Chapter 7: Welfare and Efficiency
What is efficient allocation?
Allocation that maximizes economic surplus
What is equity?
Assessing whether a policy will yield a fair distribution of economic benefits.
Why are judgements based solely on economic surplus critiqued using outcomes and processes?
Because judgements that are based solely on economic surplus only focuses on the outcome and not the process. Some believe that the process of something is more important than the outcome.
What is dead weight loss (DWL)?
DWL is the resources that are wasted when either the marginal cost is greater than the marginal benefit, or the marginal benefit is greater than the marginal cost.
What is positive analysis?
Descriptive, factual statements about the world; a hypothesis that can be proven true or false
What economic efficiency?
Economic efficiency says that if an outcome is more economically efficient, then it yields more economic surplus.
What are the two sections of normative analysis?
Efficiency and equity
What is consumer surplus?
It is the difference between the total willingness to pay and the total amount actually paid.
What are the two broad categories for economic analysis?
Positive and Normative analysis
How do you calculate economic surplus?
Producer surplus + Consumer surplus. Marginal benefit - marginal cost
What are the gains from trade?
The additional output that comes from trade
How do you calculate the market's producer's surplus?
The area below the price and above the willingness to sell or marginal cost.
What is economic surplus?
The total benefits minus total cost flowing from a decision.
How does willingness to pay relate to efficient allocation?
This means that since people value some things more than others, that the person with the largest willingness to pay, or largest marginal benefit, will get that item. This maximizes economic surplus which means that it is an efficient allocation.
What is normative analysis?
Value and moral based statements that are not factual; you can't validate empirically because you can't prove it true or false
What is the rational rule for consumer surplus?
When following the rational rule for buyers, you must keep buying that item until the marginal benefit equals the marginal cost. So if you apply this rule to consumer surplus, then your consumer surplus will be 0 if you keep buying until marginal benefit equals marginal cost.
What are distributional consequences?
When trying to find the outcome that produces the largest economic surplus, we can not only judge how large the surplus is, but who gets what. Distributional consequences assess whether the outcome seems fair or equitable. It is not just the size of the surplus that matters, but how it is distributed.
Why does someone's willingness to pay reflect the ability to pay, and not just marginal benefit, and why is this a critique of economic efficiency?
When you are willing to pay a certain price for something, it is possible that someone else is willing to pay more for the same item. This does not mean that that item necessarily produces a greater marginal benefit for the other person, but their ability to pay surpasses your ability to pay since they have more money.
How do you gain consumer surplus?
You can gain consumer surplus when your willingness to pay for an item is greater than the price of that item.
Efficient allocation of output requires that:
each unit of output will go to the person who will get the highest marginal benefit from it.
To maximize economic surplus, keep increasing output as long as:
marginal benefits exceed marginal costs.
What is producer surplus?
the difference between the lowest price a firm would be willing to accept for a good or service and the price it actually receives
What is an efficient outcome?
the outcome that produces the largest economic surplus.
