market efficiency

Question 1

what is welfare economics?

Answer 1

studies how the allocation of resources affects economic well-being

Question 2

what is consumer surplus?

Answer 2

well-being of buyers

Question 3

what is producer surplus?

Answer 3

well-being of sellers

Question 4

what is consumer surplus defined as?

Answer 4

buyer’s willingness to pay for a good minus the amount they actually pay for it

Question 5

what is meant by willingness to pay?

Answer 5

the maximum amount that a buyer is willing to pay for a good. it is a measure of the value of the good for the buyer

Question 6

how is consumer surplus shown on the graph?

Answer 6

the height of the demand curve represents the willingness to pay for the good of one particular consumer

the area below the demand curve and above the price measures the consumer surplus in the market?

Question 7

what is consumer surplus commonly used as?

Answer 7

a measure of buyers’ economic well-being in many economic models

Question 8

what are the limitations of consumer surplus as a measure of well-being?

Answer 8

drug addicts have a high willingness to pay -> high economic well-being from consuming drugs

a very poor person has a lower willingness to pay for a pizza than a rich person - is the wellbeing of the poorer person lower than the rich person?

sometimes we are willing to pay for things we end up not using -> high economic well being from consuming those things?

Question 8

how is producer surplus shown on a graph?

Answer 8

the height of the supply curve at any given point represents the marginal cost of producing the good at that point

the area below the price and above the supply curve measures the producer surplus in a market

Question 8

what is producer surplus

Answer 8

amount a seller is paid for a good minus the seller’s variables cost
it is one measure of the benefit of participating in a market for sellers

Question 9

how do we know if an allocation is efficient?

Answer 9

consumer and producer surplus may be used to address;
- is the allocation by free markets efficient
- how do we define efficiency

an allocation is efficient if it maximises total surplus: consumer surplus + producer surplus

Question 10

what happens when the allocation of resources is determined by markets?

Answer 10

• the goods are consumed by the buyers with the highest willingness to pay (ie those who value them highest)
• the goods are produced by the sellers with the lowest costs
• the quantity of goods produced maximises the sum of consumer and producer surplus

Question 10

what is the equation for total surplus?

Answer 10

consumer surplus + producer surplus

value to buyers - amount paid by buyers + amount received by sellers - cost to sellers

Question 11

what happens when the allocation of resources is determined by the markets?

Answer 11

• the goods are consumer by buyers with the highest willingness to pay (those who value them most highly)
• the goods are produced by the sellers with the lowest costs
• the quantity of goods produced maximises the sum of consumer and producer surplus

Question 12

what is Pareto efficiency?

Answer 12

(pareto optimality) occurs when it is not possible to reallocate resources in such a way as to make at least one person better off without making anyone else worse off

Question 13

what is pareto improvement?

Answer 13

occurs when an action makes at least one economic agent better off without harming another economic agent

market allocation of resources is generally pareto efficient

Question 13

what happens to pareto optimality in a free market economy?

Answer 13

pareto optimality is not restored by government action, rather by individuals actions for market actors, all seeking self-interest

policy of letting markets allocate resources without intervening is called laissez faire

Question 13

why might governments intervene?

Answer 13

markets might fail to lead to social efficiency (e.g. lack of perfect competition, externalities)
- these failures provide the major arguments in favour of government intervention in a market economy

Question 14

what is equity and why might governments intervene?

Answer 14

equity is the fairness of the distribution of well-being in society.

the allocation of resources through market does not guarantee equity

govs may intervene in order to make the market outcome more equitable