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ECON 201 PRINCIPLES OF MICROECONOMICS

ECON 201 PRINCIPLES OF MICROECONOMICS. Chapter 5. Professor Carol Cui. Recall: Allocative efficiency of a good occurs at the point where its Marginal Cost equals its Marginal Benefit. MC, MB ($). MC. P *. MB. Q. Q *. If MB > MC (underproduction), production needs to increase.

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ECON 201 PRINCIPLES OF MICROECONOMICS

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  1. ECON 201 PRINCIPLES OF MICROECONOMICS Chapter 5 Professor Carol Cui

  2. Recall: Allocative efficiency of a good occurs at the point where its Marginal Cost equals its Marginal Benefit. MC, MB ($) MC P* MB Q Q* If MB > MC (underproduction), production needs to increase. If MC > MB (overproduction), production needs to decrease.

  3. MB vs. Demand Curve • More on MB: • The value of one more unit of a good is its marginal benefit. • MB is measured by the maximum price that is willingly paid for another unit of the good. • Thus, willingness to pay determines demand.  A demand curve is a marginal benefit curve.

  4. Consumer Surplus • When people buy something for less than it is worth to them, they receive a consumer surplus. • Consumer surplus is the value of a good a consumer would pay minus the price the consumer actually paid, summed over the quantity bought.

  5. Consumer Surplus CS: The area under a demand curve and above the price line. $7 CS $3 TR D = MB 0 40 TR: Total Revenue is the blue rectangular

  6. MC vs. Supply Curve • Recall: • The cost of producing one more unit of a good is its marginal cost. • MC is the minimum price that producers must receive to induce them to offer one more unit of a good for sale. • Thus, minimum-supply price determines demand.  A supply curve is a marginal cost curve.

  7. Producer Surplus • When price exceeds marginal cost, the firm receives a producer surplus. • Producer surplus is the price a producer actually receives for a good minus the minimum price the producer would have been willing to supply the good, summed over the quantity bought.

  8. Producer Surplus P S = MC PS: The area under the price line and above the supply curve. PS Cost of Production Q

  9. Efficiency of Competitive Equilibrium At the equilibrium where supply and demand curves cross, we get the largest total surplus (i.e. consumer surplus + producer surplus). Thus, the competitive equilibrium is the most efficient allocation of resources. P S = MC PE D = MB Q QE

  10. Deadweight Loss • The decrease in total surplus that results from an inefficient level of production (i.e. produce less than or more than the equilibrium quantity) • Measure the scale of inefficiency • Could be a loss of consumer or producer surplus, but it is a loss which is no one’s gain.

  11. Underproduction P Deadweight Loss S PE D Q Q QE

  12. Overproduction P($) S Deadweight Loss PE D Q Q QE At production level Q, the area of deadweight loss must be subtracted from the area of CS plus PS to obtain the true surplus area.

  13. What Causes Deadweight Loss? • Price Regulations (Ch 6) • Price Ceiling • Price Floor • Taxes, Subsidies, Quotas (Ch 6) • Monopoly (Ch 12) • Externalities • e.g. pollution (external cost), flu vaccine (external benefit)

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