You are on page 1of 36

EFFICIENCY AND EQUITY

Efficiency: A Refresher
An efficient allocation of resources occurs when we produce the goods and services that people value most highly. Resources are allocated efficiently when it is not possible to produce more of a good or service without giving up some other good or service that is valued more highly. Efficiency is based on value, which is determined by people’s preferences.

Efficiency: A Refresher
Marginal Benefit Marginal benefit is the benefit a person receives from consuming one more unit of a good or service. We can measure the marginal benefit from a good or service by the dollar value of other goods and services that a person is willing to give up to get one more unit of it. The concept of decreasing marginal benefit implies that as more of a good or service is consumed, its marginal benefit decreases.

Efficiency: A Refresher

Figure shows the decreasing marginal benefit from each additional slice of pizza, measured in dollars per slice.

Efficiency: A Refresher
Marginal Cost Marginal cost is the opportunity cost of producing one more unit of a good or service. The measure of marginal cost is the value of the best alternative forgone to obtain the last unit of the good. We can measure the marginal cost of a good or service by the dollar value of other goods and services that a person is must give up to get one more unit of it. The concept of increasing marginal cost implies that as more of a good or service is produced, its marginal cost increases.

Efficiency: A Refresher

The Figure shows the increasing marginal cost of each additional slice of pizza, measured in dollars per slice.

Efficiency: A Refresher
Efficiency and Inefficiency If the marginal benefit from a good exceeds its marginal cost, producing and consuming more of the good uses resources more efficiently.

Efficiency: A Refresher

If the marginal cost of a good exceeds its marginal benefit, producing and consuming less of the good uses resources more efficiently.

Efficiency: A Refresher

If the marginal cost of a good equals its marginal benefit, resources are being used efficiently.

Value, Price, and Consumer Surplus
Value, Willingness to Pay, and Demand The value of one more unit of a good or service is its marginal benefit, which we can measure as the maximum price that a person is willing to pay. A demand curve for a good or service shows the quantity demanded at each price. A demand curve also shows the maximum price that consumers are willing to pay at each quantity.

Value, Price, and Consumer Surplus
The Figure shows these two ways of interpreting a demand curve. In part a, shown here, the demand curve tells us the quantity that consumers plan to buy at a given price.

Value, Price, and Consumer Surplus

In part b, shown here, the demand curve tells us the maximum price that consumers are willing to pay for a given quantity. This price measures the marginal benefit of the good at that given quantity.

Value, Price, and Consumer Surplus
Consumer Surplus Consumer surplus is the value of a good minus the price paid for it, summed over the quantity bought. It is measured by the area under the demand curve and above the price paid, up to the quantity bought. Figure on the next slide shows the consumer surplus for pizza for an individual consumer.

Value, Price, and Consumer Surplus
The price paid is the market price, which is the same for each unit bought. The quantity bought is determined by the demand curve, and the blue rectangle shows the amount paid for pizza. The green triangle shows the consumer surplus from pizza.

Value, Price, and Consumer Surplus

The consumer surplus on the 10th slice is the $2 that the consumer is willing to pay minus the $1.50 that she does pay, which is 50 cents a slice.

Cost, Price, and Producer Surplus
Cost, Minimum Supply-Price, and Supply The cost of one more unit of a good or service is its marginal cost, which we can measure as the minimum price that a firm is willing to accept. A supply curve of a good or service shows the quantity supplied at each price. A supply curve also shows the minimum price that producers are willing to accept at each quantity.

Cost, Price, and Producer Surplus
The Figure shows these two ways of interpreting a supply curve. In part a, shown here, the supply curve tells us the quantity that producers plan to sell at a given price.

Cost, Price, and Producer Surplus

In part b, shown here, the supply curve tells us the minimum price that producers are willing to accept for a given quantity. This price measures the marginal cost of producing that given quantity of the good.

Cost, Price, and Producer Surplus
Producer Surplus Producer surplus is the price of a good minus the marginal cost of producing it, summed over the quantity sold. Producer surplus is measured by the area below the price and above the supply curve, up to the quantity sold. Figure on the next slide shows the producer surplus for pizza for an individual producer.

Cost, Price, and Producer Surplus
The price is the market price, which is the same for each unit sold. The quantity sold is determined by the supply curve and the red area shows the total cost of producing pizza. The blue triangle shows the producer surplus from pizza.

Cost, Price, and Producer Surplus

The producer surplus on the 50th pizza is the $15 that the producer receives minus the $10 that it cost to produce, which is $5 a pizza.

Is the Competitive Market Efficient?
Efficiency of Competitive Equilibrium The Figure shows that a competitive market creates an efficient allocation of resources at equilibrium. In equilibrium, the quantity demanded equals the quantity supplied.

Is the Competitive Market Efficient?
At the equilibrium quantity, marginal benefit equals marginal cost, so the quantity is the efficient quantity. The sum of consumer and producer surplus is maximized at this efficient level of output.

Is the Competitive Market Efficient?
The Invisible Hand Adam Smith’s “invisible hand” idea in the Wealth of Nations implied that competitive markets send resources to their highest-valued use in society. Consumers and producers pursue their own self-interest and interact in markets. Market transactions generate an efficient—highest valued —use of resources.

Is the Competitive Market Efficient?
The Invisible Hand at Work Today The invisible hand works in our economy today. It coordinates the self-interest of producers and consumers of computers, oranges, and just about every good or service that you can think of.

Is the Competitive Market Efficient?
Obstacles to Efficiency Markets are not always efficient and the obstacles to efficiency are:  Price ceilings and floors  Taxes, subsidies, and quotas.  Monopoly  Public goods  External costs and external benefits.

Is the Competitive Market Efficient?
Underproduction and Overproduction Obstacles to efficiency lead to underproduction or overproduction and create a deadweight loss—a decrease in consumer and producer surplus.

Is the Competitive Market Efficient?
The Figure (a) shows the effects of underproduction. The efficient quantity is 10,000 pizzas a day. If production is restricted to 5,000 pizzas a day, a deadweight loss arises from underproduction.

Is the Competitive Market Efficient?
Figure (b) shows the effects of overproduction. Again, the efficient quantity is 10,000 pizzas a day. If production is expanded to 15,000 pizzas a day, a deadweight loss arises from overproduction.

Is the Competitive Market Fair?
Ideas about fairness can be divided into two groups:  It’s not fair if the result isn’t fair  It’s not fair if the rules aren’t fair

Is the Competitive Market Fair?
The Figure shows how redistribution increases efficiency. Tom is poor and has a high marginal benefit of income. Jerry is rich and has a low marginal benefit of income. Taking dollars from Jerry and giving them to Tom until they have equal incomes increases total benefit.

Predictions of Marginal Utility Theory
Marginal Utility and Elasticity We can predict the price elasticity of demand for a good by knowing the characteristics of the marginal utility of the good. If as the quantity consumed, marginal utility diminishes rapidly, then a given price change will bring a small quantity change to restore consumer equilibrium, and demand will be inelastic.

Efficiency, Price, and Value
Consumer Efficiency and Consumer Surplus When consumers maximize their utility, they are using resources efficiently. And the marginal benefit from a good or service is the maximum price the consumer is willing to pay for an extra unit of that good or service when his or her utility is maximized.

Efficiency, Price, and Value
The Paradox of Value The paradox of value “Why is water, which is essential to life, far cheaper than diamonds, which are not essential?” is resolved by distinguishing between total utility and marginal utility. Figure on the next slide illustrates the resolution of the paradox.

Efficiency, Price, and Value
The total utility and consumer surplus from water is large but the marginal utility and price of water is small. In contrast, the total utility and consumer surplus from diamonds is small but the marginal utility and price of a diamond is large.

EFFICIENCY AND EQUITY

THE END