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.