Economics - Micro - Efficiency and Equity

Start 9:30 am

Efficiency and Equity

Concerned with efficient allocation of resources.  Marginal benefit, cost, consumer/producer surplus, and schools of thought as to efficiency versus fairness.

Efficient quantity occurs when marginal benefit = marginal cost

• Goods allocated by market price
• There are other systems for allocating goods, ex. command system: central authority chooses, majority rule: e.g. taxation, personal characteristics (race, religion, sex), first come first served, lotteries, contests, and force (extortion/theft/warfare)
• When efficient, marginal benefit to society equals the marginal cost for the 'last' unit produced
• Demand curve illustrates the decreasing marginal benefit to consumers
• Downward slope means each unit will be less highly valued by consumers
• Supply slopes up to reflect the cost of producing additional units increases as more resources are bid away from other productive uses
• Efficient quantity is where supply curve intersects demand curve
• Demand curve is marginal benefit to society
• Supply curve is marginal cost to society
• Economists measure efficiency against this idealized solution

Allocative efficiency - allocation of productive resources results in maximum total benefit to consumers

Consumer surplus - top triangle (customers are first!) - total value to society

• You value a product more than you pay for it - this excess value decreases as Q increases

Producer surplus - bottom triangle - total value to producers

• Excess of market price above opportunity cost of production

Efficient quantity is that which maximizes both consumer and producer surplus.

• If production is higher than optimal, inventories will rise and price will fall back to eq and suppliers reduce production.  
• If lower than optimal, inventories will shrink and prices go up and suppliers would increase production.
• This results in optimal allocation to an industry

Obstacles to efficient allocation

• Definition of inefficient: Qs does not maximize sum of consumer and producer surpluses
• Deadweight loss: inefficiency from over or underproduction
• Sideways triangle, vertical at Qs and point at intersection
• Other obstacles
• Price controls (ceilings/floors)
• Taxes/trade restrictions/subsidies/quotas(limits)
• Monopoly (profit maximizing =/= efficient)
• Bad externalities (pollution) - higher societal costs not accounted for, so these are overproduced
• Good externalities - demand curve doesn't recognize all of society benefit so these are underproduced
• Public Goods: consumed regardless of whether you paid - freerider problem - produce less than ideal because people can benefit without paying
• Common resource: little incentive to maintain resource, so you overfish - produce greater than the efficient amount

Fairness versus Efficiency

• One school - Utilitarianism
• Not fair for individuals to have drastically different incomes
• Early economists believed in utilitarianism - each person owns equal amount of resources
• Proven wrong
• Thought was that 1) everyone wants and needs same things and has same capacity to enjoy life and 2) marginal benefit is greater for the poor than for the rich, so gain from a transfer to the poor is greater than the loss to the rich
• Biggest problem: Cost of executing wealth transfer leads to unfairness.
• High taxes means high earners work less, so less than efficient labor is supplied
• Taxation reduces savings and investment
• Economy then shrinks in absolute size
• Second problem: administrative costs, also inefficient
• Second school - Symmetry Principle
• Holds that people in similar situations should be treated similarly
• In economics, this means equality of opportunity
• Nozick (1974) - fairness based on:
• Private property rights
• Exchange only when voluntary
• Symmetry means individuals get goods in society equal in value to their contributions

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10:00 AM

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