value of water ≫ price because marginal benefit of the last unit is low

Producers are

price takers in competitive markets

Supply curve

= marginal cost curve = willingness to sell

Producer Surplus (PS)

 price – marginal cost for each unit sold

Producer Surplus Example

MC = $1, P = $3 → PS = $2

Producer Surplus Graphically

area between price line and supply curve = ½ × base × height

Economic Surplus (ES)

Consumer Surplus + Producer Surplus = (MB – MC) = total gains from trade

Markets create

gains from trade → not zero-sum. Both sides gain.

Efficient allocation

occurs when quantity is at MB = MC (equilibrium)

Deadweight Loss (DWL)

lost economic surplus from under or over-production

Overproduction

MC > MB (wasted resources)

Underproduction

missed mutually beneficial trades

Allocative Efficiency

goods go to buyers with highest WTP

Allocative Efficiency Example

• Marquis (WTP = 6, 4, 1) & Nicole (WTP = 5, 2, 0).

• At P = 3 → Marquis buys 2 tacos, Nicole 1 → max surplus = $15

Producers with lowest MC

produce first

Producers with lowest MC Example

• Cabana vs Truck taco vendors.

• Cabana makes 700 at MC ≤ 3; Truck 200 at MC ≤ 3.

• Any reallocation raises total cost → wasteful

Productive Efficiency

goods produced at lowest possible cost

Market Efficiency =

Allocative + Productive Efficiency

The Invisible Hand of the market

Achieved naturally by self-interest

Absolute advantage

who can produce more with same resources

Comparative advantage

who has lower opportunity cost

Low Opportunity Cost

Give up little

High Opportunity Cost

Give up a lot

Comparative advantage example

• Russell 20 min/pizza, 5 min/taco → OC = 4 tacos per pizza. ¼ pizza per taco

• Stephanie 12 min/pizza, 4 min/taco → OC = 3 tacos per pizza. 1/3 pizza per taco 

• Stephanie → pizza, Russell → tacos.

Specialization

When individuals, businesses, or countries focus their time and resources on producing the goods or services for which they have a comparative advantage. That is, the activities they can perform at the lowest opportunity cost, leading to an increase in total production and efficiency.

Everyone has

a comparative advantage in something — it explains trade benefits across people and countries

Prices

the signal and incentive that move markets to equilibrium

Rising price

signals producers to supply more & consumers to buy less

Prices allocate

resources efficiently without central planning

Central planning

fails because of the knowledge problem

Knowledge problem

planners can’t know every local need or preference

Market price =

opportunity cost of next best use

Price ≠ Value

value comes from subjective WTP (marginal benefit)

Price ≠ Value Example

art vs water → price low for water but total value high

Feeding America (200 food banks)

originally used central allocation of donations → inefficient

Economist Canice Prendergast

introduced a market-based auction system using “shares.”

Feeding America Results 

• More efficient allocations and higher quality food distribution.

• Donor supply ↑ (enough for 100,000 more people per day).

Feeding America Lesson 

Prices and market signals improve allocation even in charity systems — you don’t have to “believe in markets” for them to work

Input per unit opportunity cost

units gained / units lost

Output per unit opportunity cost

units lost / units gained