Transcript Efficiency

IMBA Managerial Economics
Jack Wu
Econ Efficiency: Conditions
 for all users, same marginal benefit
 for all suppliers, same marginal cost
 marginal benefit = marginal cost
Equal Marginal Benefit
if not equal
 provide more to user with higher marginal benefit
 take away from user with lower marginal benefit
Equal Marginal Cost
if not equal
 supplier with lower marginal cost should produce
more
 supplier with higher marginal cost should produce less
Marginal Benefit/Cost
 if marginal benefit > marginal cost, produce more of
the item
 if marginal benefit > marginal cost, produce less of the
item
Adam Smith’s Invisible Hand: Price
 Competitive market achieves three sufficient condition for
economic efficiency:
 buyers and sellers in a market system act independently
and selfishly, yet the overall outcome is efficient



i) users buy until marginal benefit equals price;
ii) producers supply until marginal cost equals prices;
iii) users and producers face same price.
Example of Invisible Hand
 Major policy issue: how to allocate licenses for 3G wireless
telecommunications;
 pioneer: in early 1990s, US Federal Communications
Commission showed that spectrum licenses were worth
billions;
 created pressure on other governments to allocate by auction
and not favoritism.
 Auction ensures that item goes to user with highest marginal
benefit.
De-centralization
 create internal market
 if there is a competitive market for an item, set transfer
price equal to market price
 consuming units should be allowed to outsource
UCLA Anderson School, 1989
Half an invisible hand is worse than none
 priced photocopying paper
 free bond paper
Price Ceiling
Upper limit that sellers can charge and buyers can pay
 rent control
 regulated price for electricity
Price ($ per month)
Rent Control: Equilibrium
1100
b
1000
900
0
supply
equilibrium
excess demand
290
300
demand
310
Quantity (Thousand units a month)
Price ($ per month)
Rent Control: Surpluses
buyer surplus gain = cfeg
buyer surplus loss = dgb
seller surplus loss = cfeg + geb
d
1100
1000 c
900
f
b
g
supply
e
demand
0
290
300
310
Quantity (Thousand units a month)
Rent Control: Losses
 deadweight losses -- sellers willing to provide item at
price that buyers willing to pay, but provision doesn’t
occur
 price elasticities of demand and supply
_demand more inelastic --> larger loss
_ supply more elastic --> larger loss
Price Floor
Lower limit that sellers can charge and buyers can pay
 minimum wage
 agricultural price supports
Wage ($ per hour)
Minimum Wage: Equilibrium
a
excess supply
supply
4.20
b
4.00
equilibrium
c
0
demand
8
10
11
Quantity (Billion worker-hours a week)
Wage ($ per hour)
Minimum Wage: Surpluses
seller surplus gain = fdge
seller surplus loss = ghb
buyer surplus loss = fdge + egb
a
4.20
4.00
f
d
supply
e
b
g
h
c
0
demand
8
10
11
Quantity (Billion worker-hours a week)
Minimum Wage: Losses
 deadweight losses -- sellers willing to provide item at
price that buyers willing to pay, but provision doesn’t
occur
 price elasticities of demand and supply
_supply more inelastic --> larger loss
_demand more elastic --> larger loss
Tax: Commodity Tax
“the only two sure things in life are death and taxes”
 buyer’s price - tax = seller’s price
 payment vis-à-vis incidence
 US: airlines pay tax
 Asia: passengers pay
Price ($ per ticket)
Tax: Equilibrium
804
$10
e
800
794
0
supply
b
h
900
demand
920
Quantity (Thousand tickets a year)
Tax: Surpluses
Price ($ per ticket)
buyer surplus loss = fdge + egb
seller surplus loss = djhg + ghb
revenue gain = fdge + djhg
804 f
800 d
794
0
j
$10
e
g
b
h
900
supply
demand
920
Quantity (Thousand tickets a year)
Incidence
 incidence and deadweight loss depend on price
elasticities of demand and supply
 ideal tax (no deadweight loss): inelastic
demand/supply
 who pays the tax not relevant
Discussion Question 1
 Consider a company that manages a network of
hospitals across several counties in one state.
Household incomes and the cost of living are higher in
urban than rural areas. The company, however, has set
the same prices for pharmaceuticals and services in all
of its hospitals. It has also paid the same salaries for
doctors, nurses, and other professional staff
throughout the state.
Discussion Question 1:continued
 Management has noticed that there are long waiting
lists for treatment at its urban hospitals. Can you
explain this problem?
 The company has had great difficulty in recruiting
professional staff for its urban hospitals. Can you
explain this problem?
 What advice would you give to management?
Discussion Question 2
 E-commerce is predicted to reduce the cost of
intermediary services such as those of travel agencies,
real-estate brokers, and investment advisors. Consider
the market for air travel. Suppose that, with
conventional travel agencies, the market equilibrium
price is $300 per ticket, including a $15 intermediation
cost. The quantity bought is 2 million tickets a year.
With e-commerce, however, the intermediation cost
falls to $2 per ticket.
Discussion Question 2:continued
 Using suitable demand and supply curves, illustrate the
original equilibrium with conventional travel agencies.
Represent the intermediation cost by shifting the supply
curve.

 Illustrate the new equilibrium with e-commerce.

 What factors determine the extent to which consumers
will benefit from e-commerce? Explain your answer
with demand and supply curves.
Discussion Question 3
 Typical real-estate broker: "In California, the seller
always pays the broker's commission, so, buyers get
brokerage services free."

 MBA: "If the custom were for the buyer to pay the
commission, then would sellers get brokerage services
free?"

 Real-estate broker, clearly losing patience: "That is a
purely hypothetical scenario, but if that situation were
to arise, yes, I guess you're right."
Discussion Question 3:continued
 Assume that each seller pays a brokers' commission of
$18,000. Then, the supply of houses includes the cost of
brokerage. Illustrate the market equilibrium with a
price of $310,000 per house and sale of 200,000 houses a
year.
 Now suppose that buyers rather than sellers pay the
$18,000 commission. Using your figure, illustrate the
following: (i) shift the supply curve down by $18,000
since sellers do not pay the commission, and (ii) shift
the demand curve down by $18,000 since buyers now pay
the commission.