Economics

Efficiency

Dept. of Economics @ NCKU

Weng, Ming-Hung
Is sending Christmas gifts efficient?(*)

1.Yes
2.No
 Outline
Consumer surplus
Producer surplus
Efficiency in competitive markets
 Consumer Surplus

Why would we pay to buy commodities or even

willing to wait?
 Consumer Surplus
Consumer Surplus
Buyers possible gain from consumption
The sum of differences between what you
are willing to pay and what you have to pay
(the market price)
Likely Different across buyers
Consumer Surplus (CS)
If the price is $50, CS
from buying jeans
equal to (100-
50)+(75-50)=75
Consumer Surplus
If the price is $25, CS
from buying jeans
equal to
1.75
2.125
3.150
4.200

Exhibit 5.7 Computing Consumer Surplus

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 Consumer Surplus
CS is the area
between
(continuous)
demand curve
and the market
price

Exhibit 5.8 Market-Wide Consumer Surplus 2015 Pearson Education, Ltd.

Change in Consumer Surplus

CS shrinks as
the market
price goes up

Who suffers?
Consumer Surplus (*)
Given Jeffs monthly
demand for
cigarettes at current
market price, $50,
would he accept to
quit smoking for
$2,000 a month?
1. Yes
2. No
 Consumer Surplus

Evidenced-Based Economics Example:

Would a smoker quit the
habit for $100 a month?
$100= incentives
What would motivate you?

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 Consumer Surplus

Exhibit 5.10 Experimental Results from Smoking Study

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 Producer surplus
Producer surplus
Sellers gain from selling
Sum of differences
between what the
market can actually take
home (price) and what
the firm would be
willing to accept (MC)
The area between the
market price and the
supply curve
Producer surplus
If price goes up from
$100 to $120,
Producer surplus
will
1. Go up
2. Go down
3. Remain
unchanged
 Producer surplus

Who benefits from the increase in price?

 Efficiency in Competitive Markets
Efficiency
Production efficiency
Allocation efficiency
 Comparing efficiency
Unanimous definition of efficiency
Pareto improvement
When at least one is made better off without
making someone else worse off between
scenarios

Pareto efficiency
When no one can be made better off without
making someone else worse off in a scenario
Is sending Christmas gifts efficient?

If Not, how can it be improved?

 The waiting line

Is it efficient?
If not, how can it be improved?
 Fairness vs. Efficiency (*)
Which allocation of the following is the more
efficient scenario to split $300 between two
individuals?
1. One gets $300 and the other one gets $0.
2. Each gets $140.
 Fairness vs. Efficiency

Fairness Efficiency

What if by hurting some can

increase our overall benefit?
 Efficiency in a competitive market
Efficiency in in a competitive market,
CS is Buyers benefit
PS is sellers surplus
Social Welfare (Surplus), SW=CS+PS, is what
the society can benefit from the market

Can markets composed of only self-interested

agents maximize the overall well-being of
society?
 Market efficiency
Two possible solutions for economy systems:
1. Market economy = prices direct flow of
resources, provide incentives for
participants
2. Command economy = central agency
directs resources, provides incentives
 Think
When will a trade take place?

Whats the benefit from trading?

Whats the function of price in a trade?

 Market Equilibrium
Equilibrium price? Seller Buyer
WTS WTP
1. $1
2. $2 1 $1 $5
3. $3 2 $2 $4
4. $4 3 $3 $3
5. $5 4 $4 $2
5 $5 $1
 Market Equilibrium
SW=Social Welfare Seller Buyer
(Surplus)=CS+PS at WTS WTP
equilibrium price
1. $2
1 $1 $5
2. $4 2 $2 $4
3. $6 3 $3 $3
4. $8
5. $10
4 $4 $2
5 $5 $1
 Market Equilibrium
Transaction amount Seller Buyer
under command WTS WTP
economy with P=$1
1 $1 $5
1. 1
2. 2
2 $2 $4
3. 3 3 $3 $3
4. 4 4 $4 $2
5. 5
5 $5 $1
 Market Intervention (*)
SW under command Seller Buyer
economy with P=$1 WTS WTP
is at most 1 $1 $5
1. $2
2 $2 $4
2. $4
3. $6 3 $3 $3
4. $8 4 $4 $2
5. $10 5 $5 $1
 Deadweight Loss
Deadweight loss is the loss in social
welfare from its highest level

Market intervention likely will result in

deadweight loss
Possible other costs?
 Market Intervention
deadweight loss Seller Buyer
under command WTS WTP
economy with P=$5
is at least 1 $1 $5
1. $0 2 $2 $4
2. $2
3. $4
3 $3 $3
4. $6 4 $4 $2
5. $8 5 $5 $1
 Market Intervention
SW under command Seller Buyer
economy where the
social planner WTS WTP
matches trades to 1 $1 $5
make most trades
happen.
2 $2 $4
1. $2
2. $4 3 $3 $3
3. $6
4. $8 4 $4 $2
5. $0 5 $5 $1
 Pareto efficiency

SW maximized at
cs competitive

PS equilibrium

 Price control (*)
Price gouging
monitoring (regulation)
after hurricane will
1. Increase efficiency
2. Decrease efficiency
3. Have no impact on
efficiency
Price control
 Price control
Price ceiling generally results in
DW (deadweight loss) as in D
 Impacts from price controls
Loss in efficiency in terms of SW
Redistribution of surplus
Reallocation of surplus through non-price
mechanism

Price controls act to Efficiency

restrict efficiency.
Market efficiency

Prices are the key to

the invisible hand in
a competitive
market.

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Invisible hands across industries(*)
Is the market more
efficient with new
firms coming in?
1. Yes
2. No
Invisible hands across industries
Market vs. command economy
Inefficiency in command economy
Two problems:

1. Coordination problem = bringing together

self-interested economic agents to facilitate
markets
2. Incentive problem = how to motivate agents
to participate in market activities
Attention, Kmart Shoppers!
 Conclusion
Consumer surplus (CS) evaluates buyers
benefit from trades
Producer surplus (PS) represents sellers
welfare from transactions
SW=CS+PS, Social Welfare is the surplus
brought by the market, which is maximized in
a competitive market,
Government intervention may cause
deadweight loss