ECON 100 1st Edition Lecture 9 Outline of Last Lecture I Resource Allocation Methods A Market Price B Command C Majority Rule D Contest E First Come First Served F Lottery G Personal Characteristics H Force II Benefit Cost and Surplus A Value B Individual Demand Market Demand Consumer Surplus C Individual Supply Market Supply Producer Surplus Outline of Current Lecture I Is the Competitive Market Efficient A Efficiency of Competitive Equilibrium B The Invisible Hand C Market Failure 1 Sources of Market Failure D Alternatives to the Market 1 Ideas About Fairness II Housing Market with a Rent Ceiling A Housing Shortage Increased Search Activity Black Market B Inefficiency C Fairness Current Lecture Is the Competitive Market Efficient Efficiency of Competitive Equilibrium A competitive market creates an efficient allocation of resources at equilibrium quantity demanded equals the quantity supplied When production is a Less than the equilibrium quantity MSB MSC These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute b Greater than the equilibrium quantity MSC MSB c Equal to the equilibrium quantity MSC MSB Resources are used efficiently when marginal social benefit equals marginal social cost When the 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 transactions generate an efficient highest valued use of resources Market Failure Market failurearises when a market delivers an inefficient outcome Market failure can occur because a Too little of an item is produced underproduction a deadweight loss equals the decrease in total surplus this loss is a social loss b Too much of an item is produced overproduction a deadweight loss arises from overproduction this loss is a social loss Sources of Market Failure 1 Price and Quantity Regulations a Price regulations sometimes put a block on the price adjustments and lead to underproduction b Quantity regulations that limit the amount that a farm is permitted to produce also lead to underproduction 2 Taxes and Subsidies a Taxes increase the prices paid by buyers and lower the prices received by sellers so taxes decrease the quantity produced and lead to underproduction b Subsidies lower the prices paid by buyers and increase the prices received by sellers so subsidies increase the quantity produced and lead to overproduction 3 Externalities a An externality is a cost or benefit that affects someone other than the seller or the buyer of a good an electric utility creates an external cost by burning coal that creates acid rain the utility doesn t consider this cost when it chooses the quantity of power to produce overproduction results b An apartment owner would provide an externalbenefit if she installed a smoke detector but she doesn t consider her neighbor s marginal benefit and decides not to install a smoke detector the result is underproduction 4 Public Goods and Common Resources a A public good benefits everyone and no one can be excluded from its benefits b It is in everyone s self interest to avoid paying for a public good called the free rider problem which leads to underproduction c A common resource is owned by no one but can be used by everyone d It is in everyone s self interest to ignore the costs of their own use of a common resource that fall on others called tragedy of the commons the tragedy of the commons leads to overproduction 5 Monopoly a A monopoly is a firm that is the sole provider of a good or service b The self interest of a monopoly is to maximize its profit to do so a monopoly sets a price to achieve its self interested goal c As a result a monopoly produces too little and underproduction results 6 High Transaction Costs a Transactions costs arethe opportunity cost of making trades in a market b To use the market price as the allocator of scarce resources it must be worth bearing the opportunity cost of establishing a market c Some markets are just too costly to operate when transactions costs are high the market might underproduce Alternatives to the Market When a market is inefficient can one of the non market methods of allocation do a better job Often majority rule might be used But majority rule has its own shortcomings a group that pursues the selfinterest of its members can become the majority Also with majority rule votes must be translated into actions by bureaucrats who have their own agendas There is no one efficient mechanism for allocating resources efficiently but supplemented majority rule bypassed inside firms by command systems and occasionally using first come first served markets do an amazingly good job Ideas about fairness can be divided into two groups It s not fair if the result isn t fair a The idea that only equality brings efficiency is called utilitarianism b Utilitarianism is the principle that states that we should strive to achieve the greatest happiness for the greatest number c If everyone gets the same marginal utility from a given amount of income and if the marginal benefit of income decreases as income increases then taking a dollar from a richer person and giving it to a poorer person increases the total benefit d Only when income is equally distributed has the greatest happiness been achieved e Utilitarianism ignores the cost of making income transfers recognizing these costs leads to the big tradeoffbetween efficiency and fairness f 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 a The idea that it s not fair if the rules aren t fair is based on the symmetry principle the requirement that people in similar situations be treated similarly b In economics this principle means equality of opportunity not equality of income c Robert Nozick suggested that fairness is based on two rules 1 The state must create and enforce laws that establish and protect private property 2 Private property may be transferred from one person to another only by voluntary exchange d This means that if resources are allocated efficiently they may also be allocated