Microeconomics (ECON 2106) Notes Week 5
Microeconomics (ECON 2106) Notes Week 5 ECON 2106
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This 7 page Class Notes was uploaded by Chapman Lindgren on Thursday September 15, 2016. The Class Notes belongs to ECON 2106 at University of Georgia taught by Till Schreiber in Fall 2016. Since its upload, it has received 9 views. For similar materials see Principles of Microeconomics in Economics at University of Georgia.
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Date Created: 09/15/16
Economics (2106) Notes Week 5 Resource Allocation Methods Market price: like college in the US Command: like college assignment system in Germany. Resources are allocated by the order of someone in authority Majority rule: Content: getting picked for a job over someone else First come, first serve: wait in line the longest Lottery: random Personal characteristics: restrictions of allocation on what people of certain gender/race could do/buy/etc. Force: if you want something you have to take it Benefit, Cost, and Surplus Demand, Willingness to Pay, and Value Value: what we get o The value of one or more unit of a good or service is its marginal benefit A demand curve is a marginal benefit curve o We measure value as the maximum price that a person is willing to pay Willingness to pay determines demand Price: what we pay Individual Demand and Market Demand Individual demand is the relationship between the price of a good and the quantity demanded by one person Market demand is the relationship between the price of a good and the quantity demanded by all buyers The market demand curve is the horizontal sum of the individual demand curves Economics (2106) Notes Week 5 th Lisa’s marginal benefit is $1 for the 30 slice Nick’s marginal benefit is $1 for the 10 sliceh For society overall, The white rectangle under the pink line is the amount she pays. She still gets that value out of the pizza. Economics (2106) Notes Week 5 Consumer surplus: (the triangle area under Lisa’s and Nick’s individual demand curve and above the pink line). This represents the extra money the consumer would’ve been willing to pay to receive the amount of pizza that they each purchased Supply and Marginal Cost To make a profit you need to sell at a price higher than your production costs Firms are in business to make a profit Firms distinguish between cost and price Supply, Cost, and Minimum Cost is what the producer gives up, price is what they receive Marginal cost: the cost of one more unit of a good or service o Marginal cost is the minimum price that a firm is willing to accept, but minimum supply-price determines supply A supply curve is a marginal cost curve Individual Supply and Market Supply The relationship between the price of a good and the quantity supplied by one producer is called individual supply. The relationship between the price of a good and the quantity supplied by all producers in the market is called market supply. Producer Surplus Producer Surplus is the excess amount received from the sale of a good over the cost of producing it To calculate the producer surplus, pricereceived forthegood−supply pri(marginal cos) Economics (2106) Notes Week 5 Is the Competitive Market Efficient? Efficiency of Competitive Equilibrium In equilibrium, the quantity demanded = the quantity supplied When production is: o Less than the equilibrium quantity, MSB > MSC o Greater than the equilibrium quantity, MSC > MSB o Equal to the equilibrium quantity, MSC = MSB Resources are used efficiently when marginal social benefit social benefit equals marginal social cost When efficient quantity is produced, total surplus (the sum of consumer surplus and producer surplus) is maximized 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 transaction generate an efficient- highest value – use of resources Market Failure Markets don’t always achieve an efficient outcome Market failure arises when a market delivers an inefficient outcome Market failure can occur because o Too little of an item is produced (underproduction) OR o Too much of an item is produced (overproduction) Economics (2106) Notes Week 5 Underproduction The efficient quantity is 10,000 pizzas per day. If production is restricted to 5,000 pizzas a day, there is underproduction and the quantity is inefficient A deadweight loss equals the decrease in total surplus Overproduction Again, the efficient quantity is 10,000 pizzas per day. If production is expanded to 15,000 a day, a deadweight loss arises from overproduction Sources of Market Failure In competitive markets, underproduction or overproduction arise when there are o Price and quantity regulations o Taxes and subsidies o Externalities o Public goods and common resources o Monopoly o High transaction costs Price and Quantity Regulations Price regulations sometimes put a block on the price adjustments and lead to underproduction Quantity regulations that limit the amount that a farm is permitted to produce also lead to underproduction Taxes and Subsidies Taxes increase the prices paid by buyers and lower the prices received by sellers o So taxes decrease the quantity produced and lead to underproduction Subsidies lower the prices paid by buyers and increase the prices received by sellers o So subsidies increase the quantity produced and lead to overproduction Externalities An externality is a cost or benefit that affects someone other than the seller or the buyer of a good An electric utility crates an external cost by burning coal that creates acid rain o The utility doesn’t consider this cost when it chooses the quantity of power to produce. Overproduction results Economics (2106) Notes Week 5 An apartment owner would provide an external benefit if she installed a smoke detector o But she doesn’t consider her neighbor’s marginal benefit and decides not to install a smoke detector. Underproduction results Public Goods and Common Resources A public good benefits everyone and no one can be excluded from its benefits It is in everyone’s self-interest to avoid paying for a public good (free- rider problem) which leads to underproduction A common resource is owned by no one but can be used by everyone o It is in everyone’s self-interest to ignore the costs of their own use of a common resource that fall on others (tragedy of the commons which leads to overproduction Monopoly A monopoly is a firm that is the sole provider of a good or service The self-interest of a monopoly is to maximize its profit. It sets a price to achieve its self-interested goal As a result, a monopoly produces too little and underproduction results High Transactions Costs Transactions costs are the opportunity cost of making trades in a market. To use the market price as the allocator of scarce resources, it must be worth bearing the opportunity cost of establishing a market. Some markets are just too costly to operate. When transactions costs are high, the market might underproduce. Information gathering about hard-to-observe quality can lead to high transactions costs 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 It’s not fair if the result isn’t fair The idea that only equality brings efficiency is called utilitarianism. Utilitarianism is the principle that states that we should strive to achieve “the greatest happiness for the greatest number.” If everyone gets the same marginal utility from a given amount of income, and if the marginal benefit of income decreases as income Economics (2106) Notes Week 5 increases, then taking a dollar from a richer person and giving it to a poorer person increases the total benefit. Only when income is equally distributed has the greatest happiness been achieved. The Big Tradeoff Utilitarianism ignores the cost of making income transfers. Recognizing these costs leads to the big tradeoff between efficiency and fairness. Because of the big tradeoff, John Rawls proposed that income should be redistributed to the point at which the poorest person is as well off as possible. It’s Not Fair If the Rules Aren’t Fair The idea that “it’s not fair if the rules aren’t fair” is based on the symmetry principle. The symmetry principle is the requirement that people in similar situations be treated similarly.
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