Chapter4; the efficiency of Markets

market outcomes are Pareto efficient menaing

markets allocate the production and consumption of goods in a way that maxi- mizes the net benefits to society.

free makrets

a socially desirable means of allocating goods and services; without any explicit coordination, the interactions of individual consumers and producers, each motivated by self-interest, nonetheless combine to advance the common good. BUYT makrts cna also fail

competitive markets

where multiple buyers and sellers operate independently, meaning no single person or business has enough power to dictate prices or control the entire market. Instead, prices are set naturally by the forces of supply and demand.

typically effective institutions for allocating resources, but are unlikely to provide adequate levels of environmental quality without some govern- ment intervention.

Defining Markets

a market is a decentralized collection of buyers and sellers whose interactions determine the allocation of a good or set of goods through exchange.

1. a market is an institution for allocating goods from those who produce or own them to those who want to buy them. of course, markets are not the only means of allocating goods, such as lottery , auction, govenrmnet food stamps, etc

2. markets are based on the exchange of payment for goods or services rather than one-way allocation of scarce resources (as in the cases of food stamps)

3. markets are decentralized. distinguishes them from auctions and from centralized economies

centralized economies

where a government planner orders producers to make specified quanti- ties for sale or distribution to consumers

the law of demand

as the price falls, the quantity demanded by consumers rises

demand curve

a demand curve summarizes how much buyers in the aggregate will buy at a given market price,with all other factors (such as the prices of other goods) held constant. a measure of the marginal benefits to consumers

at each quantity, the demand curve summarizes what buyers are willing to pay for one more unit of a good, given how much they have consumed already—their marginal willingness to pay.

supply curve

representing the relationship between the quantity of a good produced and the price producers are willing to accept to produce one more unit. the marginal cost curve of the industry.

• Marginal cost is the cost of producing one more unit of a good.

the supply curve represents the amount the coffee shops are willing to accept in order to produce one more unit of a good—one more cup of coffee.

Moreover, higher prices allow new firms with higher costs of production to enter the mar- ket, expanding output further.

market equilibrium

the forces of demand and the opposing forces of supply just counterbalance each other.

the market will “automatically” tend to establish this equilibrium price and quantity and to maintain them as long as the underlying factors that drive demand and supply (such as income, people’s tastes, and production costs) remain unchanged.

the intersection of the demand and supply curves.

shortage

demand greater than supply

consumers’ marginal willingness to pay

the measure of their benefit from consuming a good.

how is the market price determined

at the margin

consumer surplus

The difference between what consumers would be willing to pay for a good and what they actually pay is called

surplus covers the whole area below the demand curve and above the price.

the sum of producer and consumer surplus

is a measure of the net ben- efits produced by market interactions.

this measure of net benefits is maximized at the point where supply equals demand.thus the market equilibrium achieves the maximum possible net surplus from the market.

market efficiency is reached under these three conditions:

1. markets must be competitive, in the sense that all firms and consumers must take prices as given. that is, individual firms and consumers must be unable to manipulate the market price in their favor. Thus not one firm with a monopoly, since the monopolist will set a higher price that maximizes its own profit.

2. the information available to firms and consumers about the quality of the good or service being traded must be symmetric, understood equally by buyers and sellers.

3. markets must be complete; they must capture all the good and ill effects resulting from a market transaction; the costs of a good or service must be fully paid for by those who produce it, and the consumer who buys that good or service must enjoy the entire benefit from it.

if market is not efficient it fails