CHAPTER 3.
ECONOMIC
EFFICIENCY AND MARKET
Dr. Nguyen Thi Thanh Huyen
1. DEMAND
Definition
The amount of a particular good or service
that a consumer is willing and able to
buy at a given price in a given time
period
Demand and Marginal Benefit
People value many different goods and services
The total benefit (value) of a good to a person
is the benefit gained from the whole of the
amount of the good consumed
The marginal benefit (value) of a good to a
person is the additional benefit that consuming
the last unit provides
A person’s relative valuation of a good is
expressed in their willingness to pay
Willingness to Pay
Willingness to pay for additional units of a
good declines with quantity for each
individual
People vary in their willingness to pay
depending on their incomes and
preferences
At the level of the market will find
willingness to pay will decline with quantity.
Willingness to Pay and Demand
Curves
Under most circumstances, a demand
curve can also be thought of as a marginal
benefit curve or as a marginal willingness
to pay curve
The area under the demand curve to the
left of the last unit purchased can be
thought of as measuring total benefit or
total willingness to pay
Willingness to Pay and Demand
Curves
Total benefit or total WTP for Q1
(green shaded area)
P1 P1 = MB or marginal WTP
at Q1
D
Q1 Q
Consumers’ Surplus
Given a price of P1 consumers purchase
up to Q1. They pay P1 for all units
although previous units are valued
P more
Consumers’ Surplus: excess
of total WPT over amount actually paid
P1 P1 = MB or marginal WTP
at Q1
D
Q1 Q
Amount actually paid (P1 x Q1)
II. SUPPLY
Supply is defined as the quantity of a
product that a producer is willing and
able to supply onto the market at a
given price in a given time period.
Supply and Marginal Cost
The cost of production of a good is its
opportunity cost--the other goods that
could have been produced instead with
the resources used
Provided all productive resources are
priced in competitive markets, the
opportunity cost of producing something
will be reflected in the cost of production
(cost of the productive resources used)
Supply and Marginal Cost
The marginal cost of production is the
opportunity cost of producing one more unit of
the good
Marginal opportunity costs tend to rise with
output
Producers will only produce up to the point
where the price they receive equals the
marginal cost of production (profit max)
The supply curve is a marginal cost curve
Supply and Marginal Cost
P
MC=S
15
Marginal opportunity cost
Of the 10th unit = $15
10 Q
Firm will supply the 10th unit if the price is
$15. This is the minimum price that producers
will accept for that unit of production
Producers’ Surplus
P
S=MC
Producers’ Surplus
15
Cost of production
10
Q
Producer would have been willing to
Produce units 1-9 for less than $15 but
Receives the same price for all units
Is the Competitive Market Efficient?
S=MC
P
CS E Sum of CS and
15 Ps is the
Social Surplus
PS
D=MB
10 Q
At E the Social Surplus is maximized.
Maximum of total benefit over the
total opportunity cost.
Underproduction and
Overproduction
P
Deadweight loss S
Underproduction
Q’ Q* Q
P
S
Deadweight loss
Overproduction
D
Q
Q* Q’
Efficiency and Equity
Efficiency is an allocation of resources
where MB=MC
An efficient allocation can only be defined
given some initial allocation of resources
between individuals
Willingness to pay is budget constrained
Efficient markets may well result in very
unequal distributions of income
Market Failure
Markets can fail because of:
Externalities causing the social cost/benefit of
production to exceed the private cost/benefit.
Imperfect information means merit goods
are under-produced while demerit goods are
over-produced or over-consumed
Market dominance by monopolies can lead
to under-production and higher prices than
would exist under conditions of competition
Public goods problems are often closely related
to the free rider problem
…
FREE RIDERS