Lecture04

ECON 1001AEF / A121F

  • Course: Foundations of Social Sciences: Economics

  • Lecture 04: Efficiency and Fairness of Markets

  • Presented by: Hong Kong Metropolitan University

Agenda

  • Alternative methods of allocating scarce resources

    • Define features of an efficient allocation

  • Distinguish between value and price

    • Define consumer surplus

  • Distinguish between cost and price

    • Define producer surplus

  • Evaluate the efficiency of alternative resource allocation methods

  • Discuss concepts of fairness in resource allocation

    • Evaluate fairness of different methods

Resource Allocation Methods

  • Various methods for allocating scarce resources:

    • Market Price: Resources allocated based on willingness to pay.

    • Command: Allocated by authority orders.

    • Majority Rule: Decisions made by majority vote.

    • Contest: Resources awarded based on performance.

    • First-Come, First-Served: Resources allocated to those first in line.

    • Sharing Equally: Equal distribution among participants.

    • Lottery: Resources allocated randomly.

    • Personal Characteristics: Based on individual traits.

    • Force: Resources allocated through coercion or power.

Market Price

  • Definition: Resource allocation based on price willingness.

  • Most resources supplied are allocated through market price.

  • Labor services and consumption are market-driven.

  • Efficiency in market-based resource allocation noted in most goods and services.

Command System

  • Definition: Allocation by authority orders.

  • Typical in job roles where tasks are assigned.

  • Effective in organizations with clear hierarchies but less effective in broader economies.

Majority Rule

  • Definition: Resource allocation determined by majority preference.

  • Used in societal decisions (e.g., taxation, public resource allocation).

  • Effective when collective decision-making suppresses self-interest.

Contest

  • Definition: Resources allocated to winners of competitions.

  • Examples include sports and award events (e.g., Oscars).

  • Effective when monitoring individual efforts is challenging.

First-Come, First-Served

  • Definition: Allocation to those who arrive first.

  • Common in casual dining, supermarkets, and airlines.

  • Most effective for sequential resource usage.

Sharing Equally

  • Definition: Equal distribution among participants.

  • Example: Sharing food equally (e.g., dessert).

  • Works best in small groups with shared objectives.

Lottery

  • Definition: Allocation based on chance.

  • Widespread in state lotteries and casinos.

  • Effective when distinguishing characteristics of users is difficult.

Personal Characteristics

  • Definition: Allocation based on specific traits.

  • Examples: Personal choices in partners or job offers.

  • Risk of discrimination and fairness issues.

Force

  • Definition: Resource allocation via coercion.

  • Historical examples include war and theft.

  • Can establish legal frameworks for voluntary market exchanges.

Using Resources Efficiently

  • Allocative Efficiency: Producing goods and services valued most by consumers.

  • Limits on production: Cannot produce more of one good without less of another.

  • Production Possibility Frontier (PPF) illustrates potential production constraints.

Marginal Benefit

  • Definition: Benefit from consuming an additional unit.

  • Preferences determine marginal benefit; decreases as consumption increases.

Marginal Cost

  • Definition: Opportunity cost of producing one more unit.

  • Marginal cost increases with more production.

  • Linked to the slope of the PPF.

Efficient Allocation

  • Definition: Highest-valued resource allocation.

  • Efficient if no increase in one good without reducing a higher-valued one.

  • Requires comparing marginal benefit and marginal cost for allocation decisions.

Demand and Marginal Benefit

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

  • The demand curve represents consumer willingness to pay based on marginal benefit.

Consumer Surplus

  • Definition: Difference between consumer value and cost.

  • Calculated over the quantity consumed, represented visually in economic graphs.

Supply and Marginal Cost

  • Definition: Cost incurred by sellers, linked to production cost.

  • Supply curves depict minimum price for various production levels.

Producer Surplus

  • Definition: Difference between market price received and production cost.

  • Visual representation shows the benefit received by producers.

Markets and Efficiency

  • Competitive markets achieve efficient resource allocation when supply equals demand.

  • Total surplus (consumer surplus + producer surplus) is maximized in competitive settings.

The Invisible Hand

  • Concept proposed by Adam Smith, suggesting that competitive markets self-regulate.

  • Each participant's self-interest inadvertently promotes overall economic welfare.

Market Failure

  • Definition: Occurs when markets fail to allocate resources efficiently.

  • Causes: Underproduction or overproduction leading to deadweight loss.

Public Goods and Common Resources

  • Public goods: Non-excludable, leading to the free-rider problem.

  • Common resources: Shared use leads to the tragedy of the commons due to overuse.

Market Inefficiencies

  • Factors causing market inefficiencies include regulations, taxes, externalities, and monopolies.

Summary on Fairness and Efficiency

  • Two perspectives on fairness:

    1. Fairness in rules vs. fairness in outcomes.

    2. Tradeoffs exist between efficiency and fairness, known as the 'big tradeoff.'

  • Income redistribution can create inefficiencies, reducing overall economic gain.

References

  • Bade, R. & Parkin, M. (2014). Essential Foundations of Economics, Global Edition (7th ed.). Person.