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110Ch05

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Published on September 12, 2007

Author: Gabir

Source: authorstream.com

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Chapter 5: Efficiency & Equity – Objectives:  Chapter 5: Efficiency andamp; Equity – Objectives Define consumer surplus Define producer surplus Explain some sources of inefficiency in our economy Efficiency: A Refresher:  Efficiency: A Refresher Marginal cost is the opportunity cost of producing one more unit. Marginal benefit is the benefit received from one more unit of a good. Efficiency and Inefficiency If marginal benefit exceeds marginal cost, producing and consuming more of the good uses resources more efficiently. Efficiency: A Refresher:  Efficiency: A Refresher If marginal cost exceeds marginal benefit, producing and consuming less of the good uses resources more efficiently. If marginal cost equals marginal benefit, resources are being used efficiently. Value, Willingness to Pay, and Demand:  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 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. Consumer Surplus:  Consumer Surplus Consumer surplus is the value of a good minus the price paid for it, summed over the quantity bought. The price paid is the market price, same for each unit. The quantity bought is determined by the demand. The blue rectangle shows the amount paid. The green triangle shows the consumer surplus. Consumer Surplus:  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, Minimum Supply-Price, and Supply:  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 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. Producer Surplus:  Producer Surplus Producer surplus is the price minus the marginal cost of production, summed over the quantity sold. The price is the market price same for each unit sold. The quantity sold is determined by supply. The red area shows the total cost of producing pizza. The blue triangle shows the producer surplus from pizza. Producer Surplus:  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?:  Is the Competitive Market Efficient? In equilibrium, the quantity demanded equals the quantity supplied. 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?:  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. The Invisible Hand Works in Our Economy Today It coordinates the self interest of producers and consumers of computers, oranges, and just about every goods and services. Is the Competitive Market Efficient?:  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 External costs and external benefits. Public goods and common resources Underproduction and Overproduction:  Underproduction and Overproduction Effects of Underproduction Government puts a quota on pizza production at 5,000 pizzas. A dead weight loss arises from underproduction. The efficient quantity is 10,000 pizzas a day. Obstacles to efficiency lead to underproduction or overproduction and create a deadweight loss—a decrease in consumer and producer surplus. Underproduction and Overproduction:  Underproduction and Overproduction Effects of Overproduction If production is expanded to 15,000 pizzas a day, a dead weight loss arises from overproduction. Here the government pays a subsidy of $10 to producers. The efficient quantity is 10,000 pizzas a day.

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