Download Chapter 5 Efficiency and Equity Answers to Review Quizzes

EFFICIENCY AND EQUITY
Chapter 5
Efficiency and Equity
Answers to Review Quizzes
Page 105
1.
The alternative methods of allocating resources are: market price, command, majority rule,
contest, first-come, first-served, lottery, personal characteristics, and force.
2.
Market prices work well to allocate resources to the production of consumer goods such as
automobiles where many individuals are able to express their particular preferences.
Universities operate in a command system where the Dean’s office allocates resources to
different departments based on his/her understanding of their needs. If the majority of
Canadians want additional resources allocated to health care, they may vote for a federal party
that includes that promise in their election platform. Contests are often seen in the form of
promotions where the individual effort of a worker is hard to observe and reward. The
promise of winning a promotion may serve as strong motivation to work hard. Concert goers
wishing to see a major act are often confronted with a first-come, first-served allocation of
tickets. Owners of the venue can then ensure that all seats are filled, but capacity is not
exceeded. Lotteries are used to allocate hunting licenses. Governments might have a desire to
allocate licenses to the safest hunters but are not able to make the distinction and therefore
have no reason to differentiate between potential hunters when allocating the licenses.
Personal characteristics are used in allocating jobs (and therefore income). This may be
beneficial if certain characteristics (eg., the ability to operate under pressure) matter in job
performance. Police use force or the threat of force prevent the allocation of resources
through theft.
3.
Market prices may result in deserving individuals not receiving an allocation of housing.
Command systems resulted in major economic chaos in places like North Korea and
Romania. Majority rule might result in too few resources being allocated to the needs of
minorities. Contests produce winners but also produce losers. Individuals may work hard for
a promotion but not get one. First-come, first-served mechanisms may produce inefficient
queuing where valuable time is lost waiting in line. Lotteries allocate resources on the basis of
luck. In allocating fishing quotas, it would be better to award them to the most efficient
fishers. Discrimination results in individuals without the desired personal characteristics
receiving a smaller allocation of resources. War is an obvious example of a bad outcome of
the use of force to allocate resources.
Page 107
1.
The value or marginal benefit of a good or service is measured by the maximum price people
are willing to pay for one more unit of a good or service.
2.
Consumer surplus is the value of a good minus the price paid for it. It is shown on a graph as
the area below the demand curve and above the price.
CHAPTER 5
Page 109
1.
The marginal cost of producing a good or service and the minimum supply-price are the
same. The cost of producing one more unit of a good or service is its marginal cost or
opportunity cost. The marginal cost is the minimum price that producers must be offered to
induce them to produce another unit of the good or service.
2.
Producer surplus is the price of a good minus the opportunity cost of producing it. It is
shown on a graph as the area above the supply curve and below the price.
Page 113
1.
Competitive markets use resources efficiently. Resource use is efficient when the sum of
consumer surplus and producer surplus is maximized. The demand curve is a marginal benefit
curve and the supply curve is a marginal cost curve. In equilibrium, marginal benefit equals
marginal cost—the condition that gives an efficient use of resources.
2.
Deadweight loss is the decrease in consumer surplus and producer surplus that results from
an inefficient level of production. A deadweight loss occurs when actual production is greater
than or less than the efficient quantity.
3.
The obstacles to achieving an efficient allocation of resources in the market economy are:
price and quantity regulations that result in underproduction; tax and subsidies that lead to
under- and over-production, respectively; externalities that lead to underproduction when
positive and underproduction when negative; public goods which are under-produced and
common resources which are over-used; monopolies that under-produce, and; high
transactions costs that cause under-production.
Page 117
1.
The two approaches to fairness are
•
•
It’s not fair if the result isn’t fair
It’s not fair if the rules aren’t fair
2.
The utilitarian idea of fairness is that equality is fair. To achieve equality, income is transferred
from the rich to the poor until the marginal utility of the last dollar of income is the same for
all households. Utilitarianism ignores the cost of making the income transfers. These costs
lead to a tradeoff between efficiency and fairness. So, the problem with utilitarianism is that
achieving equality comes at the expense of losing efficiency.
3.
The big tradeoff is a tradeoff between efficiency and fairness. Income is transferred from
high-income earners to low-income earners by taxation. Taxing income from labour makes
people work less and taxing income from capital makes people save less. The quantity of
capital and the quantity of labour are both less than the efficient quantity. When a dollar is
taken from a rich person, government administration takes part of the dollar so the entire
dollar is not received by a poor person.
4.
The idea of fairness developed to deal with the big tradeoff is that equality should be pursued
so that the poorest is as well off as possible. The main idea of fairness based on fair rules is
equality of opportunity. This is the economic application of the symmetry principle—the
requirement that people in similar situations be treated similarly.
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EFFICIENCY AND EQUITY
Worksheet Without Answers
1.
An article in The Economist provided an application of the concept of allocative efficiency. The
article focused on the allocation of resources available for the annual health budget of
Tanzania—about $10 per person per year.
The rule you learned in Chapter 5, “produce at the point where the marginal benefit equals the
marginal cost,” is applicable in this situation with some modification. Define marginal cost as
“the opportunity cost of medical services devoted to battling a particular disease” and
marginal benefit as “years of life saved from an additional unit of medical service spent on
fighting the disease”.
Researchers in Morogoro, Tanzania found that the pre-1998 health budget reflected serious
resource misallocation. “Malaria, for example, accounted for 30 percent of the years of life lost
in Morogoro, but only 5 percent of the 1996 health budget. A cluster of childhood problems,
including pneumonia, diarrhea, malnutrition, measles and malaria, constituted 28 percent of
the disease burden, but received only 13 percent of the budget. On the other hand,
“Tuberculosis, which accounted for less than 4 percent of years of life lost, received 22
percent of the budget.” (“For 80 Cents More.” The Economist August 15, 2002)
a.
Use the diagrams below to indicate the current situation in Tanzania for medical care
devoted to malaria and tuberculosis.
b.
Could Tanzania be made better off with no increase in its health care budget? Refer to
your answer to part (a).
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CHAPTER 5
Worksheet With Answers
1.
An article in The Economist provided an application of the concept of allocative efficiency. The
article focused on the allocation of resources available for the annual health budget of
Tanzania—about $10 per person per year.
The rule you learned in Chapter 5, “produce at the point where the marginal benefit equals the
marginal cost,” is applicable in this situation with some modification. Define marginal cost as
“the opportunity cost of medical services devoted to battling a particular disease” and
marginal benefit as “years of life saved from an additional unit of medical service spent on
fighting the disease”.
Researchers in Morogoro, Tanzania found that the pre-1998 health budget reflected serious
resource misallocation. “Malaria, for example, accounted for 30 percent of the years of life lost
in Morogoro, but only 5 percent of the 1996 health budget. A cluster of childhood problems,
including pneumonia, diarrhea, malnutrition, measles and malaria, constituted 28 percent of
the disease burden, but received only 13 percent of the budget. On the other hand,
“Tuberculosis, which accounted for less than 4 percent of years of life lost, received 22
percent of the budget.” (“For 80 Cents More.” The Economist August 15, 2002)
a.
Use the diagrams below to indicate the current situation in Tanzania for medical care
devoted to malaria and tuberculosis.
In both figures the dotted line indicates the quantity of units of medical care devoted to
each illness. Currently fewer than the efficient number of units of medical care are
devoted to malaria and, as the figure shows, for this disease the marginal benefit of an
additional unit exceeds the marginal cost. And more than the efficient number of units of
medical care are devoted to tuberculosis and, as the figure shows, for this disease the
marginal benefit of an additional unit is less than the marginal cost.
b.
Could Tanzania be made better off with no increase in its health care budget? Refer to
your answer to part (a).
Because the marginal benefit of the last unit of medical care devoted to malaria is greater
than its marginal cost and because the marginal benefit of the last unit of medical care
devoted to tuberculosis is greater than its marginal cost, Tanzanians can enjoy a net gain
by transferring resources away from tuberculosis and into treatment for malaria. This
transfer moves both markets closer to the efficient quantity of resources. In both
“markets” the figures show that there is a deadweight loss from inefficiency. The
“market” for medical care devoted to malaria suffers from underproduction and the
“market” for medical care devoted to tuberculosis suffers from overproduction.
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