Chapter 5: Equity & Efficiency

Question 1

What are the 8 resource allocation methods?

Answer 1

1. market price
2. command system
3. Majority rule
4. Contest
5. First come, first served
6. Lottery
7. Personal characteristics
8. force

Question 2

Market Price

Answer 2

○ Allocates scarce resources towards those who are willing & able to pay the price to get a resource
○ 2 kinds of people decide not to pay market price - (1) those who can afford to pay but choose not to buy & (2) too poor & cant afford to buy

Question 3

Majority Rule

Answer 3

○ A majority of voters choose
○ E.g. used to elect government officials that make decisions about allocating resources such as tax & health care
○ Works well when decisions affect large # of people & self-interest in suppressed in a way so that resources are used effectively

Question 4

Command System

Answer 4

○ Allocates resources by the order (command) of someone in authority
○ Canadian economy use sx extensively inside firms & government departments
E.g. At job, someone tells you what to do, labour allocated to specific tasks by command
○ Works well in orgs w. clear lines of authority & responsibly & where it is easy to monitor activities
Works badly for large scale activities

Question 5

Contest

Answer 5

○ Allocates resources to winner
○ E.g. Tennis players compete against one another & winner gets a pay-off

Question 6

First come, first served

Answer 6

○ Allocates based on those who wait in line first
E.g. restaurant seating, pool reservation, etc.

Question 7

Lottery

Answer 7

Allocates to those who pick the winning #, draw the lucky cards, or come up lucky on some other gaming sx

Question 8

Personal characteristics as an allocation method

Answer 8

people w/ the right characteristics get the resources
E.g. choose marriage partner on the basis of personal characteristics

Question 9

Force as an allocation method

Answer 9

○ War - use of military force by one nation against another
○ Theft - taking w/o consent
○ Can play a positive role in resource allocation
○ Provides stats w/ method of transferring wealth from rich to the poor, & provides legal framework in which voluntary exchanges in markets takes place
○ State provides ultimate force that enable courts to do their work

Question 10

Resources are allocated efficiently & in social interest when……

Answer 10

they are used in ways that people value most highly
occurs when the quantities produced are at the point on the PPF at which marginal benefit = marginal cost

Question 11

what is the difference between price & value?

Answer 11

Value is what we get, price is what we pay
Marginal benefit measured by maximum price willing to pay for another unit
Willingness to pay determines demand - demand curve is a marginal benefit curve

Question 12

What is the difference between individual & market demand?

Answer 12

• Individual demand - relationship between the price of a good & quantity demanded by one person
• Market Demand - relationship between the price of a good & the quantity demanded by all buyers
  ○ Considered the marginal benefit curve for society (marginal
  social benefit)

Question 13

What is consumer surplus?

Answer 13

• When people buy something for less than it is worth to them, they receive a consumer surplus
  excess benefit received from a good over the amount paid for it
  Formula: marginal benefit of a good - its price/the quantity bought

Question 14

How doe producers distinguish cost & price?

Answer 14

○ Cost - what’s given up when a good is produced
○ Price - received when good is sold

Question 15

What is marginal cost of supply?

Answer 15

Marginal cost - cost of producing an additional unit
○ Minimum price that must be received to induce a firm to offer one more unit of a good for sale
○ Price determines supply - marginal cost curve

Question 16

individual & market supply

Answer 16

• Individual Supply - relationship between the price of a good & quantity supplied by one producer
• Market Supply - relationship between the price of a good & quantity supplied by all producers

Question 17

Producer Surplus

Answer 17

Producer surplus - excess of the amount received from the sale of a good over the cost of producing it
Calculate it as the price received - marginal cost (or minimum supply-price)/quantity sold

Question 18

Is the Competitive Market Efficient?

Answer 18

Equilibrium in a competitive market occurs when the quantity demanded = the quantity supplied (at the intersection of the demand curve & supply curve)

Question 19

Total surplus

Answer 19

sum of consumer surplus & producer surplus
When efficient quantity is produced, total surplus is maximized
Buyers & sellers acting in self-interest end up promoting the social interest

Question 20

Market Failure

Answer 20

• Occurs when a market is inefficient
  Too little (underproduction) or too much (overproduction) of an item produced

Question 21

Sources of market failure

Answer 21

○ Price Regulation - price cap or price floor block price adjustments that balance quantity demanded & quantity supplied & lead to underproduction
§ Can also lead to underproduction

○ Taxes - increase prices paid by buyers & lower the price received by sellers (underproduction)

○ Subsidies - payments by the government to producers, decrease the prices paid by buyers, increase the prices received by sellers & lead to overproduction

○ Externalities - cost or benefit that affects someone other than the seller or buyer

○ Public good - good or service from which everyone benefits & no one can be excluded

○ Common resources - owned by non one but available to be used by everyone

○ Monopoly - firm is a sole provider; self-interest maximize profit & has no competitors

○ Transaction cost - costs of the service that enable a market to bring buyers & sellers together
§ E.g. when you buy a house you buy the services of an agent & lawyer to do the transaction

Question 22

Is the Competitive Market Fair?

Answer 22

• Economists agree about efficiency
  ○ Agree it makes sense to make the economic pie as large as possible & produce it at the lowest cost
  ○ Don’t agree about equity - don’t agree about what are fair shares of economic pie for all the people who make it

Question 23

How is fairness divided?

Answer 23

○ Its not fair if the result isn’t fair
○ Its nor fair if the rules aren’t fair

Question 24

Its Not Fair if the Result Isn’t Fair

Answer 24

General idea: unfair if peoples incomes are too unequal
Concepts: Utilitarianism, big trade-off, theory of justice

Question 25

Utilitarianism

Answer 25

principle that states we should strive to achieve the greatest happiness for the greatest number
Idea that only equity brings efficiency
Income must be transferred from the rich to the poor to the point of complete equality - point where there is no rich & no poor

Question 26

The Big Trade-Off

Answer 26

recognizes the costs of making income transfers leads to a trade off between efficiency and fairness

Question 27

John Rawls Theory of Justice

Answer 27

solution to big-trade-off
○ Fair distribution of economic pie involves making the poorest person as well off as possible
○ Incomes of rich should be taxed after paying costs of administration, what is left is given to the poor
○ Tax mustn’t be so high that they shrink economic pie to point where poorest person ended up with the smaller piece

Question 28

Its Not Fair if the Rules Aren’t Fair

Answer 28

• Symmetry principle - requirement that people in similar situations be treated similarly
  ○ “treat others the way you want to be treated”

Question 29

Nozicks Fair rules view

Answer 29

idea of fairness as an outcome cannot work & that fairness must be based on the fairness of the rules

i. State must enforce laws that establish & protect private property
□ Everything valuable must be owned by individual’s & state must ensure theft is prevented

ii. Private property may be transferred from one person to another only by voluntary exchange
□ Only legitimate way a person can acquire property is to buy in exchange for something else that the person owns

Question 30

Price Gouging

Answer 30

offering to sell an essential item following a natural disaster at a higher price than normal
preventing voluntary market transaction leads to inefficiency - makes some people worse off w/o making anyone better off
Calling the price rise “gouging: & blocking it w/ laws that prevent additional units from being made available creates a deadweight

Question 31

How do we measure market failure/inefficiency?

Answer 31

Measure the scale of inefficiency by deadweight loss - decrease in total surplus that results from an inefficient level of production
Ultimately effects entire society - social loss