Efficiency and Equity pt 1

Question 1

What are the 8 methods of allocating resources?

Answer 1

1. Market price
2. Command
3. Majority Rule
4. Contest
5. First come first serve
6. Lottery
7. Personal characteristics
8. Force

Question 2

How are resources allocated using the market price?

Answer 2

The people who are willing and able to pay that price get the resource.

Question 3

How are resources allocated using a command system?

Answer 3

Allocating by order from someone in authority. Labour is allocated to specific tasks by command. Works well when authority is clear and activities are easy to monitor.

Question 4

How does majority rule allocate resources?

Answer 4

A majority of voters choose how they are allocated. Used to elect governments. Works well when the decisions affect lots of people.

Question 5

How do contests allocate resources?

Answer 5

They allocate resources to a winner. Sporting events use this method. They work when the efforts of the player are hard to monitor and reward directly. They are motivating - people work hard to win even if they don’t actually win.

Question 6

How are resources allocated using first come first served?

Answer 6

Resources allocated to those who are first in line. Common at restaurants. Works best when a scare resource can serve one user at a time, minimises waiting times if the first user is picked.

Question 7

How do lotteries allocate resources?

Answer 7

To those who pick the winning number. Works best when there is no effective way to distinguish among potential users of a scarce resource

Question 8

How are resources allocated based on personal characteristics?

Answer 8

People with the right characteristics get the resources. Some of the resources that matter most are allocated e.g marriage partner

Question 9

How are resources allocated by force?

Answer 9

War/theft are examples of this.

Question 10

How do we know when resources are allocated efficiently and in the social interest?

Answer 10

When they ate used in ways that people value most highly, the point on the PPF at which marginal benefit = marginal cost

Question 11

What is the difference between value and price?

Answer 11

Value = what we get
Price = what we pay

Question 12

What is marginal benefit?

Answer 12

The value of one more unit of a good. Measured by the maximum price that is willingly paid for another unit of the good.

Question 13

How does willingness to pay relate to demand and marginal benefit curve?

Answer 13

Willingness to pay determines demand. A demand curve is a marginal benefit curve.

Question 14

What is individual demand?

Answer 14

The relationship between the price of a good and the quantity demanded by one person.

Question 15

What is market demand?

Answer 15

The relationship between the price of a good and the quantity demanded by all buyers. It is the horizontal sum of all the individual demand curves and is formed by adding all the quantities demanded by all the individuals at each price.

Question 16

What is marginal social benefit?

Answer 16

The marginal benefit to the entirety of society

Question 17

What is consumer surplus?

Answer 17

When people buy something for less than it is worth to them. The excess of the benefit received from a good over the amount paid for it. Calculated as the marginal benefit of a good minus its price, summed over the quantity bought.

Question 18

What is the difference between cost and price?

Answer 18

Cost = what the firm gives up
Price = what the firm receives when it sells a good

Question 19

What is marginal cost?

Answer 19

The minimum price that producers must receive to induce them to offer one more unit of a good or service for sale, the cost of producing one additional unit

Question 20

How does supply relate to marginal cost?

Answer 20

A supply curve is a marginal cost curve.

Question 21

What is the individual supply?

Answer 21

The relationship between the price of a good and the quantity supplied by one producer

Question 22

What is the market supply?

Answer 22

The relationship between the price of a good and the quantity supplied by all producers

Question 23

What is producer surplus?

Answer 23

When price exceeds marginal cost, the firm receives a producer surplus. Producer surplus is the excess of the amount received from the sale of a good or service over the cost of producing it.

Question 24

How do consumer and producer surplus relate to the efficiency of a market?

Answer 24

They can be used to measure the efficiency of a market

Question 25

When does equilibrium occur in a competitive market?

Answer 25

When the QD = QS at the intersection of the demand and supply curves, this is a condition for allocative efficiency, at this intersection MSC = MSB

Question 26

What is a market failure?

Answer 26

A situation where an efficient outcome is not achieved. It is a result of under and over production

Question 27

How do we measure inefficiency in terms of underproduction?

Answer 27

We measure the scale of inefficiency by deadweight loss, which is the decrease in total surplus that results from an inefficient level of production

Question 28

How do we measure inefficiency in terms of overproduction?

Answer 28

When total surplus is reduced to less than its maximum. Inefficient production creates a deadweight loss that is borne by the entire of society e.g social loss

Question 29

What is the concept of deadweight loss?

Answer 29

The idea that there is too much or too little production so that the quantity produced does not meet the quantity that society actually wants

Question 30

What are the sources of market failure?

Answer 30

1. Price and quantity regulations
2. Taxes and subsidies
3. Externalities
4. Public goods and common resources
5. Monopoly
6. High transaction costs

Question 31

How do price and quantity regulations result in market failure?

Answer 31

They limit the amount of production leading to underproduction or overproduction through creating price ceilings and price floors

Question 32

What are price ceilings?

Answer 32

Maximum prices that can be charged, there is a shortage beyond the point where p intersects q at the price max

Question 33

What are price floors?

Answer 33

Minimum prices that result in a surplus as producers produce where p and q correspond on the demand curve which is higher than consumers actually demand

Question 34

How do taxes result in market failure?

Answer 34

Taxes increase the prices paid by buyer and lower that received by sellers. They decrease the QS and lead to underproduction

Question 35

How do subsidies result in market failure?

Answer 35

Subsidies decrease the price paid buyers and increase the price received by sellers. They increase the quantity produced = over production

Question 36

How do externalities (cost/benefit affecting someone other than seller) result in market failure?

Answer 36

External cost example - electricity produced emitting CO2, no consideration of climate change, overproduction.

External benefit - installing a smoke detector and decreasing neighbour’s fire risk, underproduction

Question 37

How do public goods and common resources result in market failure?

Answer 37

A common resource is owned by no one but available to be used by everyone. It is in everyone’s self interest to ignore the costs they impose on others when they decide how much of a common resource to use. The result is that the resource is overused

Question 38

How do monopolies result in market failure?

Answer 38

Monopolies produce too little and charge to high a price leading to underproduction

Question 39

How do high transaction costs result in market failure?

Answer 39

When the transaction costs are high, the market might underproduce