Flagship Course Module 1 Overview

1. Flagship CourseModule 1 Overview The Basics of Market

2. Three Fundamental Questions • What goods and services should be produced and how? • How much of each type of good and service should be produced? • How should these goods and services be distributed among members in society?

3. Three Fundamental Questions • What goods and services should be produced and how? • How much of each type of good and service should be produced? • How should these goods and services be distributed among members in society? MARKET

4. Market Under certain conditions markets can lead to a: • Technically • Cost-effectively and • Allocatively Efficient allocation of resources.

5. Prices Ensure That: • On the production side resources are used in their most productive way • On the consumption side goods go to those who value them most

6. Efficiency-equity Relationship Equity Income and wealth distribution Individual ability and willingness to pay Efficiency Market-based resource allocation

7. Conditions for a Well-functioning Market1- Production Side • Many producers • Free entry and exit of producers • Low fixed cost • No production externality

8. Conditions for a Well-functioning Market2- Consumption Side • Informational symmetry • No consumption externality • No dominant consumer

9. Externality • Production externality Social cost = Private cost + E • Consumption externality Social benefit = Private benefit ± E

10. Determinants of Supply • Price • Production cost production continues to increase to the point where marginal cost equals marginal revenue

11. Determinants of Demand • Price • Tastes, preferences and needs • Income • Price of complementary/substitute goods

12. Demand Schedule Price elasticity of demand Price P2 P1 Q1 Q’2 Q’1 Q2 Quantity

13. Demand Schedule Vertical height of demand schedule Price P2 P1 Q1 Quantity Q2

14. Supply Schedule Price elasticity of supply Price P2 P1 Quantity Q1 Q2

15. Supply Schedule Price P2 Vertical height of supply schedule P1 Q2 Q1 Quantity

16. Interaction of Demand and Supply Schedule D Price S PE P0 Q0d Q0s QE Quantity

17. Externality • Production externality Social cost = Private cost + E • Consumption externality Social benefit = Private benefit ± E

18. Efficiency of the Market MSC = Marginal Social Cost MPC = Marginal Private Cost P = Price MPB = Marginal Private Benefit MSB = Marginal Social Benefit MSC = MPC = P = MPB = MSB

19. Efficiency of the Market • Consumers’ surplus: Consumers’ value – Price • Producers’ surplus: Price – Actual production cost Efficiency = Maximizing Surplus

20. Surplus S = MSC a c P b D = MSB Q Surplus = (a + c) + (b – c) = a + b

21. Surplus S = MSC a d c P e b D = MSB Q Surplus = (a + c - e) + (b – c - d) = (a + b) – (d + e)

22. Efficiency of the Market S = MSC a PE b D = MSB QE Surplus = a + b

23. Market Failure MSC = MPC = P = MPB = MSB Examples: • Water contamination by pesticides MSC > MPC • Inability of consumers to judge the true value of a good (automobile) P > MPB • Monopoly MPC < P

24. Government Role in Market Failure

25. Major Features of Health Care • Uncertainty and risk • Informational asymmetries • Supplier-induced demand • Derived demand • Externality

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