Lecture 5

Welfare economics is the study of how the allocation of resources affects economic well-being. Market price When a market price allocates scarce resources, the people who are willing and able to buy a resource get the resource.

Command

A command system allocates the resources by the order of someone in authority. Works well in organizations with clear lines of authority. Does not work well at allocating resources in the entire economy.

Majority rule

Resources are allocate in accord with majority vote. Works well when the allocation decisions being made affect a large number of people. Self-interest leads to bad decisions.

Contest Resources are allocated to the winner.

First-come, first-serve Lottery Personal characteristics Resources are allocated to people with the right characteristics.

Force Resources are allocated to those who can forcibly take the resources.

Marginal benefit is the maximum price that people are willing and able to pay for another unit of a good or service. Hence, the demand curve for a good or service is also its marginal benefit curve. The market demand curve is the marginal social benefit (MSB) curve. A consumer surplus is the value (or marginal benefit) of a good minus the price paid for it, summed over the quantity bought.

Marginal cost is the minimum price that producers must receive to induce them to produce another unit of a good or service. Hence, the supply curve for a good or service is also its marginal curve. The market supply curve is the economys marginal social cost (MSC) curve. Producer surplus is the price of a good minus its minimum supply-price (or the marginal cost), summed over the quantity sold. Efficiency of competitive equilibrium

The marginal benefit to the entire society is the marginal social benefit curve.

If all the benefits from a good go to its consumers (who is willing and able to consume it) The demand curve is the same as the MSB curve.

The marginal cost to the entire society is the marginal social cost curve, MSC.

If all costs of producing a good are paid by the producers (who is planning to sell the good) the market supply curve is the same as MSC curve.

Efficiency happens when: MSB of the last unit produced = MSC MSB intersects MSC at equilibrium point. Total surplus is maximized

Deadweight loss is: Social loss Decreases total surplus that results from an inefficient level of production.

Obstacles to efficiency:

Externalities An externality is a cost of a benefit that affects someone other than the seller or buyer.

Public goods and common resources:

A public good is a good or service that is consumed simultaneously by everyone even if they dont pay for it a free-rider problem in which people do not pay for their share of goods. A common resource is owned by no one but available to be used by everyone. Are generally over-used because no on owns the resource.

Monopoly

A monopoly is a firm that has sole control of a market.

To maximize its profit, a monopoly produces less than the efficient quantity inefficient.

High transaction costs

The opportunity costs of making a trade are transaction costs. High transaction costs underproduction because too few transaction take place.

Lecture 6
Price ceiling A legal maximum on the price at which a good can be sold.

Price floor A legal minimum on the price at which a good can be sold.

Price ceiling

A price ceiling is set above the equilibrium market forces naturally move the economy to the equilibrium, and the price ceiling has no effect. A price ceiling is set below the equilibrium

The forces of supply and demand cannot move the price toward equilibrium. A shortage in quantity. A black market

A black market:

A rent ceiling also encourages illegal trading in a black market in which the equilibrium price is higher than the rent ceiling price. The level of black market rent depends on how tightly the rent ceiling is enforced.

When the rent ceiling is strictly enforced, black market will be closer to the maximum that consumers are willing to pay.

A tax on sellers: Imposing a tax on sellers decreases supply S curve shifts leftward.

tax on buyers:

Imposing a tax on buyers decreases demand because the tax lowers the amount they are willing to pay to the sellers. D curve shifts leftward.

With perfectly inelastic demand, buyers pay the entire tax. With perfectly elastic demand, sellers pay the entire tax. The less elastic of demand, the larger the tax burden paid by the buyers (and the smaller tax burden paid by the sellers). The more elastic of demand, the smaller the tax burden paid by the buyers (and the larger tax burden paid by the sellers) With perfectly inelastic supply, sellers pay the entire tax. With perfectly elastic supply, buyers pay the entire tax. The less elastic of supply, the larger the tax burden paid by the sellers (and the smaller tax burden paid by the buyers). The more elastic of supply, the smaller the tax burden paid by the sellers (and the larger tax burden paid by the buyers)

Production Quotas

Is an upper limit to the quantity of a good that may be produced in a specific period of time. Production quotas will only have an impact if they are set below the equilibrium level of output in a market

Production Subsidies Is a payment made by government to a producer Increases supply

Lecture 8