Chapter 5

Chapter Overview

• Topic: Efficiency and Equity in Microeconomics (ECON 2010U)

• Focus: Understanding alternative resource allocation methods, consumer and producer surplus, market efficiency, and concepts of fairness.

Learning Objectives

• Describe methods for allocating scarce resources.

• Explain the connection between demand and marginal benefit, and define consumer surplus.

• Discuss the relationship between supply and marginal cost, and define producer surplus.

• Identify conditions for market efficiency and inefficiency.

• Evaluate claims regarding fairness in market outcomes.

Resource Allocation Methods

• Scarce Resource Allocation Techniques:

  • Market Price

  • Command

  • Majority Rule

  • Contest

  • First-Come, First-Served

  • Lottery

  • Personal Characteristics

  • Force

Methods of Resource Allocation

Market Price

• Allocation based on individuals willing to pay the market price.

Command

• Resources allocated by authority (e.g., employer directing employees). Works well in organizations but less so in large economies.

Majority Rule

• Resources allocated according to the majority vote. Effective for collective decisions.

Contest

• Resources awarded to winners based on ability; effective when monitoring efforts is difficult.

First-Come, First-Served

• Allocates resources to those who arrive first; used in casual dining and supermarkets.

Lottery

• Random allocation of resources, effective when users cannot be distinguished; e.g., airport landing slots.

Personal Characteristics

• Resource allocation based on characteristics; can lead to discrimination.

Force

• Use of force influences resource allocation historically; can facilitate wealth redistribution by the state.

Benefit, Cost, and Surplus

Value and Willingness to Pay

• Distinction between value (benefit received) and price (cost paid).

• Marginal Benefit: Maximum price a person would pay for an additional unit.

Demand Curves

• Reflects individual demand (price vs. quantity for one person) and market demand (aggregate demand).

Consumer Surplus

• Defined as the benefit received from a good exceeding the price paid.

• Measured as the area under the demand curve above the price paid.

• Example: Lisa’s demand at $1 for pizza yields consumer surplus based on willingness to pay.

Marginal Cost and Supply

Producer Surplus

• Defined as the difference between the amount received from sale and production cost.

• Graphically represented as the area below the market price and above the supply curve.

Supply Curves

• Illustrate the relationship between price and quantity supplied by firms.

• Market supply curve is the horizontal sum of individual supply curves.

Market Efficiency

Competitive Equilibrium

• At equilibrium, quantity demanded equals quantity supplied, maximizing total surplus (consumer + producer).

• Discussion of deadweight loss due to underproduction or overproduction.

Underproduction vs. Overproduction

• Underproduction: Results in inefficient lower output (e.g., 5,000 pizzas when the efficient quantity is 10,000).

• Overproduction: Leads to inefficient higher output (e.g., producing 15,000 pizzas instead of 10,000).

Sources of Market Failure

• Identifiable when markets do not achieve efficient outcomes.

• Factors include:

  • Price and quantity regulations

  • Taxes and subsidies

  • Externalities (positive/negative impacts on third parties)

  • Public goods and common resources (leading to free-rider and tragedy of commons problems)

  • Monopoly (maximizing profits at the expense of total quantity produced)

  • High transaction costs affecting market operations.

Conclusion

• Effectiveness of resource allocation methods impacts consumer and producer surpluses, overall market efficiency, and perceptions of fairness in economic outcomes.