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MARKET EFFICIENCY ch 3,4 7(skim) (“market efficiency” posted under extra readings tab on Bb) Prelim: measuring efficiency - Recall that we evaluate actions “at the margin” o The issue is not whether an action is “good” ro “bad” but whether a little more action will generate more benefits than costs - Consider a patent, an exclusive right to sell a product for 20 yrs o The benefit of a patnt is that it provides firms and induviduals with the incentive to develop new and better products o The cost of a patent is that it reduces competition, and thus allows patent holders to charge higher prices - Would it be efficient to have longer patent protection o If extending the duration of patents would generate additional benefits of $35 billion and additional costs of $20 billion, we would judge the action to be EFFICIENT (MB>MC) - An action is efficient only if the marginal benefits are greateer than the marginal costs - The MOST EFFICIENT action is one that produces the biggest net gain (i.e. biggest postivie difference between MB and MC) The social welfare consequences of markets - What purpose do markets serve o Markets are a medium which allows buyers and sellers to efficiently allocate resources - Trade in markets (and specialization) are big reasons why people are so much better off today than 200, 100, 50 years ago o Greater caloric intake o Longer life expectancy o Lower rates of infant mortality How can we measure the benefit of a given market - The gains from trade are measured of how much better off the operation of a market makes us - Simple ex: o John would get $25 in benefits from a widget, but doesn’t have one o Sarah has a widget, and an opportunity cost of letting it go of $10 o If the widget moves from Sarah to John, the values rises from 10 to 25 - If the trade occurs, society is $15 better off Gains form trade and markets - Assume trade occurs at the equilibrium price. How large are the gains to society o The demand curve indicates the benefits enjoyed by consumers o Supply curve indicates the costs to producers of supplying the good o Trade occurs where the benefit to consumers is greater than the cost to producers o The area (triangle) represents the total gains from trade generated in that market o The gains from trade are also known as the “TOTAL SURPLUS” Who gets the surplus - Some of the surplus is enjoyed by consumers and some is enjoyed by producers o The market price is the consumers opportunity cost (what they must give up to obtain a unit of the product)  Thus: the area between demand curve and the market price indicates how much better of consumers are bc they can trade in this market  This is the CONSUMER SURPLUS (CS) o The market price is also the benefit that suppliers receive for selling their product  This the area between the market price and the supply curve indicates ow much better off producer are bc they can trade in this market  This is called PRODUCER SURPLUS (CS) o The sum of the two is the TOTAL SURPLUS generated in that market