Topic 7 - Efficiency and Exchange

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Efficiency And Exchange

Market Equilibrium And Efficiency

  1. Market Equilibrium occurs when demand intersects to supply. At equilibrium there is no tendency for change
  2. Pareto Efficiency is a situation is efficient if there is no opportunity for exchange that will make at least one person better off without harming others
  3. Pareto Improving Transactions are transaction that leave at least one person better off without harming others

[1]

At equilibrium, total economic surplus is maximised. This is because at any other price, quantity exchanged will be lower.

Efficiency is not always desirable for everyone on an individual basis. This is because efficiency does not always yield certain outcomes such an equality. Pricing controls reduce efficiency as it creates a situation where transactions that would benefit people without harming others are forgone, refer to the price ceiling example in topic 3.

Examples

[2]

Price Ceiling

Price Ceiling of Milk Market

  • In response to inadequate nutrition for low income families
    • At Equilibrium, $1.40, many people cannot afford milk to meet their children’s nutritional requirement
      • 3000L sold, Consumer Surplus = $900/day, Producer Surplus = $900/day, Total Economic Surplus = $1800
  • Legislators set max price of $1
    • 1000L Sold, Consumer Surplus = $800, Producer Surplus = $100, Total Economic Surplus = $1900
      • Loss of $800 - Conservative Estimate (Assumes Buyers have the highest reservation prices)

PC7.jpg


Subsidies

Subsidies also ensure efficiency is not reached as people who do not value the good as much as others (at the equilibrium price), hence the value received is less than the cost to society as the diagram illustrates.

  • Supply is perfectly elastic (world price = $2), At equilibrium, P = $2, Q = 4000
    • Consumer Surplus = $4000, Total Economic Surplus = $4000
  • Introduction of $1 subsidy to consumers
    • Q = 6000, Consumer Surplus = $9000, Total Economic Surplus = $9000 BUT Tax Cost $6000, Thus loss of $1000 economic surplus
      • Also, MC of additional milk to society is still $2, while MB declines to $1, the cumulative decrease in surplus is $1000
        • Still can be good for low income families (higher income families pay a higher proportion of tax
        • But for the same expense we could create more benefits for low income earners

PC71.jpg

1st Come, 1st Serve Policies

Airliners often overbook planes to compensate for people who don’t show up they use 1st come first serve basis to ration seats

  • E.g. 37 people show up for a 33 seated plane- 4 people needed to be bumped off
    • Reservation Prices to not get bumped off (i.e. would take that amount to miss the flight - See Diagram Below
      • Max = 60, Min = 24 (25,26,27), Avg = 42
        • If 4 random people kicked off loss of economic surplus = 4*42 = 168
        • If use a compensation policy (informal auction or silent market)
          • Loss of economic surplus = $27*4 – 3 – 2 – 1 = $102 ($66 less)
            • Financed via slightly higher ticket prices in return for assured seats

PC72.jpg


Sport & Entertainment promoters often under price tickets (to boast a full house – central to image) and also provide affordability for their loyal fan base

  • There is cash on the table when the price is prevented from rising to clear the market (this is because the people who value the tickets the most may not be able to purchase them
    • Ticket Scalpers
      • Clear the cash on the table, e.g. Sold Eagles Tickets for $4000, face value $669

Pricing Public Services

Government must price public services based on the marginal cost of producing it

Taxes And Efficiency

Taxes can be justified if the value of the public services provided by the tax is worth more than the deadweight loss caused by the tax

  • If supply is more elastic than demand, consumers will bear the majority of the costs
    • If there is perfect elasticity of supply, consumers bear all the costs
  • If supply is more inelastic than demand, suppliers will bear the majority of the costs

This is a good website for further info

This diagram illustrates the dead weightloss caused by a $1 tax on the hamburger market [3]

PC74.jpg

Deadweight Loss Principle

PC73.jpg [4]



References

  1. Frank, Jennings, Bernanke, R, 2011. Principles of Microeconomics. 3rd ed. Australia: MCGRAW-HILL.
  2. Frank, Jennings, Bernanke, R, 2011. Principles of Microeconomics. 3rd ed. Australia: MCGRAW-HILL.
  3. Frank, Jennings, Bernanke, R, 2011. Principles of Microeconomics. 3rd ed. Australia: MCGRAW-HILL.
  4. Frank, Jennings, Bernanke, R, 2011. Principles of Microeconomics. 3rd ed. Australia: MCGRAW-HILL.
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