Transcript Chapter 6 PowerPoint

Chapter 6 PowerPoint
Markets, Maximizers and
Efficiency
The Logic of Maximizing Behavior
(Tregarthen & Rittenberg, 2000, p. 131)
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Economists assume that decisionmakers
make choices in a way that maximizes the
value of some objective.
Maximization involves determining the
change in total benefit and the change in
total cost with each unit of an activity.
These changes are called marginal benefit
and marginal cost, respectively.
The Logic of Maximizing Behavior
(Tregarthen & Rittenberg, 2000, p. 131)
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IF the marginal benefit of an activity
exceeds the marginal cost, the
decisionmaker will gain by increasing the
activity.
IF the marginal cost of an activity exceeds
the marginal benefit, the decisionmaker
will gain by reducing the activity.
The Logic of Maximizing Behavior
(Tregarthen & Rittenberg, 2000, p. 131)
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The area under the marginal benefit curve for an
activity gives its total benefit; the area under the
marginal cost curve gives the activity’s total cost.
Net benefit equals total benefit less total cost
(NB=TB-TC).
The marginal decision rule states that the net
gain from an activity is maximized at the point at
which the marginal benefit of the activity equals
the marginal cost.
Maximizing the Marketplace
(Tregarthen & Rittenberg, 2000, p. 136)
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In a competitive system in which demand
and supply determine prices, the demand
and supply curves can be considered as
marginal benefit and marginal cost curves
respectively.
Maximizing the Marketplace
(Tregarthen & Rittenberg, 2000, p. 136)
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An efficient allocation of resources is one
that maximizes the net benefits of each
activity. We expect it to be achieved in
markets that satisfy the efficiency
condition, which requires a competitive
market and well-defined, transferable
property rights.
Maximizing the Marketplace
(Tregarthen & Rittenberg, 2000, p. 136)
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Consumer surplus is the amount by which
the total benefit to consumers from some
activity exceeds their total expenditure for
it.
Producer surplus is the amount by which
the total revenues of producers exceed
their total costs.
Maximizing the Marketplace
(Tregarthen & Rittenberg, 2000, p. 136)
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An efficient allocation of resources doesn’t
necessarily mean an equitable allocation
of resources.
An inequitable allocation of resources
implies that the distribution of income and
wealth is inequitable. Judgments about
equity in the distribution of income and
wealth are normative judgments.
The Logic of Maximizing Behavior
In order to achieve efficiency:
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Markets must be competitive
Property rights must be exclusive and transferable.
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Exclusivepossible for owner of property to exclude others
from using the resource
Transferablethe owner of the resource must be allowed to
sell or lease it to someone else (if it isn’t transferable,
exchange can’t occur).
Efficiency conditionrequires a competitive market
with well-defined and transferable property rights
Economic Systems
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Traditional Economies
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Market Economies
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Allocation decisions will be based on how previous
generations have done it; continuity and stability
valued
Individuals and privately owned firms answer the
three economic questions; market prices signal to
producers what to produce; goods and services
allocated based on price
Command Economies
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An authority such as the government, feudal lord or
central planners answer the three economic questions
Characteristics of a Market
Economy
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Private Property
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Individual control and ownership of resources and
products
Property rights-set of rules that specify the ways in
which an owner can use a resource
What types of incentives do well defined property
rights provide?
Free Enterprise
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Within legal limits, individuals are free to open
businesses, work where they want, and buy what
they want
Characteristics of a Market
Economy
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Self-Interest
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Drives people to get the best job they can,
get the most for their money, and to earn the
most profit in their businesses
1776 Wealth of Nations invisible hand
Competition
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Keeps prices in line with the costs of
production
Characteristics of a Market
Economy
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System of Markets and Prices
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Forces of supply and demand (not
government) determine prices
Surplus versus shortage
Limited Government
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Government intervention needed in some
circumstances (where goods and services are
not efficiently provided by markets)
Brainstorm
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What functions should the government
perform?
Remember one characteristic of a market
economy is limited government
Role of Government in Market
Economy
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Provide a legal system to make and
enforce laws and to protect private
property rights
Provide public goods that individuals or
private businesses wouldn’t provide
Correct market failures such as
external costs and benefits
Role of Government in Market
Economy
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Maintain competition by regulating
monopolies
Redistribute income by taxing those
with larger incomes and helping those in
need
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Taxes
Social welfare programs
Role of Government in Market
Economy
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Stabilize the economy by reducing
unemployment and inflation and
promoting economic growth
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Fiscal policy
Monetary policy
Private Goods
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Most goods and services produced in
market economies are private goods and
services. The consumers who purchase
these goods consume these goods.
Private goods are goods for which
exclusion is possible and for which the
marginal cost of another user is positive
Examples:
Public Goods
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Public goods differ from private goods
because they have the following
characteristics:
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Shared consumption: When one person
consumes a public good, it does not prevent
others from also consuming the good
Nonexclusion: Once a public good is produced
it is difficult or impossible to exclude others
from consuming the good even if they didn’t
pay for it.
Public Goods
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Because people can consume public goods
without paying for them (the free rider
problem), private businesses do not have
incentives to produce enough public
goods. Therefore, the government
provides them, through tax dollars, if
people want them.
More on Public Goods
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Few examples of pure public goods, but many
goods have some public good characteristics and
are therefore provided by the government
How do the following illustrate shared
consumption and/or non-exclusion?
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Fire protection, police protection, lighthouses,
weather forecasts etc.
Public goods are examples of positive
externalities
Externalities
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Externalities are an example of market failure
Market prices usually reflect the costs producers
pay to produce goods and the benefits
consumers receive from the good. A kind of
market failure occurs when market prices fail to
reflect all the costs and all the benefits involved.
This kind of market failure is called an
externality problem.
Externalities
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Externalities exist when some of the costs
or benefits associated with the production
or consumption of a product spill over to
third parties, who do not produce or pay
to consume the product.
Markets fail when markets “are not
competitive and/ or when property rights
are not well defined and fully transferable”
(Tregarthen & Rittenberg, 2000, p. 137).
Positive Externalities
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Positive: benefits enjoyed by someone
who does not produce or pay to consume
a product
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Examples:
Government usually subsidizes the production
of externalities or provides them
Negative Externalities
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Negative externalities: costs paid by
someone who does not produce or pay to
consume a product
Example:
Because of these costs the government
provides incentives (laws/fines) to reduce
production of these goods or services