part 3 markets and efficiency concept of economic (allocative) efficiency introduced previously...
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![Page 1: Part 3 Markets and Efficiency Concept of economic (allocative) efficiency introduced previously Decreasing marginal benefits and increasing marginal costs](https://reader036.vdocuments.net/reader036/viewer/2022081519/56649d255503460f949fc688/html5/thumbnails/1.jpg)
Part 3Markets and Efficiency
• Concept of economic (allocative) efficiency introduced previously
• Decreasing marginal benefits and increasing marginal costs
• Efficient allocation where MB = MC• This assumes all costs and benefits
are included (including environmental costs)
• Do competitive markets produce efficient outcomes?
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Demand and Marginal Benefit
• People value many different goods and services
• The total benefit (value) of a good to a person is the benefit gained from the whole of the amount of the good consumed
• The marginal benefit (value) of a good to a person is the additional benefit that consuming the last unit provides
• A person’s relative valuation of a good is expressed in their willingness to pay
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Willingness to Pay
• People have a limited budget so that purchasing one thing for $5 means not purchasing the other things that $5 could have bought
• If I pay $5 for a unit of a good it means I value that unit of that good at least as much as (and maybe more than) the other things I could have bought for $5
• My willingness to pay for the last unit I purchase is a measure of its marginal benefit to me
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Willingness to Pay
• Willingness to pay for additional units of a good declines with quantity for each individual
• People vary in their willingness to pay depending on their incomes and preferences
• At the level of the market will find willingness to pay will decline with quantity.
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Willingness to Pay and Demand Curves
• Under most circumstances (small or zero income effects from price changes) a demand curve can also be thought of as a marginal benefit curve or as a marginal willingness to pay curve
• The area under the demand curve to the left of the last unit purchased can be thought of as measuring total benefit or total willingness to pay
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Willingness to Pay and Demand Curves
P
Q
Total benefit or total WTP for Q1
Q1
P1P1 = MB or marginal WTPat Q1
(green shaded area)
D
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Consumers’ Surplus
P
Q
Consumers’ Surplus: excessof total WPT over amount actually paid
Q1
P1P1 = MB or marginal WTPat Q1
Amount actually paid (P1 x Q1)
Given a price of P1 consumers purchase up to Q1. They pay P1 for all units although previous units are valued more
D
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Supply and Marginal Cost
• The cost of production of a good is its opportunity cost--the other goods that could have been produced instead with the resources used
• Provided all productive resources are priced in competitive markets, the opportunity cost of producing something will be reflected in the cost of production (cost of the productive resources used)
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Supply and Marginal Cost
• The marginal cost of production is the opportunity cost of producing one more unit of the good
• Marginal opportunity costs tend to rise with output
• Producers will only produce up to the point where the price they receive equals the marginal cost of production (profit max)
• The supply curve is a marginal cost curve
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Supply and Marginal Cost
MC=S
10
Marginal opportunity costOf the 10th unit = $15
15
P
Q
Firm will supply the 10th unit if the price is$15. This is the minimum price that producerswill accept for that unit of production
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Producers’ Surplus
S=MC
15
P
Q10
Producers’ Surplus
Cost of production
Producer would have been willing to Produce units 1-9 for less than $15 but Receives the same price for all units
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Is the Competitive Market Efficient?
S=MC
D=MB
15
P
10 Q
CS
PS
At E the Social Surplus is maximized.Maximum of total benefit over the total opportunity cost.
E Sum of CS andPs is the Social Surplus
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Is the Market Always Efficient?
• Markets may not result in economic efficiency for a number of reasons - Price floors and ceilings- Taxes, subsidies, quotas- Monopoly- Public goods- External costs or benefits
• These barriers to efficiency are very widespread
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Inefficiencies: Underproduction and
OverproductionP
S
D
Q
Deadweight loss
Deadweight loss
Q’
Q’
S
D
P
Q
Underproduction
Overproduction
Q*
Q*
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Efficiency and Equity
• Efficiency is an allocation of resources where MB=MC
• An efficient allocation can only be defined given some initial allocation of resources between individuals
• Willingness to pay is budget constrained
• Efficient markets may well result in very unequal distributions of income
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Markets with Price or Quantity Regulation
• Housing markets and rent ceilings
Shortage
Qs Qd
Rc
Rb
Deadweight loss
S
Q
Rent
D
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Markets with Price or Quantity Regulation
• Labour Markets with minimum wages
Qd Qs
WminS
Q
Wage
D
Unemployment
W*
Q*
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Markets with Price or Quantity Regulation
• Agricultural markets--problems of price and income instability due to supply fluctuations and inelastic demand
• Markets in inventories and price stabilization
• Attempts to raise farm incomes
- Price floors
- Quotas
- Subsidy programs
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Agricultural Price Floors and Quotas
P
Q
D
S
Q*Q’
Q’ = quota amount
P*
P’
Surplus at P’
Q”
P’ = price floor
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Agricultural Subsidies
D
S
S-subsidy
Q* Q’
P*P’
P’+sub
Subsidy
P
Q
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Sales Taxes and Prices
• The incidence of a sales tax
• Incidence and the elasticity of demand and supply
Per unit tax
P*
P’+ tax
P’
S + tax
S
D
P
Q
Taxrevenue
Q*Q’
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Sales Taxes and Efficiency
Tax revenueP’
Q’
Consumers’ surplus
Producers’ surplus
Deadweight loss
D
S
S+tax
P
Q