Chapter 5 - Notes PDF

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Chapter 5/Module 4: Efficiency and Equity4 Research Allocation MethodsScarce resources might be allocated by:1. Market Price  When a market allocates a scarce resource, the people who get the resource are those who are willing to pay the market price.  Most scarce resources that are supplied get a...

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Chapter 5/Module 4: Efficiency and Equity 4.1 Research Allocation Methods Scarce resources might be allocated by: 1. Market Price  When a market allocates a scarce resource, the people who get the resource are those who are willing to pay the market price.  Most scarce resources that are supplied get allocated by a market price. In a competitive market, prices will continue to adjust until the quantity supplied equals the quantity demanded for a good/service.  Decentralized market planning approach: people who are willing and able to buy a resource get the resource (willingness to pay for a good/service). 2. A command system  Allocation via a command system allocates resources by the order (command) of someone in authority (e.g. labour time in a job allocate to specific tasks by command).  Command systems in organizations when very clear lines of authority exist that is not overruled.  Centralized market planning approach/planned market approach: Cuba and North Korea leverage a command system to allocate scarce resources; difficult with a large set of types of wants and needs for millions of people. 3. Majority Rule  When resources are allocated in accordance with the majority vote. The majority vote is represented by an elected government (e.g. tax rates on public, private use, and tax dollars between competing uses).  Large number of individuals are impacted by a decision  Self interest  bad decision 4. Contest  A contest allocates resources to a winner/groups of winners. The reward/prize can increase total outputs  the top performers are recognized for their achievement.  A contest works well when the efforts of the “players”/” team members are hard to monitor and reward directly. 5. First Come, First Served Allocation  Resources are allocated to those who come first in line. E.g. tables in restaurants, checkouts in supermarkets.  Works best when scarce resources can just serve one person at a time in a sequence. 6. Lottery  Allocate resources to those with the winning number, who draw the lucky cards, or who come up lucky on a gaming system (lotteries and casinos).  Work well when there is no effective way of distinguishing among potential users of the scarce resource. 7. Personal Characteristics  Allocate resources to those with the “right” characteristics.

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This method is used in unacceptable ways: allocating the best jobs to white males and discriminating against minorities and women. 8. Force  Ex. war, theft, taking property of others without their consent.  Force provides an effective way of allocating resources. Ex. the state transfers wealth from the rich to the poor (through forced taxes and transfers) and established the legal framework in which voluntary exchange can take place in markets. Contests do a good job in resource allocation when the efforts of the player are hard to monitor and reward directly. 4.2 Introduction to Consumer     

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Demand curve: the entire relationship between the price of a good/service and the quantity demanded for a good/service (inverse relationship) Marginal benefit: the willingness and ability to pay; benefits of consuming one more of a good/service. The demand curve is a marginal benefit curve, the max. willingness to pay for an additional unit of a good/service. Individual demand curve: is the relationship between the quantity demanded and the price of a good/service for a single individual. Market demand curve: the horizontal sum of individual demand curve and is formed by the quantities demanded by all individuals at each price  Marginal social benefit curve (MSB) Market demand curve = sum of all individual quantities demanded at each price. Consumer Surplus: “deal” when a consumer buys a good/service for less than it is worth to us. The excess of benefit received from a good/service over the amount paid for the good/service. o The marginal benefit of a good/service minus its price summed over the quantity bought o On the graph, consumer surplus is under the demand curve, but above the price that the consumer must pay for the good (market equilibrium price) o Calculate on the graph for consumer surplus for the area of a triangle (base x height / 2). o Horizontal sum by adding both quantities demanded at a price for all individuals to create a market demand curve. o If horizontal sum is calculated at each price = derive the market demand curve. o When price rises, the consumer surplus goes down. A fall in price increases consumer surplus. Market Consumer Surplus: Adding individuals consumer surplus no longer triangle but a trapezoid on the graph. Consumer surplus identifies benefits obtained by consumers, over and above the consumer is charged. The net benefit or change when the price of a good or service changes

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The consumer surplus for the market from the production of the 100th unit of a good? The marginal social benefit from the 100th unit minus the price paid for the 100th unit.

4.3 Introduction to Producer Surplus 

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Supply curve: the entire relationship between the price of a good/service and the quantity supplied for a good/service (willingness and ability to sell is the measure of the marginal cost  the cost incurred from producers producing one more unit of a good or service. The supply curve is a marginal cost curve which equates to the min. price that producers must receive to induce them to produce another unit of a good/service. Individual supply curve: is the relationship between the quantity supplied and the price of a good/service for a single producer Market supply curve: the horizontal sum of individual supply curves and is formed by adding quantities supplied by all producers at each price  marginal social cost curve (MSC) Horizontal sum  adding individual’s quantity supplied to achieve market supply curve. When the price that the supplier receives for a good/service, exceeds the marginal cost = producer surplus  the area above the supply curve but below the market equilibrium price (the price the producer receives). Producer surplus: excess amount received from a sale of a good/service over the cost of producing the good/service. o There is a difference between the amount the producer is willing to receive for a good/service vs the price that the producer does receive for a good/service. o The marginal cost of the good/service – the price of the good/service, summed over the quantity sold = producer surplus. (area of a triangle = base x height / 2) for a single individual. o The market producer surplus = triangle plus a trapezoid = the total cost of production o When the price rises, the producers increase the quantity of output they supply = increase in the producer surplus. o When the price falls = decrease in the producer surplus. o Producer surplus identifies benefits obtained by engaging in market transactions, over and above the cost of production  pricing strategy for a good/service.  Marginal cost is the minimum price of a producer must receive to induce them to offer one more unit of a good/service for sale.  The marginal cost of producing an additional basket of tomatoes is $5.00. The consumer is willing to pay a max. of $9.00 for an additional basket. A farmer sells a basket of tomatoes for $6.00 each. The farmer receives a producer surplus from selling an additional basket of tomatoes equal to $1.00

4.4 Competitive Equilibrium and Efficiency

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Market demand curve = marginal social benefit curve (MSB) Market supply curve = marginal social cost curve (MSC) Point of allocative efficiency (equilibrium)  point where the quantity demanded = quantity supplied. The marginal social benefit (MSB) on the demand curve = the marginal social cost curve on the supply curve. MSB=MSC (intersection) The left of the intersection where MSB exceeds MSC (MSB>MSC) The right of the intersection where MSC exceeds MSB (MSB < MSC)

first fundamental theorem of welfare economics” that under appropriate conditions, competitive equilibrium is Pareto efficient (an efficient allocation: it is not possible to rearrange the use of resources and make someone better off without making someone else worse off.

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Total surplus = consumer surplus + producer surplus A competitive equilibrium is on where: market equilibrium is achieved, where the quantity demanded = quantity supplied, allocative efficiency is achieved, where the goods/services are produced at the lowest possible cost in the quantities that produce the greatest possible value, resources are used where they are most valued, MSB=MSC, the total surplus is maximized. What happens to the consumer and producer surplus as move away from the market equilibrium. o “Invisible hand” – competition leads self-interest consumers and producers to make choices that unintentionally promote social interest. o A competitive market equilibrium will produce an efficient allocation, use society’s resources efficiently if obstacles do not stand in the way. o The marginal cost of the last unit produced in the market equals the marginal benefit of the last unit is produced. Market failure: when the market does not efficient outcome, a good/service is underproduced or over produced. (distorted market). When the efficient quantity is produced, the sum of the consumer surplus and producer surplus is maximized.

4.5 Introduction to market failures

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Underproduction: the market is producing fewer when compared to the competitive market equilibrium. As the consumer surplus decreases = the producer surplus decreases = the total surplus decreasing. However, after a certain quantity demanded exceeds its costs. MSB > MSC. The resulting allocation does not achieve allocative efficiency = deadweight loss to society = decrease in the total surplus. Overproduction: the market is producing more when compared to the competitive market equilibrium. Resources are wasted, the consumer is willing to pay less than the marginal cost to produce the good/service. The cost of the good/service exceeds its benefits, MSB < MSC. The resulting allocation does not achieve allocative efficiency = deadweight loss to society, social loss occurs.

Sources of Market Failure      

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Price regulations: the limit the max. price that firms can charge for their goods put a block on the equilibrium price adjustments and lead to underproduction. Price regulations: that limit the min. wage the workers can be paid for their labour put a block on the equilibrium price adjustments and lead to unemployment. Quantity regulations: limit the amount that a firm is permitted to produce also lead to underproduction. Taxes: increase the price paid by buyers and lower the prices received by sellers. Taxes decrease the quantity produced and lead to underproduction. Subsides: lower the price paid by buyers and increase the prices received by sellers. Subsidies increase the quantity produced and lead to overproduction. Externality: when the economic actions of one individual/group of individuals directly affect the economic outcomes of another individual/group of individuals. o External cost  overproduction  deadweight loss o External benefit  underproduction  deadweight loss. Public Goods and Common Resources: consumed simultaneously by everyone even if they don’t pay for it. Ex. Street lights. Free rider problem  underproduction: some individuals will take a free ride for a service by avoiding to pay for the service. Common resource: owned by no one but can be used by everyone  in everyone’s selfinterest to ignore the costs of their own use of a common resource. o Ex. tragedy of the commons  overproduction. Monopoly: a firm that is the sole provider of a good/service. The self interest is to maximize its profits. Transaction costs: are opportunity costs of making trades in a market. When transactions costs are high, the market might underproduce transactions.

There is no efficient mechanism to allocate all resources  supplemented majority rule, bypassed inside firms by command systems, and occasionally using first come, first served, markets. Market for hotdogs becomes a monopoly, then there will be a deadweight loss in the market for hot dogs and underproduction of hot dogs. Negative externality results in overproduction 4.6 Is a competitive market fair? Fairness divided into 2 groups: 1. It’s not fair if the results aren’t fair. “fair results view” 2. It’s not fair if the rules aren’t fair. “fair rules view” Fair Results View

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Utilitarianism: principle states that we should strive to achieve the greatest happiness for the greatest number of individuals. Fairness requires equality of incomes, and to secure equality of incomes, a form of income transfer (from the rich to the poor) or redistribution needed (income equally distributed). Increase total benefit  everyone gets the same marginal utility from a given amount of income. If the marginal benefit of income decreases as the income increases, then taking a dollar from a richer person and giving it to a poorer person increases the total benefit. Income transfers create a trade off  taxing worker = deterrent to working more hours = less goods/services produced. Reduce the size of the pie but share it equally. However, the utilitarianism is not fair as it ignores trade offs and the cost of transfers. Modified utilitarianism view: the difference in incomes can be largely attributed to your inherent abilities and the socioeconomic status. o a set of rules adopted to help those less fortunate and find ways to make the playing field more even esp for those at the bottom of the SES. o A bigger share of a smaller pie vs the smaller share of a bigger pie.

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Symmetry principle: the requirement that people in similar situations be treated similarly. In 1974, Robert Nozick suggested that government should promote fairness by establishing property rights for individuals and allowing only voluntary exchange of these resources. The equality of economic opportunity vs the equality of economic outcome A competitive equilibrium is not one of fairness depends on the definition of fairness.

A modified version of utilitarianism proposed by John Rawls could be summarized by make the poorest as well off as possible. The essence of the philosopher Robert Nozick’s proposal is that fairness must be based on fairness of rules.

Discussion: Is inequality worsening? The decline of fast food suggests otherwise:

The Gini Co-efficient Real estate has become unaffordable in many places “majority of people are suffering because of the rich getting richer” People don’t spend more time and money on food when either resource is in short supply. What argument is the author making? Peter Nowak, is the author of “Is inequality worsening? The decline of fast food suggests otherwise” His argument states that inequality still exists which impacts majority of the people because of advances in technology and decline in sales of fast food with the transition of premium/gourmet food trends. Technology advances that result in the decrease in sales of microwaves and increased food options to eat, decrease in the consumption of microwave food  people are starting to eat better moving towards premium products in response to the fast rise of “gourmet” options. Malls moving food courts upscale, microwave sale decrease, struggling fast food companies, and premium/gourmet trends  people are willing to devote more time or more money in their food consumption

Based on the learnings and concepts from Module 4, I disagree with the author of the article. This is because of the change in consumer preferences; consumers are willing to spend a higher proportion of their income on healthier food choices opposed to spending their money on fast food options. Consumer preferences can change over time regardless of the change in the individual’s income (although a change in a person’s income can cause someone to spend more or less). Furthermore, a concept in Module 4 on the resource allocation methods specifically resource allocation by market price. When a market allocates a scarce resource, the people who get the resource are those who are willing to pay the market price. In this case, the healthier food choices, gourmet/premium foods are what consumers choose to pay for and consume opposed to spending their money on fast foods. In a competitive market, prices will continue to adjust until the quantity supplied equals the quantity demanded for a good/service. Overall, this concept is known as decentralized market planning approach where people who are willing and able to buy a resource get the resource in this case gourmet food options. The decline of sales in the fast food industry as stated by the author is impacted by the choices made by consumers make on where to spend their money. This statistic does not mean that consumers have a higher income. Correlation does not mean causation. Thus, the statement in the article the “richer are getting richer as the poor are getting poor” is not true in today’s society. People are allocating their resources differently Nowak mentions in the article that “the Gini Co-efficient – has been growing in many developed countries over the past few decades (especially in the United States)”

The definition of the Gini Co-efficient is used to gauge economic inequality, measuring income distribution, and wealth distribution among a population. It is used to measure how far a country’s wealth or income deviates from a totally equal distribution. A country that has a Gini Co-efficient that is closer to 0 means that it is close to complete equality. In comparison, a country that has a Gini Co-efficient that is closer to 1 means that it is close to complete inequality. The concept of the Gini Coefficient relates to the concept learned in Module 4: one of the two perspectives learned to analyze the fairness of a competitive market. The concept under “Fair Results View” discusses about utilitarianism principle states that we should strive to achieve the greatest happiness for the greatest number of individuals. Fairness requires equality of incomes, and to secure equality of incomes, a form of income transfer (from the rich to the poor) or redistribution needed (income equally distributed). To increase the total benefit, everyone gets the same marginal utility from a given amount of income. If the marginal benefit of income decreases as the income increases, then taking a dollar from a richer person and giving it to a poorer person increases the total benefit. Income transfers create a tradeoff; however, the utilitarianism is not fair as it ignores tradeoffs and the cost of transfers. Lastly, the modified utilitarianism view: the difference in incomes can be largely attributed to your inherent abilities and the socioeconomic status. This view involves a set of rules adopted to help those less fortunate and find ways to make the playing field more even especially for those at the bottom of the socioeconomic status. 

A bigger share of a smaller pie vs the smaller share of a bigger pie...