Econ Notes Ch 5 Market Price Resources are allocated in various ways price get the resource Command When a market price allocates a scarce resource the people who are willing and able to pay that Command system allocates resources by the order command of someone in authority o Ex If you have a job your labor is allocated to specific tasks by a command o Works well in organizations in which the lines of authority and responsibility are clear and it is easy to monitor the activities being performed Majority Rule Majority rule allocated resources in the way that a majority of voters choose o Ex Majority rule decides how tax dollars are allocated among competing uses o Works well when the decisions being made affect large numbers of people and self interest must be suppressed to use resources most effectively Contest Allocates resources to a winner o Ex Bill Gates won in providing the world s personal computer operating system o Causes workers to work harder for the prize First come first served Lottery Allocates resources to those who are first in line o Ex Restaurants o Works best when a scarce resource can serve just one user at a time Allocate resources to those who become lucky in a gaming system o Ex Lotteries card games Pitt housing o Work best when there is no effective way to distinguish among potential users of a scarce resource Personal characteristics Allocate resources to people with the right characteristics o Ex Picking a husband good picking workers based on race with discrimination bad Resources are allocated efficiently and in the social interest when they are used in the ways that people value most highly Force Bad Examples o War and theft Good Examples o Legal system taxes Value what we get Price what we pay Marginal benefit the value of one more unit of a good or service Demand curve marginal benefit curve Efficient allocation occurs at the point where 1 Marginal benefit marginal cost 2 Demand curve intersects supply curve 3 Consumers Surplus Producers Surplus are maximized Individual demand the relationship between the price of a good and the quantity demanded by one person Market demand the relationship between the price of a good and the quantity demanded by all buyers Market demand curve the horizontal sum of the individual demand curves and is formed by adding the quantities demanded by all the individuals at each price at what quantity is the market willing to pay 1 for the marginal unit Marginal social benefit curve market demand curve Consumer surplus the excess of the benefit received from a good over the amount paid for it the difference between consumers willingness to pay for a good and current market price summed over quantity bought area of triangle above price line and below demand curve All goods and services have decreasing marginal benefit so people receive more benefit from their consumption than the amount they pay Cost what a firm gives up when it produces a good or service Price what a firm receives when it sells the good or service Supply curve marginal cost curve Individual supply the relationship between the price of a good and the quantity supplied by one producer Market supply the relationship between the price of a good and the quantity supplied by all producers Market supply curve the horizontal sum of the individual supply curves and is formed by adding the quantities supplied by all the producers at each price Marginal social cost societies marginal cost Producer surplus the excess of the amount received from the sale of a good or service over the cost of producing it the difference between the current price of good and cost of production summed over quantity sold calculated as the price received minus the marginal cost summed over the quantity sold triangle below the price and above the supply curve Equilibrium in a competitive market occurs when quantity demanded quantity supplied Marginal social benefit marginal social cost allocative efficiency Total surplus the sum of consumer surplus and producer surplus Market failure a situation in which a market delivers an inefficient outcome Can occur because too little of an item is produced or too much is produced Underproduction consumers are willing to buy more than the suppliers are willing to sell for Overproduction suppliers want to sell more than the consumers want to buy Deadweight loss the decrease in total surplus that results from an inefficient level of production Sources of Market failure Price and quantity regulations o Price regulations like laws that require employers to pay a minimum wage sometimes block the price adjustments that balance the quantity demanded and the quantity supplied and leads to underproduction o Quantity regulations limit the amount a farm can produce which leads to o Price ceiling a regulation that makes it illegal to charge a price above the specified underproduction limit i e rent control o Price floors a regulation that makes it illegal to charge or pay a price below the specified level i e minimum wage Taxes and subsidies to underproduction Externalities o Taxes increase the prices paid by buyers and lower the prices received by sellers Lead o Subsidies payments by the government to producers decrease the prices paid by buyers and increase the prices received by sellers leads to overproduction o Externality a cost or a benefit that affects someone other than the seller or the buyer External cost arises when an electric utility burns coal and emits CO2 doesn t consider environmental factors leads to overproduction External benefit arises when an apartment owner installs a smoke detector and decreases his neighbor s fire risk doesn t consider the benefit to her neighbor when she decides to install them underproduction Public goods and common resources o Public good a good or service that is consumed simultaneously by everyone even if o common resource owned by no one but is available to be used by everyone leads to they don t pay for it leads to underproduction i e National Defense overuse of that resource i e Atlantic salmon o Monopoly a firm that is the sole provider of a good or service leads to Monopoly underproduction High transaction costs o Transaction costs the costs of the services that enable a market to bring buyers and sellers together leads to underproduction When a market is inefficient we resort to nonmarket methods It s not fair if the result isn t fair Utilitarianism a principle that states that we should strive to achieve the