Efficiency IMBA Managerial Economics Jack Wu Econ

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 3 G wireless telecommunications; pioneer: in early 1990 s, 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 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 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 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 j 0 $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 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 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 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.