Ch05-Lecture+Notes

# Ch05-Lecture+Notes - Resource Allocation Methods Well study...

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Resource Allocation Methods We’ll study market (or market price mechanism). How market price functions as a signal of scarcity or abundance How and under what circumstances market helps to allocate resources efficiently How and under what circumstances market may result in an undesirable outcome What other allocation methods can be used to augment market mechanism [ ] Benefit, Cost, and Surplus Demand = Willingness to Pay = Marginal Benefit: The three statements below have the same meaning. “The quantity of pizza demanded at the price of \$1.00/slice is 30 slices.” “The consumer is willing to pay \$1.00 for the 30 th slice.” “The consumer’s marginal benefit from the 30 th slice is \$1.00.” Market demand is the sum of individual demands. Graphically, you get the market demand curve by horizontally adding all individual demand curves. Consumer surplus is the difference between what consumers are willing to pay and what they actually pay. Use the words correctly: Always specify the price, or the quantity, at which consumer surplus is calculated. For example, to compute an individual’s consumer surplus at 30 slices of pizza, First note the price at which 30 slices are demanded, say \$1.00. Next, compute the difference between what consumer is willing to pay for the 1 st slice and \$1.00. Then compute the difference between what consumer is willing to pay for the 2 nd slice and \$1.00. : : Then compute the difference between what consumer is willing to pay for the 29 th slice and \$1.00. Then compute the difference between what consumer is willing to pay for the 30 th slice and \$1.00 (this is 0!).

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Finally, sum all the differences you have computed. That sum is the consumer surplus at 30 slices. Graphically, consumer surplus is, approximately , the area below the demand curve and above horizontal line at the price \$1.00: When the good is measured in small enough units, this is a good approximation. [ ] Supply = Willingness to Sell = Marginal Cost:
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