lecture 5 market values and social values readings: chapter 5
TRANSCRIPT
Lecture 5
Market Values and Social Values
Readings: Chapter 5
Recent Event
• Several years ago, Newfoundland announced that gasoline prices would be regulated by the government.
• The Newfoundland government judges that market prices are not meeting Newfoundland’s social objectives.
• They believe regulated prices will serve the interests of Newfoundland society better than unregulated market prices.
What questions does this raise?
• This action by the Newfoundland government is unusual. Most governments prefer to let the market determine the price for commodities.
• Q: Why do governments usually prefer to leave market prices unregulated?
• A: Competitive markets generate prices that lead to an efficient allocation of societies scarce resources.
What is efficiency?
Economists understand efficiency to be a social outcome in which society’s scarce resources are used to produce the goods and services that people value the most. To find efficient social outcome recall marginal analysis.
How is an efficient social outcome found?
Marginal benefit
• is the benefit that a person receives from is the benefit that a person receives from consuming one more unit of a good or service.consuming one more unit of a good or service.
• Measured as the maximum amount that a person is Measured as the maximum amount that a person is willing to give up for willing to give up for one additional unitone additional unit..
Principle of decreasing marginal benefit:
• Marginal benefit decreases as consumption increases.
How is an efficient social outcome found? Marginal cost
• is the opportunity cost of producing one more unit of a good or service.
• Measured as the value of the best alternative forgone.
Principle of increasing marginal cost:
• Marginal cost increases as the quantity produced increases.
Efficiency and Inefficiency
• To determine whether an outcome is efficient requires comparison of the marginal cost (MC) and marginal benefits (MB).
• Resources are efficiently utilized when MB = MC
• If MB>MC then increase output.• If MB<MC then decrease output.
The Efficient Quantity of Pizza
0 50 5 1010 1515 2020
55
1010
1515
2020
2525
Quantity (thousands of pizzas per day)Quantity (thousands of pizzas per day)
Ma
rgin
al c
os
t a
nd
ma
rgin
al b
ene
fit
Ma
rgin
al c
os
t a
nd
ma
rgin
al b
ene
fit
(do
llars
wo
rth
of
go
od
s a
nd
se
rvic
es
)(d
olla
rs w
ort
h o
f g
oo
ds
an
d s
erv
ice
s)
MBMBEfficient quantityEfficient quantityof pizzaof pizza
MCMC
Pizza valued morePizza valued morehighly than it costs:highly than it costs:Increase productionIncrease production
Pizza costs morePizza costs morethan it is valued:than it is valued:Decrease Decrease productionproduction
How are value and price related?
• For economists, the value of one more unit of a good or service is the same thing as its marginal benefit.
• Marginal benefit can be expressed as the maximum price people are willing to pay for an additional unit.
• Willingness to pay determines demand.
Quantity (thousands of pizzas per day)Quantity (thousands of pizzas per day)0 50 5 1010 15 15 20 20
55
1010
1515
2020
2525
Pri
ce
(do
llars
pe
r p
izza
)P
ric
e (d
olla
rs p
er
piz
za)
Price determinesPrice determinesquantity demandedquantity demanded
DD
Demand, Willingness to Pay, and Marginal Benefit
Quantity ofQuantity ofpizzaspizzasdemandeddemandedat $15 a pizzaat $15 a pizza
Demand, Willingness to Pay, and Marginal Benefit
Quantity (thousands of pizzas per day)Quantity (thousands of pizzas per day) 0 50 5 1010 15 15 2020
55
1010
1515
2020
2525
Pri
ce (
do
llar
s p
er p
izza
)P
rice
(d
oll
ars
per
piz
za)
DD = = MBMB
Maximum priceMaximum pricewillingly paid willingly paid for the 10,000thfor the 10,000thpizzapizza
Quantity determinesQuantity determineswillingness to paywillingness to pay
Do market prices reflect the total value of a good?
Consumer surplus is the value of a good minus the price paid for it.
• Most goods purchased in the market are valued more highly than the market price.
• Most people pay less for the good than they value it, creating a consumer surplus.
TotalTotal
benefitbenefitAmountAmountpaidpaid
ConsumerConsumersurplussurplus
A Consumer’s Demand and Consumer Surplus
Quantity (slices of pizzas per week)Quantity (slices of pizzas per week)
0 100 10 2020 30 40 30 40
0.500.50
1.001.00
1.501.50
2.002.00
2.502.50
Pri
ce
(do
llars
pe
r sl
ice)
Pri
ce
(do
llars
pe
r sl
ice)
Lisa’s consumerLisa’s consumersurplus from thesurplus from the10th pizza10th pizza
DD
MarketMarketpriceprice
What is marginal cost?What is marginal cost?
The cost of producing one more unit of a good or service is its marginal cost.
• For a firm, it is the marginal value of the resources used in the production of one more unit applied to the next best activity.
• Therefore, the marginal cost is the minimum price required by producers to produce another unit of output.
What does Marginal Cost look like?
• The supply curve in a competitive industry can also be interpreted as the curve which gives the minimum price required to produce a certain level of output.
A supply curve is a marginal cost curve.
Quantity (thousands of pizzas per day)Quantity (thousands of pizzas per day)
55
1010
1515
2020
2525
Pri
ce (
do
llar
s p
er p
izza
)P
rice
(d
oll
ars
per
piz
za) Price determinesPrice determines
quantity suppliedquantity supplied SS
Quantity of pizzasQuantity of pizzassupplied at $15supplied at $15a pizzaa pizza
0 50 1000 50 100 150150 200200
Supply, Minimum Supply Supply, Minimum Supply Price, and Marginal CostPrice, and Marginal Cost
Quantity (thousands of pizzas per day)Quantity (thousands of pizzas per day)
55
1010
1515
2020
2525
Pri
ce (
do
llar
s p
er p
izza
)P
rice
(d
oll
ars
per
piz
za)
Quantity determines Quantity determines minimum supply priceminimum supply price
SS = = MCMC
0 50 5 10 10 15 15 20 20
Minimum supply Minimum supply price for 10,000thprice for 10,000thpizzapizza
Supply, Minimum Supply Supply, Minimum Supply Price, and Marginal CostPrice, and Marginal Cost
Producer Surplus
Producer surplus is the value of a good minus the opportunity cost of producing it. If a firm sells something for more that it costs to produce, the firm obtains a producer surplus.
Total Total revenuerevenue
A Producer’s Supplyand Producer Surplus
55
1010
1515
2020
2525
Pri
ce (
do
llar
s p
er p
izza
)P
rice
(d
oll
ars
per
piz
za)
SS = = MCMC
Quantity (pizzas per day)Quantity (pizzas per day)0 500 50 100100 150150 200200
CostCostof productionof production
ProducerProducersurplussurplus
Max’s producerMax’s producersurplus from the surplus from the 50th pizza50th pizza
MarketMarketpriceprice
What does the market do?
• We already know that markets produce equilibrium prices.
• When demand exceeds supply, the price will increase
• When demand is less than supply, the price will decrease
• An equilibrium price emerges that determines what society produces, how much society produces, and who gets society’s product.
An Efficient Market for Pizza
Quantity (thousands of pizzas per day)Quantity (thousands of pizzas per day)0 50 5 1010 15 15 20 20
Pri
ce (
do
llar
s p
er p
izza
)P
rice
(d
oll
ars
per
piz
za)
SS
Marginal cost Marginal cost (opportunity cost)(opportunity cost)of pizzaof pizza
Marginal benefit Marginal benefit (value) of pizza(value) of pizza1010
1515
2020
2525
DD
ConsumerConsumersurplussurplus
ProducerProducersurplussurplus55
Consumer’sConsumer’sexpenditureexpenditure
==Producer’sProducer’s
revenuerevenueEfficient quantityEfficient quantityof pizzasof pizzas
Are market prices useful social values?
At the competitive equilibrium, the marginal benefit to consumers of last unit purchased equals the marginal cost to producers of supplying that last unit.
Resources are being used Resources are being used efficiently.efficiently.
An Efficient Market for Pizza
Quantity (thousands of pizzas per day)Quantity (thousands of pizzas per day)0 50 5 1010 15 15 20 20
Pri
ce (
do
llar
s p
er p
izza
)P
rice
(d
oll
ars
per
piz
za)
S = MCS = MC
Marginal cost Marginal cost (opportunity cost)(opportunity cost)of pizzaof pizza
Marginal benefit Marginal benefit (value) of pizza(value) of pizza1010
1515
2020
2525
D = MBD = MB
ConsumerConsumersurplussurplus
ProducerProducersurplussurplus55 Efficient quantityEfficient quantity
of pizzasof pizzas
Why is this efficient?Why is this efficient?
• At the competitive equilibrium, the sum of consumer surplus and producer surplus is maximized.
• By maximizing this net benefit, the total benefit is maximized.
• Any alternative application of society’s scarce resources would reduce the net benefit and hence the total benefit.
Reducing Resource Used in Pizza Production
Quantity (thousands of pizzas per day)Quantity (thousands of pizzas per day)0 50 5 1010 15 15 20 20
Pri
ce (
do
llar
s p
er p
izza
)P
rice
(d
oll
ars
per
piz
za)
SS
1010
1515
2020
2525
DD55
Net Loss
The Invisible HandAdam Smith first proposed the
idea that competitive markets allocate resources efficiently in his 1776 book, The Wealth of Nations.
Each participant in a competitive market is “led by an invisible hand to promote an end [the efficient use of resources] which was no part of his intention.”
Implications• Competitive markets generally do a good
job of efficiently allocating resources.• Governments (like Newfoundland) have,
from time to time, intervened and impose different values.
• In the next lecture we examine how governments can intervene to impose different values on the market and what the social implications of such intervention can be.