ECON1101 Chapter Notes - Chapter 7: Pareto Efficiency, Price Ceiling, Economic Surplus
Natasha Warrell
Chapter 7 – The Interaction of People in Markets
Individual Consumers and Firms in a Market:
Invisible Hand: The idea that free interaction of people in a market economy leads to
a desirable social outcome – term was coined by Adam Smith
Competitive equilibrium model: A model that assumes utility maximisation on the part
of consumers and profit maximisation on the part of firms, along with competitive
markets and freely determined prices
Are Competitive Markets Efficient: Meaning of Efficient:
• Inefficient: wastes scarce resources
• Efficient: does not waste scarce resources
The Need for a More Precise Definition:
Pareto Efficient: A situation in which it is not possible to make someone better off
without making someone else worse off (if a market is not efficient in the sense of
Pareto then something is wrong with the market)
Three Conditions for Efficient Outcomes:
1. The marginal benefit must equal the marginal cost of the last item produced
2. Every producer’s marginal cost is the same – if not, production could be
increased without increasing costs
3. Every consumer’s marginal benefit is the same – if not, there could be a gain
for some people with no loss for anyone else
First Theorem of Welfare Economics: The conclusion that a competitive market
results in an efficient outcome; sometimes called “the invisible hand theorem”; the
definition of efficiency used in the theorem is Pareto efficiency
Individual Consumers and Firms in a Market: Efficiency and Income Inequality
Income inequality: Disparity in levels of income among individual in the economy
Measuring Waste from Inefficiency: Maximising the Sum of Producer Plus Consumer
Surplus:
• Attractive feature of competitive markets – maximise the sum of producer
plus consumer surplus
• Recall that the producer surplus for all producers is the area above the supply
curve and below market price line
• Recall that the consumer surplus for all consumers is the area below the
demand curve and above the market price line
Measuring Waste from Inefficiency: Deadweight Loss:
Deadweight Loss: the loss in producer and consumer surplus because of an
inefficient level of production
The Deadweight Loss from Price Floors and Ceilings:
• Price ceiling: specify a max price at which a good can be bought or sold
• Price floor: specify a min price at which a good can be bought or sold
find more resources at oneclass.com
find more resources at oneclass.com
Document Summary
Chapter 7 the interaction of people in markets. Invisible hand: the idea that free interaction of people in a market economy leads to a desirable social outcome term was coined by adam smith. Competitive equilibrium model: a model that assumes utility maximisation on the part of consumers and profit maximisation on the part of firms, along with competitive markets and freely determined prices. Inefficient: wastes scarce resources: efficient: does not waste scarce resources. Pareto efficient: a situation in which it is not possible to make someone better off without making someone else worse off (if a market is not efficient in the sense of. Pareto then something is wrong with the market) First theorem of welfare economics: the conclusion that a competitive market results in an efficient outcome; sometimes called the invisible hand theorem ; the definition of efficiency used in the theorem is pareto efficiency. Individual consumers and firms in a market: efficiency and income inequality.
