Flagship Course Module 1 Overview The Basics of Market

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?

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

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

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

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

Conditions for a Well-functioning Market 1- Production Side Many producers Free entry and exit of producers Low fixed cost No production externality

Conditions for a Well-functioning Market 2- Consumption Side Informational symmetry No consumption externality No dominant consumer

Externality Production externalityProduction externality Social cost = Private cost + E Consumption externalityConsumption externality Social benefit = Private benefit ± E

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

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

Demand Schedule Quantity Price P1P1 P2P2 Q2Q2 Q1Q1 Q’ 2 Q’ 1 Price elasticity of demand

Demand Schedule Quantity Price P1P1 P2P2 Q2Q2 Q1Q1 Vertical height of demand schedule

Supply Schedule Quantity Price P1P1 P2P2 Q2Q2 Q1Q1 Price elasticity of supply

Supply Schedule Quantity Price P1P1 P2P2 Q2Q2 Q1Q1 Vertical height of supply schedule

Interaction of Demand and Supply Schedule Quantity Price PEPE P0P0 Q0sQ0s QEQE Q0dQ0d S D

Externality Production externalityProduction externality Social cost = Private cost + E Consumption externalityConsumption externality Social benefit = Private benefit ± E

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

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

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

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

Efficiency of the Market a b Surplus = a + b S = MSC D = MSB QEQE PEPE

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

Government Role in Market Failure Failure Government Role Water contamination by pesticides Taxation Inability of consumers to judge the true value of a good Public education Regulatory approach MonopolyAnti-trust regulations

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

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