Chapter 6 PowerPoint Markets, Maximizers and Efficiency

Chapter 6 PowerPointChapter 6 PowerPoint

Markets, Maximizers and Markets, Maximizers and EfficiencyEfficiency

The Logic of Maximizing BehaviorThe Logic of Maximizing Behavior(Tregarthen & Rittenberg, 2000, p. 131)(Tregarthen & Rittenberg, 2000, p. 131)

Economists assume that decisionmakers Economists assume that decisionmakers make choices in a way that maximizes make choices in a way that maximizes the value of some objective.the value of some objective.

Maximization involves determining the Maximization involves determining the change in total benefit and the change change in total benefit and the change in total cost with each unit of an activity. in total cost with each unit of an activity. These changes are called marginal These changes are called marginal benefit and marginal cost, respectively.benefit and marginal cost, respectively.


IF the marginal benefit of an activity IF the marginal benefit of an activity exceeds the marginal cost, the exceeds the marginal cost, the decisionmaker will gain by increasing decisionmaker will gain by increasing the activity.the activity.

IF the marginal cost of an activity IF the marginal cost of an activity exceeds the marginal benefit, the exceeds the marginal benefit, the decisionmaker will gain by reducing decisionmaker will gain by reducing the activity.the activity.


The area under the marginal benefit curve The area under the marginal benefit curve for an activity gives its total benefit; the for an activity gives its total benefit; the area under the marginal cost curve gives area under the marginal cost curve gives the activity’s total cost. the activity’s total cost.

Net benefit equals total benefit less total Net benefit equals total benefit less total cost (NB=TB-TC).cost (NB=TB-TC).

The marginal decision rule states that the The marginal decision rule states that the net gain from an activity is maximized at net gain from an activity is maximized at the point at which the marginal benefit of the point at which the marginal benefit of the activity equals the marginal cost.the activity equals the marginal cost.

Maximizing the MarketplaceMaximizing the Marketplace(Tregarthen & Rittenberg, 2000, p. 136)(Tregarthen & Rittenberg, 2000, p. 136)

In a competitive system in which In a competitive system in which demand and supply determine demand and supply determine prices, the demand and supply prices, the demand and supply curves can be considered as curves can be considered as marginal benefit and marginal cost marginal benefit and marginal cost curves respectively.curves respectively.


An efficient allocation of resources is An efficient allocation of resources is one that maximizes the net benefits one that maximizes the net benefits of each activity. We expect it to be of each activity. We expect it to be achieved in markets that satisfy the achieved in markets that satisfy the efficiency condition, which requires a efficiency condition, which requires a competitive market and well-defined, competitive market and well-defined, transferable property rights.transferable property rights.


Consumer surplus is the amount by Consumer surplus is the amount by which the total benefit to consumers which the total benefit to consumers from some activity exceeds their from some activity exceeds their total expenditure for it.total expenditure for it.

Producer surplus is the amount by Producer surplus is the amount by which the total revenues of which the total revenues of producers exceed their total costs.producers exceed their total costs.


An efficient allocation of resources An efficient allocation of resources doesn’t necessarily mean an doesn’t necessarily mean an equitable allocation of resources.equitable allocation of resources.

An inequitable allocation of resources An inequitable allocation of resources implies that the distribution of implies that the distribution of income and wealth is inequitable. income and wealth is inequitable. Judgments about equity in the Judgments about equity in the distribution of income and wealth are distribution of income and wealth are normative judgments.normative judgments.

The Logic of Maximizing BehaviorThe Logic of Maximizing Behavior

In order to achieve efficiency:In order to achieve efficiency: Markets must be competitiveMarkets must be competitive Property rights must be exclusive and Property rights must be exclusive and

transferable.transferable. ExclusiveExclusivepossible for owner of property to exclude possible for owner of property to exclude

others from using the resourceothers from using the resource TransferableTransferablethe owner of the resource must be the owner of the resource must be

allowed to sell or lease it to someone else (if it isn’t allowed to sell or lease it to someone else (if it isn’t transferable, exchange can’t occur).transferable, exchange can’t occur).

Efficiency conditionEfficiency conditionrequires a competitive requires a competitive market with well-defined and transferable market with well-defined and transferable property rightsproperty rights

Economic SystemsEconomic Systems

Traditional EconomiesTraditional Economies Allocation decisions will be based on how previous Allocation decisions will be based on how previous

generations have done it; continuity and stability generations have done it; continuity and stability valuedvalued

Market EconomiesMarket Economies Individuals and privately owned firms answer the Individuals and privately owned firms answer the

three economic questions; market prices signal to three economic questions; market prices signal to producers what to produce; goods and services producers what to produce; goods and services allocated based on priceallocated based on price

Command EconomiesCommand Economies An authority such as the government, feudal lord An authority such as the government, feudal lord

or central planners answer the three economic or central planners answer the three economic questionsquestions

Characteristics of a Market Characteristics of a Market EconomyEconomy

Private PropertyPrivate Property Individual control and ownership of resources Individual control and ownership of resources

and productsand products Property rights-set of rules that specify the Property rights-set of rules that specify the

ways in which an owner can use a resourceways in which an owner can use a resource What types of incentives do well defined What types of incentives do well defined

property rights provide?property rights provide? Free EnterpriseFree Enterprise

Within legal limits, individuals are free to open Within legal limits, individuals are free to open businesses, work where they want, and buy businesses, work where they want, and buy what they wantwhat they want


Self-InterestSelf-Interest Drives people to get the best job they Drives people to get the best job they

can, get the most for their money, and can, get the most for their money, and to earn the most profit in their to earn the most profit in their businessesbusinesses

1776 1776 Wealth of NationsWealth of Nations invisible hand invisible hand CompetitionCompetition

Keeps prices in line with the costs of Keeps prices in line with the costs of productionproduction


System of Markets and PricesSystem of Markets and Prices Forces of supply and demand (not Forces of supply and demand (not

government) determine pricesgovernment) determine prices Surplus versus shortageSurplus versus shortage

Limited GovernmentLimited Government Government intervention needed in Government intervention needed in

some circumstances (where goods and some circumstances (where goods and services are not efficiently provided by services are not efficiently provided by markets)markets)

BrainstormBrainstorm

What functions should the What functions should the government perform?government perform?

Remember one characteristic of a Remember one characteristic of a market economy is limited market economy is limited governmentgovernment

Role of Government in Market Role of Government in Market EconomyEconomy

Provide a Provide a legal systemlegal system to make to make and enforce laws and to protect and enforce laws and to protect private property rightsprivate property rights

Provide Provide public goodspublic goods that that individuals or private businesses individuals or private businesses wouldn’t providewouldn’t provide

Correct Correct market failuresmarket failures such as such as external costs and benefitsexternal costs and benefits


Maintain competitionMaintain competition by by regulating monopoliesregulating monopolies

Redistribute incomeRedistribute income by taxing by taxing those with larger incomes and those with larger incomes and helping those in needhelping those in need TaxesTaxes Social welfare programsSocial welfare programs


Stabilize the economyStabilize the economy by reducing by reducing unemployment and inflation and unemployment and inflation and promoting economic growthpromoting economic growth Fiscal policyFiscal policy Monetary policyMonetary policy

Private GoodsPrivate Goods

Most goods and services produced in Most goods and services produced in market economies are private goods market economies are private goods and services. The consumers who and services. The consumers who purchase these goods consume these purchase these goods consume these goods.goods.

Private goods are goods for which Private goods are goods for which exclusion is possible and for which the exclusion is possible and for which the marginal cost of another user is positivemarginal cost of another user is positive

Examples:Examples:

Public GoodsPublic Goods

Public goods differ from private Public goods differ from private goods because they have the goods because they have the following characteristics:following characteristics: Shared consumption: When one person Shared consumption: When one person

consumes a public good, it does not consumes a public good, it does not prevent others from also consuming the prevent others from also consuming the goodgood

Nonexclusion: Once a public good is Nonexclusion: Once a public good is produced it is difficult or impossible to produced it is difficult or impossible to exclude others from consuming the exclude others from consuming the good even if they didn’t pay for it.good even if they didn’t pay for it.

Public GoodsPublic Goods

Because people can consume public Because people can consume public goods without paying for them (the goods without paying for them (the free rider problem), private free rider problem), private businesses do not have incentives to businesses do not have incentives to produce enough public goods. produce enough public goods. Therefore, the government provides Therefore, the government provides them, through tax dollars, if people them, through tax dollars, if people want them.want them.

More on Public GoodsMore on Public Goods

Few examples of pure public goods, but Few examples of pure public goods, but many goods have some public good many goods have some public good characteristics and are therefore provided characteristics and are therefore provided by the governmentby the government

How do the following illustrate shared How do the following illustrate shared consumption and/or non-exclusion?consumption and/or non-exclusion? Fire protection, police protection, lighthouses, Fire protection, police protection, lighthouses,

weather forecasts etc.weather forecasts etc. Public goods are examples of positive Public goods are examples of positive

externalitiesexternalities

ExternalitiesExternalities

Externalities are an example of market Externalities are an example of market failurefailure

Market prices usually reflect the costs Market prices usually reflect the costs producers pay to produce goods and the producers pay to produce goods and the benefits consumers receive from the good. benefits consumers receive from the good. A kind of market failure occurs when A kind of market failure occurs when market prices fail to reflect all the costs market prices fail to reflect all the costs and all the benefits involved. This kind of and all the benefits involved. This kind of market failure is called an externality market failure is called an externality problem.problem.

ExternalitiesExternalities

Externalities exist when some of the Externalities exist when some of the costs or benefits associated with the costs or benefits associated with the production or consumption of a product production or consumption of a product spill over to third parties, who do not spill over to third parties, who do not produce or pay to consume the product.produce or pay to consume the product.

Markets fail when markets “are not Markets fail when markets “are not competitive and/ or when property competitive and/ or when property rights are not well defined and fully rights are not well defined and fully transferable” (Tregarthen & Rittenberg, transferable” (Tregarthen & Rittenberg, 2000, p. 137).2000, p. 137).

Positive ExternalitiesPositive Externalities

Positive: benefits enjoyed by Positive: benefits enjoyed by someone who does not produce or someone who does not produce or pay to consume a productpay to consume a product Examples: Examples:

Government usually subsidizes the Government usually subsidizes the production of externalities or provides production of externalities or provides themthem

Negative ExternalitiesNegative Externalities

Negative externalities: costs paid by Negative externalities: costs paid by someone who does not produce or someone who does not produce or pay to consume a productpay to consume a product

Example: Example: Because of these costs the Because of these costs the

government provides incentives government provides incentives (laws/fines) to reduce production of (laws/fines) to reduce production of these goods or servicesthese goods or services

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Chapter 6 PowerPoint Markets, Maximizers and Efficiency