Chapter 7: Welfare & Efficiency

Positive analysis

Describes what is happening, explaining why, or predicting what will happen.

Normative analysis

Prescribes what should happen, which involves value judgments.

Economic efficiency

An outcome is more economically efficient if it yields more economic surplus.

Economic surplus

The total benefits minus total costs flowing from a decision; it measures how much a decision has improved your well-being.

Efficient outcome

The efficient outcome yields the largest possible economic surplus.

Equity

A measure of fairness. An outcome yields greater equity if it results in a fairer distribution of economic benefits.

Consumer surplus

The economic surplus you get from buying something.

Consumer surplus = Marginal benefit - Price

Producer surplus

The economic surplus you get from selling something.

Producer surplus = Price - Marginal cost

Voluntary exchange

Buyers and sellers exchange money for goods only if they both want to.

Efficient production

Producing a given quantity of output at the lowest possible cost, which requires producing each good at the lowest marginal cost.

Efficient allocation

Allocating goods to create the largest economic surplus, which requires that each good goes to the person who’ll get the highest marginal benefit from it.

Efficient quantity

The quantity that produces the largest possible economic surplus.

Rational Rule for Markets

Produce more of a good if its marginal benefit is greater than (or equal to) the marginal cost.

Market failure

When the forces of supply and demand lead to an inefficient outcome.

Five sources of market failure

1. Market power

2. Externalities

3. Private information

4. Irrationality

5. Government regulations

Deadweight loss

How far economic surplus falls below the efficient outcome.

Deadweight loss = Economic surplus at efficient quantity - Actual economic surplus

Government failure

When government policies lead to worse outcomes.

Distributional consequences

Who gets what.