CHAPTER 5 Efficiency. Efficiency: A Refresher According to economists, allocative efficiency means...
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Transcript of CHAPTER 5 Efficiency. Efficiency: A Refresher According to economists, allocative efficiency means...
![Page 1: CHAPTER 5 Efficiency. Efficiency: A Refresher According to economists, allocative efficiency means the resources have been used to produce the goods.](https://reader030.fdocuments.us/reader030/viewer/2022032518/56649cca5503460f94992361/html5/thumbnails/1.jpg)
CHAPTER 5
Efficiency
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Efficiency: A Refresher
According to economists, allocative efficiency means the resources have been used to produce the goods and services that people value the most.
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Efficiency: A Refresher
Marginal benefit is the benefit that a person receives from consuming one more unit of a good or service– measured as the maximum amount that a
person is willing to give up for one additional unit
Principle of decreasing marginal benefit– marginal benefit decreases as consumption
increases
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Efficiency: A Refresher
Marginal cost is the opportunity cost of producing one more unit of a good or service.– measured as the value of the best alternative
foregone
Principle of increasing marginal cost– marginal cost increases as the quantity
produced increases
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Efficiency and Inefficiency
Allocative efficiency depends upon a comparison of marginal cost and marginal benefit.
Three possibilities– marginal benefit exceeds marginal cost– marginal cost exceeds marginal benefit– marginal benefit equals marginal cost
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Efficiency and Inefficiency
What is the economically efficient
quantity of pizza?
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The Efficient Quantity of Pizza
MB
0 5 10 15 20
5
10
15
20
25
Quantity (thousands of pizzas per day)
Mar
gina
l cos
t and
mar
gina
l ben
efit
(dol
lars
wor
th o
f go
ods
and
serv
ices
)
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The Efficient Quantity of Pizza
0 5 10 15 20
5
10
15
20
25
Quantity (thousands of pizzas per day)
Mar
gina
l cos
t and
mar
gina
l ben
efit
(dol
lars
wor
th o
f go
ods
and
serv
ices
)
MB
MC
![Page 9: CHAPTER 5 Efficiency. Efficiency: A Refresher According to economists, allocative efficiency means the resources have been used to produce the goods.](https://reader030.fdocuments.us/reader030/viewer/2022032518/56649cca5503460f94992361/html5/thumbnails/9.jpg)
The Efficient Quantity of Pizza
0 5 10 15 20
5
10
15
20
25
Quantity (thousands of pizzas per day)
Mar
gina
l cos
t and
mar
gina
l ben
efit
(dol
lars
wor
th o
f go
ods
and
serv
ices
)
MB
MC
Pizza valued morehighly than it costs:Increase production
Pizza costs morethan it is valued:Decrease production
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The Efficient Quantity of Pizza
0 5 10 15 20
5
10
15
20
25
Quantity (thousands of pizzas per day)
Mar
gina
l cos
t and
mar
gina
l ben
efit
(dol
lars
wor
th o
f go
ods
and
serv
ices
)
MB
MCEfficient quantityof pizza
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Value, Price, and Consumer Surplus
What is meant by “Value”?– Value of an item is the same thing as its
marginal benefit
– Marginal benefit - the maximum price people
are willing to pay for an additional unit
– Willingness determines demand
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Consumer Surplus
Consumer surplus is the value of a good minus the price paid for it.– if a person buys something for less than they
are willing to pay for it, a consumer surplus exists
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A Consumer’s Demand and Consumer Surplus
Quantity (slices of pizzas per week)0 10 20 30 40
0.50
1.00
1.50
2.00
2.50
Pric
e (d
olla
rs p
er s
lice
)
D = MB
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A Consumer’s Demand and Consumer Surplus
Quantity (slices of pizzas per week)0 10 20 30 40
0.50
1.00
1.50
2.00
2.50
Pric
e (d
olla
rs p
er s
lice
)
Marketprice = $1.50
D = MB
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A Consumer’s Demand and Consumer Surplus
Quantity (slices of pizzas per week)0 10 20 30 40
0.50
1.00
1.50
2.00
2.50
Pric
e (d
olla
rs p
er s
lice
)
Marketprice = $1.50
Amountpaid = $30 D = MB
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A Consumer’s Demand and Consumer Surplus
Quantity (slices of pizzas per week)0 10 20 30 40
0.50
1.00
1.50
2.00
2.50
Pric
e (d
olla
rs p
er s
lice
)
Marketprice = $1.50
Amountpaid = $30
Consumer surplus from 20 pizzas = .5(20x1)=$10
D = MB
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A Consumer’s Demand and Consumer Surplus
Quantity (slices of pizzas per week)0 10 20 30 40
0.50
1.00
1.50
2.00
2.50
Pric
e (d
olla
rs p
er s
lice
)
Marketprice = $1.50
Amountpaid = $30
Consumer surplus from 20 pizzas = .5(20x1)=$10
D=MB
ConsumptionValue of 20 slices=$30 + $10 = $40
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Cost, Price, and Producer Surplus
Cost vs. Price– Cost is what the producer gives up.– Price is what the producer receives.
Marginal cost is the cost of producing one more unit.
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Producer Surplus
Producer surplus is the revenue from a good minus the opportunity cost of producing it.– if a firm sells something for more than it costs
to produce, a producer surplus exists
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A Producers Supplyand Producer Surplus
Quantity (pizzas per day)
5
10
15
20
25
Pric
e (d
olla
rs p
er p
izza
)
Price determinesquantity supplied
S=MC
0 50 100 150 200
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5
10
15
20
25
Pric
e (d
olla
rs p
er p
izza
)
S=MC
Quantity (pizzas per day)
Marketprice = $15
0 50 100 150 200
A Producers Supplyand Producer Surplus
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5
10
15
20
25
Pric
e (d
olla
rs p
er p
izza
)
S=MC
Quantity (pizzas per day)
Marketprice
Cost of Production = .5(100x10) + (100x5) = $1,000
0 50 100 150 200
A Producers Supplyand Producer Surplus
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5
10
15
20
25
Pric
e (d
olla
rs p
er p
izza
)
S=MC
Quantity (pizzas per day)
MarketpriceProducer surplus
= .5(10x100) = $500
0 50 100 150 200
A Producers Supplyand Producer Surplus
Cost of Production = .5(100x10) + (100x5) = $1,000
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5
10
15
20
25
Pric
e (d
olla
rs p
er p
izza
)
S=MC
Quantity (pizzas per day)
Marketprice
Cost of Production= $1,000
Producer surplusof $500 equals profit
0 50 100 150 200
A Producers Supplyand Producer Surplus
ProductionValue of 100
slices=$1000+$500
=$1,500
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Is the CompetitiveMarket Efficient?
Recall– Supply and demand will force the price toward
the equilibrium price
Question: Is this the efficient quantity of pizza?
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An Efficient Market for Pizza
Quantity (thousands of pizzas per day)0 5 10 15 20
Pric
e (d
olla
rs p
er p
izza
)
S Marginal cost--opportunity cost--of pizza
Marginal benefit--value--of pizza
Efficient quantityof pizzas
5
10
15
20
25
D
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Is the CompetitiveMarket Efficient?
At Competitive Equilibrium
– Resources are being used efficiently– The sum of consumer surplus and producer
surplus is maximized
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Quantity (thousands of pizzas per day)0 5 10 15 20
Pric
e (d
olla
rs p
er p
izza
)
S
5
10
15
20
25
D
An Efficient Market for Pizza
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Quantity (thousands of pizzas per day)0 5 10 15 20
Pric
e (d
olla
rs p
er p
izza
)
S
Producersurplus = .5(10x10)=50
5
10
15
20
25
D
An Efficient Market for Pizza
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Quantity (thousands of pizzas per day)0 5 10 15 20
Pric
e (d
olla
rs p
er p
izza
)
S
Producersurplus= .5(10x10) =50
Consumersurplus= .5(10x10)=50
5
10
15
20
25
D
An Efficient Market for Pizza
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Quantity (thousands of pizzas per day)0 5 10 15 20
Pric
e (d
olla
rs p
er p
izza
)
S
Producersurplus= .5(10x10) =50
Consumersurplus= .5(10x10)=50
5
10
15
20
25
D
An Efficient Market for Pizza
Consumer Surplus+
Producer Surplus=50 +50 = 100
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The Invisible Hand
Adam Smith - Wealth of Nations in 1776– Participants in a competitive market are “led by
an invisible hand to promote an end (the
efficient use of resources) which was not part of
his intention.”
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Sources of Inefficiency
Price ceilings and floors
Taxes, subsidies, and quotas
Monopoly
Public goods
External costs and benefits
These lead to underproduction or overproduction.
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Sources of Inefficiency
Deadweight Loss– The decrease in consumer and producer surplus
that results from an inefficient allocation of resources
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Underproduction (Say Monopoly)
Quantity (thousands of pizzas per day)0 5 10 15 20
Pric
e (d
olla
rs p
er p
izza
)
S
5
10
15
20
25
D
![Page 36: CHAPTER 5 Efficiency. Efficiency: A Refresher According to economists, allocative efficiency means the resources have been used to produce the goods.](https://reader030.fdocuments.us/reader030/viewer/2022032518/56649cca5503460f94992361/html5/thumbnails/36.jpg)
Quantity (thousands of pizzas per day)0 5 10 15 20
Pric
e (d
olla
rs p
er p
izza
)
S
5
10
15
20
25
D
UnderproductionConsumer Surplus
= .5(5x5)=12.5
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Quantity (thousands of pizzas per day)0 5 10 15 20
Pric
e (d
olla
rs p
er p
izza
)
S
5
10
15
20
25
D
UnderproductionConsumer Surplus
= .5(5x5)=12.5
Producer Surplus= (5x10) + .5(5x5)= 50 + 12.5 = 62.5
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Quantity (thousands of pizzas per day)0 5 10 15 20
Pric
e (d
olla
rs p
er p
izza
)
S
5
10
15
20
25
D
UnderproductionConsumer Surplus
= .5(5x5)=12.5
Producer Surplus= (5x10) + .5(5x5)= 50 + 12.5 = 62.5
Deadweightloss = .5(10x5) = 25
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Quantity (thousands of pizzas per day)0 5 10 15 20
Pric
e (d
olla
rs p
er p
izza
)
S
5
10
15
20
25
D
UnderproductionConsumer Surplus
= .5(5x5)=12.5
Producer Surplus= (5x10) + .5(5x5)= 50 + 12.5 = 62.5
Deadweightloss = .5(10x5) = 25
Consumer Surplus+
Producer Surplus= 12.5 + 62.5 = 75
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Quantity (thousands of pizzas per day)0 5 10 15 20
Pric
e (d
olla
rs p
er p
izza
)
S
5
10
15
20
25
D
Overproduction (Say Government Subsidy)
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Quantity (thousands of pizzas per day)0 5 10 15 20
Pric
e (d
olla
rs p
er p
izza
)
D
S
5
10
15
20
25
Overproduction
A
B
C
D
E
Consumer SurplusGain = B + G
Producer SurplusGain = A + D
Government Subsidy= B + G + A + D + F
FDeadweight Loss= B + G + A + D - B - G - A - D - F= F
G
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Quantity (thousands of pizzas per day)0 5 10 15 20
Pric
e (d
olla
rs p
er p
izza
)
D
S
5
10
15
20
25
Deadweightloss
Overproduction
A
B
C
D
E
Consumer SurplusGain = B + G
Producer SurplusGain = A + D
Government Subsidy= B + G + A + D + F
FDeadweight Loss= B + G + A + D - B - G - A - D - F= F
G