Lecture 4

• Alternative methods of allocating scarce resources

  • Market price
  • Command
  • Majority rule
  • Contest
  • First-come, first-served
  • Sharing equally
  • Lottery
  • Personal characteristics
  • Force
• Market price

  The people who get the resource are those who are willing to pay the market price
• Command system

  Allocates resources by the order (command) of someone in authority
• Majority rule

  Allocates resources in the way that a majority of voters choose
• Contest

  Allocates resources to a winner (or group of winners)
• First-come, first-served

  Allocates resources to those who are first in line
• Sharing equally

  Everyone gets the same amount of the resource
• Lottery

  Allocates resources to those with the winning number, draw the lucky cards, or come up lucky
• Personal characteristics

  Allocates resources to those with the "right" characteristics
• Force

  Plays a role in allocating resources, e.g. war, theft
• Allocative efficiency


  A situation in which the quantities of goods and services produced are those that people value most highly
• Production efficiency


  Producing on the production possibilities frontier (PPF)
• Marginal benefit


  The benefit that a person receives from consuming one more unit of a good or service
• Marginal benefit decreases as the quantity of the good increases - the principle of decreasing marginal benefit
• Marginal cost

  The opportunity cost of producing one more unit of a good or service, measured by the slope of the PPF
• The efficient allocation is the highest-valued allocation, where it is not possible to produce more of any good without producing less of something else that is valued more highly
• When marginal benefit exceeds marginal cost


  The efficient quantity is larger, so too few of the good are being produced
• When marginal cost exceeds marginal benefit


  The efficient quantity is smaller, so too many of the good are being produced
• Value


  What the buyer gets
• Price


  What the buyer pays
• Demand curve


  Shows the marginal benefit curve, the maximum price people are willing to pay for each unit of the good
• Consumer surplus


  The marginal benefit from a good or service minus the price paid for it, summed over the quantity consumed
• Cost


  What a seller must give up to produce the good
• Price


  What a seller receives for the good
• Marginal cost curve

  Shows the amount of other goods and services that must be given up to produce one more unit of the good
• The efficient allocation occurs at the intersection of the marginal benefit curve and the marginal cost curve
• Demand

  Willingness to pay, marginal benefit
• Consumer surplus

  Marginal benefit from a good or service minus the price paid for it, summed over the quantity consumed
• Consumer surplus from pizzas

  • Market price of a pizza is $10
  • People buy 10,000 pizzas and spend $100,000 a day
  • People are willing to pay $15 for the 5,000th pizza, so consumer surplus is $5
  • Consumer surplus from 10,000 pizzas is $50,000

  
• Total benefit from pizzas is $150,000 - the $100,000 spent plus the $50,000 consumer surplus

  
• Price

  What a seller receives when the good is sold
• Marginal cost

  The cost of producing one more unit of a good or service
• The seller will produce one more unit if the price exceeds or equals its marginal cost
• Supply curve

  A marginal cost curve
• Supply curve

  • Shows the quantity supplied at each price, other things remaining the same
  • Shows the minimum price that firms must be offered to supply a given quantity
• Producer surplus

  The price of a good minus the opportunity cost of producing it, summed over the quantity produced
• Producer surplus for pizza producers

  • Market price is $10
  • Marginal cost of 5,000th pizza is $6, so producer surplus is $4
  • Producer surplus from 10,000 pizzas is $40,000

  
• The cost of 10,000 pizzas is $60,000 a day - the total revenue of $100,000 minus the producer surplus of $40,000

  
• Efficient pizza market

  • Marginal benefit curve
  • Marginal cost curve
  • When marginal cost equals marginal benefit, quantity is efficient
  • Consumer surplus plus producer surplus is maximized

  
• Competitive market

  • Demand curve shows buyers' marginal benefit, supply curve shows sellers' marginal cost
  • At equilibrium, marginal benefit equals marginal cost
  • Resource allocation is efficient, delivers the efficient quantity