Competitive Market Equilibrium: Signals and Social Surplus

Unit 2, Microeconomics

Incentive role of prices

Prices provide producers and consumers the incentive to respond to price changes.

Given a price change, producers have the incentive to change the quantity supplied in

accordance with the law of supply, while consumers have the incentive to change the

quantity demanded based on the law of demand.

Rationing

A method used to divide or apportion goods and services or resources among the

various interested parties

Resource allocation

Apportioning available resources or factors of production to particular uses for

production purposes.

Consumer surplus

The benefit enjoyed by buyers when paying a price that is lower than the maximum price

a consumer is / all consumers in a market are willing to pay for a good and how much

they actually pay.

Producer surplus

The benefit enjoyed by producers by receiving a price that is higher than the price they

were willing to receive.

Social/community surplus

The sum combination of consumer surplus and producer surplus.

Welfare loss

A loss of a part of social surplus (consumer plus producer surplus) that occurs when

there is market failure so that marginal social benefits are not equal to marginal private

benefits.

Efficiency

In general, it involves making the best use of scarce resources. May refer to producing at

the lowest possible cost or to allocative efficiency where social surplus is maximum (to be

continued).

Allocative efficiency

Achieved when just the right amount of goods and services are produced from society’s

point of view so that scarce resources are allocated in the best possible way (to be

continued)

Allocative inefficiency

When either more or less than the socially optimal amount is produced and consumed so

that misallocation of resources results.

Socially optimum output

This occurs where there is allocative efficiency (to be continued)