Chapter 5: Allocative efficiency

• the most deriable point to produce along the ppf

Resource Allocation methods

• market price

  • the people who are wiiling and able to pay the price get the resource

    • those who decide not to pay

    • those who cannot pay

• command

  • allocates resources in the order (command) of someone in authority

  • works in organizations in which the lines of authority and responsibility are clear and it is easy to monitor the activities being preformed.

• majority rule

  • allocated resources in the way that a majority of voter chose

  • works well when teh decision made affect large numbers of people and self-intreste must be suppresses to used resources most effectively

• contest

  • allocates resources to a winner

• first come first serve

  • allocates resources to those who are firts in line

• lottery

  • allocate resources to those who pick the winning number, draw lucky cards, or come up lucky on some other gaming system

  • work best when there is no effective way to distinguish among potential users of a scarce resource

• personal characteristics

  • allocated based on personal characteristics, people with the “right” characteristics get the resource.

• force

  • provides a method for trasnfering wealth from the rich to the poor, and provides the legal framework in which voluntary exchange inmarkets takes place

  • Good

    • rule of law

  • ill

    • war, theft

Benifit, cost, and surplus

marginal analysis

• if the marginal benefit of an action is greater than the marginal cost of the action, then do the action

• if the marginal benefit of an action is less than the marginal cost of the action, then do not the action

  • marginal: a small additional change

Marginal benefit

measuring marginal benefit

1. maximum price the consumer is willing to pay

2. value to the consumer

   1. cant value more/less than the value

3. marginal benefit to the consumer (MB)

4. Marginal social benefit (MSB)

   1. her benefit is society's benefit

• as quantity increases the MSB decreases

• as quantity increases the MSB increases

marginal cost

measuring marginal cost

1. minimum price the produces is willing to accept

2. marginal cost to the producer (MC)

3. marginal social cost (MSC)

• as quantity increases the MSC increases

• as quantity decreases MSC decreases

allocative efficiency

• quantity the quantity the maximises societies total surplus

put the MSB and MSC curves together

• benefit-cost (surplus) of the unit

  • good thing to have

  • not the same as where your producing more of a good where the quantity supplied minus the quantity demanded is positive

• total surplus of all the units

• Q produces all the units that have a surplus of benefit over cost

  • the allocative efficiency

• if u produce more, u produce looser surplus and taking aways

• if u produce less you loose out on the possibility of some surplus

• total surplus is the shaded region

  • or area of the triangle

invisible hand

• the equilibrium quantity is the same as the allocative efficient quantity

• adam smith

  • “people, pursuing only their own self interest are nonetheless led, as if by an invisible hand, to advance the social interest”

  • gov intervention is unnecessary

division of surplus

consumer surplus

• the difference between the maximum price a consumer is willing to pay (=MB=MSB) minus the price actually paid, summed over the quantity consumed

• area under the MSB and above the Price

• Consumer surp:

  • 1/2 x BxH= 1/2x1,000x$10= $5000

producer surplus

• The difference between the price actually received minus the minimum price of a producer is willing to accept (=MC=MSC), summed over the quantity produced.

• 1/2xBH=1/2x1000$10=$5000

Market failure: deadweight loss

what happens if less than the efficient quantity is produced?

what happens if more than the efficient quantity is produced?

• loss to society, missing out or a reduction on the total surplus which is called the deadweight loss

• production at the allocated efficiency ensures that the total amount of surplus is produced.

sources of market failure

• Price and Quantity Regulations

  • Price caps or floors hinder price adjustments, causing underproduction.

  • Quantity regulations limit production, also leading to underproduction.

• Taxes and Subsidies

  • Taxes increase buyer prices, lower seller prices, resulting in underproduction.

  • Subsidies lower buyer prices, increase seller prices, leading to overproduction.

• Externalities

  • Externality: a cost/benefit affecting non-parties in a transaction.

  • External cost (e.g., from coal emissions) leads to overproduction.

  • External benefit (e.g., smoke detectors) results in underproduction.

• Public Goods and Common Resources

  • Public goods (e.g., national defense) face underproduction due to free-riding.

  • Common resources (e.g., Atlantic salmon) are overused as individuals ignore imposed costs.

• Monopoly

  • A monopoly is a sole provider of a good/service, resulting in underproduction by charging high prices.

• High Transaction Costs

  • High costs of facilitating transactions can lead to market underproduction.

  • Example: local tennis courts operate on a first-come, first-served basis due to high transaction costs.