Economics
– Market Efficiency and
Market Failure
Acknowledgement: Tucker, Schiller and Hubbard and
O’Brien PowerPoints
What will you learn in this
chapter?
–You will study situations in
which the market is efficient
and situations where the
market mechanism fails.
Economic Surplus
– Economists use the idea of
“surplus” to refer to the benefit
that people derive from engaging in
market transactions.
Consumer Surplus
– Consumer surplus is the difference
between the highest price a
consumer is willing to pay for a good
or service and the actual price the
consumer receives.
Consumer Surplus
– How much benefit do the potential consumers derive
from the market?
– That depends on the price and their marginal benefit,
the additional benefit to a consumer from consuming
one more unit of a good or service.
– If the price is low, many of the consumers benefit.
– If the price is high, few (if any) of the consumers
benefit.
Producer Surplus
– Producer surplus is the difference
between the lowest price a firm
would be willing to accept for a good
or service and the price it actually
receives.
Producer Surplus
– Producer surplus can be thought of in much
the same way as consumer surplus.
– The lowest price a firm would accept for a
good or service is the marginal cost of
producing that good or service.
– Marginal cost: the additional cost to a firm of
producing one more unit of a good or service.
Market Efficiency
– Efficiency in a market can be achieved in two ways:
– A market is efficient if all trades take place where the
marginal benefit exceeds the marginal cost, and no
other trades take place.
– A market is efficient if it maximizes the sum of
consumer and producer surplus (i.e. the total net
benefit to consumers and firms), known as the
economic surplus.
Economic Efficiency
– The demand curve describes the marginal benefit of each
additional unit, while the supply curve describes the marginal
cost of each additional unit of the product.
– If the quantity is too low, the value to consumers of the next unit
exceeds the cost to producers.
– If the quantity is too high, the cost to producers of the last unit is
greater than the value consumers derive from it.
– Only at the competitive equilibrium is the last unit valued by
consumers and producers equally—economic efficiency.
Market Efficiency
Deadweight Loss
Disequilibrium
– In some markets, the objective of
politicians is to prevent prices from
reaching the equilibrium price.
Disequilibrium
– One option a government has for affecting a
market is the imposition of a price ceiling or a
price floor.
– Price ceiling: A legally determined maximum
price that sellers can charge.
– Price floor: A legally determined minimum
price that sellers may receive.
Price Ceiling: Rent Control
Deadweight Loss
Price Floor: Minimum Wage
Deadweight Loss
Counterproductive Price Controls
– It is clear that when a government imposes
price controls,
– Some people are made better off,
– Some people are made worse off, and
– The economy generally suffers, as
deadweight loss will generally occur.
In Support of Price Controls
– Economists seldom recommend price controls,
with the possible exception of minimum wage
laws. Why minimum wage laws?
– Price controls might be justified if there are strong
equity effects to override the efficiency loss.
– The people benefitting from minimum wage laws
are generally poor.
Externalities
– Negative externalities might result from consumption.
– Example: cigarette smoke
– Pollution is an example of a negative externality in
production.
– Externalities might also be positive.
– Example: college education
Positive Externality
– College educations have positive externalities.
– The marginal social benefit from a college
education is greater than the marginal private
benefit to college students.
– When there is a positive externality in consuming a good
or service, too little of the good or service will be
produced at market equilibrium.
Negative Externality
– Pollution is a negative externality.
– The marginal social cost from pollution is greater
than the marginal private cost to firms producing
pollution.
– When there is a negative externality in producing a good
or service, too much of the good or service will be
produced at market equilibrium.
Market Failure
– A situation in which the price system
results in too few or too many
resources used in the production of a
good or service. This inefficiency may
justify government intervention.
Market Failure
– If there are negative or positive externalities, the
market equilibrium will not result in the efficient
quantity being produced.
– There will be deadweight loss.
– The larger the externality, the greater is likely to be the size
of the deadweight loss—the extent of the market failure.
