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5
EFFICIENCY AND
EQUITY
Chapter Key Ideas
Self-Interest and the Social Interest
A. Every purchase made by a consumer is an expression of that consumer’s values over what
should be produced with our scarce resources. Consumers make these decisions out of selfinterest, trying to make themselves the happiest they can with the limited resources they
have. Do these choices necessarily promote the social interest—that is, what is best for
society?
B. The market economy generates high incomes for some and low incomes for others. What
is a fair distribution of goods and services across society?
C. This chapter explains how economists approach questions about the social interest as well
as the conditions under which competitive markets can yield efficient outcomes, and it
describes the sources of inefficiency and explores different concepts of fairness.
Outline
I.
Efficiency and the Social Interest
A. Recall from Chapter Two that an efficient allocation of resources occurs when we cannot
produce more of one good without giving up the production of some other good that is
valued more highly.
1.
This definition implies that it is not possible to make someone better off without
making someone worse off.
 Efficiency is based on values, which are determined by people’s preferences.
B. Marginal benefit is the benefit a person receives from consuming one more unit of a
good or service.
1.
We can measure the marginal benefit from a good by the dollar value of other goods
that a person is willing to give up to get one more unit.
2.
The concept of decreasing marginal benefit implies that as more of a good is
consumed, its marginal benefit decreases.
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3.
Figure 5.1 shows the decreasing
marginal benefit from each
additional slice of pizza, measured in
dollars per slice.
C. Marginal cost is the opportunity cost of
producing one more unit of a good. The
measure of marginal cost is the value of
the best alternative forgone to obtain the
last unit of the good.
1.
We can measure the marginal cost of
a good or service by the dollar value
of other goods and services that a
person is must give up to get one
more unit of it.
2.
The concept of increasing marginal
cost implies that as more of a good
or service is produced, its marginal cost increases.
3.
Figure 5.1 also shows the increasing marginal cost of each additional slice of pizza,
measured in dollars per slice.
D. Efficiency and Inefficiency
1.
If the marginal benefit from a good exceeds its marginal cost, producing and
consuming one more unit of the good uses resources more efficiently.
2.
If the marginal cost of a good exceeds its marginal benefit, producing and consuming
one less unit of the good uses resources more efficiently.
3.
If the marginal benefit from a good equals its marginal cost, producing and consuming
one more unit of the good or one less unit of the good uses resources less efficiently.
4.
When marginal benefit equals marginal cost, we cannot improve on this allocation of
resources. It is efficient. In Figure 5.1, the efficient quantity of pizza is 10,000 pizzas
per day.
II. Value, Price, and Consumer Surplus
A. The value of one more unit of a good or service is its marginal benefit, which we can
measure as maximum price that a person is willing to pay.
1.
A demand curve for a good or service shows the quantity demanded at each price. A
demand curve also shows the maximum price that consumers are willing to pay at each
quantity.
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2.
Figure 5.2 shows two ways of interpreting a demand curve.
3.
Because a demand curve shows the maximum price that consumers are willing to pay
for the last unit of the good at each quantity available, a demand curve is a marginal
benefit curve.
B. Consumer surplus is the value of a good minus the price paid for it, summed over the
quantity bought.
1.
The price paid is the market price, which is the same for each unit bought. The
quantity bought is determined by the demand curve.
2.
Consumer surplus is measured by the area under the demand curve and above the price
paid, up to the quantity bought.
3.
Figure 5.3 shows the consumer
surplus for pizza for an individual
consumer.
III. Cost, Price, and Producer Surplus
A. The cost of one more unit of a good or
service is its marginal cost, which we
can measure as minimum price that a
firm is willing to accept.
1.
A supply curve of a good or service
shows the quantity supplied at each
price. A supply curve also shows the
minimum price that producers are
willing to accept at each quantity.
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2.
Figure 5.4 shows two ways of interpreting a supply curve.
3.
Because a supply curve shows the minimum price that producers are willing to accept
for the last unit of the good at each quantity available, a supply curve is a marginal
cost curve.
B. Producer surplus is the price of a good minus the marginal cost of producing it,
summed over the quantity sold.
1.
The price of a good is its market price,
which is the same for each unit sold.
2.
The quantity sold is determined by the
supply curve.
3.
Producer surplus is measured by the area
below the price and above the supply
curve, up to the quantity sold.
4.
Figure 5.5 shows the producer surplus for
pizza for an individual producer.
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IV. The Efficiency of a Market Equilibrium
A. Figure 5.6 shows that a competitive
market creates an efficient allocation of
resources at equilibrium.
1.
The demand curve can be thought
of as the marginal benefit curve for
society, and the supply curve as the
marginal cost curve for society.
2.
In equilibrium, the quantity
demanded equals the quantity
supplied, which means the marginal
benefit to society of the last unit
consumed equals the marginal cost
to society of making the last unit
available for consumption.
3.
The sum of consumer and producer
surplus is maximized at this
efficient level of output. No other
quantity bought and sold will
produce as much consumer or
producer surplus.
B. Adam Smith’s Invisible Hand idea in
his book Wealth of Nations implied that
competitive markets motivate consumers
and producers to send resources to their
highest valued use in society.
1.
Consumers and producers make
decisions in their own self-interest
when they interact in markets.
2.
These market transactions can
generate an efficient allocation of
resources allocated to their highestvalued use in society.
C. Markets are not always efficient. Some obstacles to efficiency include:
1. Price ceilings and floors: Artificial constraints on price.
2. Taxes, subsidies, and quotas: Place a wedge between price received by sellers and
price offered by sellers.
3. Monopoly: A lack of competitive pressure places a wedge between marginal cost and
selling price.
4. Public goods and Common Resources: Marginal benefits (costs) no longer equal social
marginal benefits (costs)
5. External costs and external benefits: The full benefits (costs) do not accrue to the
consumer (producer)
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D. Underproduction and Overproduction
1.
Obstacles to efficiency lead to
underproduction or overproduction
and create a deadweight loss—a
decrease in consumer and producer
surplus.
2.
Figure 5.7 shows the dead weight
loss from underproduction and
overproduction.
V. Is the Competitive Market Fair?
A. Economists agree about efficiency, but
disagree about equity. To help understand
why, Ideas about fairness can be divided
into two groups:
1. It’s not fair if the result isn’t fair
2. It’s not fair if the rules aren’t fair
B. It’s Not Fair if the Result Isn’t Fair
1.
The idea that “it’s not fair if the
result isn’t fair” began with
utilitarianism, which is the
principle that states that we should
strive to achieve “the greatest
happiness for the greatest number.”
2.
If everyone gets the same marginal
utility from a given amount of
income, and if the marginal benefit
of income decreases as income
increases, taking a dollar from a
richer person and given it to a poorer
person increases the total benefit. In
this way, only when income is
equally distributed has the greatest happiness been achieved.
3.
Utilitarianism ignores the cost of making income transfers. Recognizing these costs
leads to the big tradeoff between efficiency and fairness.
4.
Because of the big tradeoff, John Rawls proposed that income should be redistributed
to point at which the poorest person is as well off as possible.
C. It’s Not Fair If the Rules Aren’t Fair
1.
The idea that “it’s not fair if the rules aren’t fair” is based on the symmetry
principle, which is the requirement that people in similar situations be treated
similarly.
2.
In economics, this principle means equality of opportunity, not equality of income.
Robert Nozick suggested that fairness is based on two rules:
a)
The state must create and enforce laws that establish and protect private property.
b) Private property may be transferred from one person to another only by voluntary
exchange.
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Reading Between the Lines
A news article discusses inefficiency in water use. The analysis points out that in some places, such
as Ethiopia, less than the efficient quantity of water is used from the Nile whereas in other places,
such as Egypt, more than the efficient quantity of water is used from the Nile. In both circumstances,
a deadweight loss results.
New in the Seventh Edition
The discussion of how consumer choices made in self-interest influence the social interest is
expanded.
Te a c h i n g S u g g e s t i o n s
1. Efficiency: A Refresher
The substance of this section is identical to Chapter 2, pp. 35–37. Explain that this section in
Chapter 5 provides an alternative example of the same ideas as those in Chapter 2 and serves as a
springboard for going forward and seeing the connection between what they’ve learned about
demand, supply, market price, and quantity in Chapter 3 and what they learned about efficiency in
Chapter 2. Emphasize that learning economics isn’t memorizing facts, but understanding principles
and ideas, and that one idea builds on another.
2. Value, Price, and Consumer Surplus
One thing that students sometimes get hung up on is the exact shape of the consumer surplus area—
steps versus the complete triangle. The point isn’t worth laboring, but if students raise the matter
and are curious, you might explain that we’re assuming that the good (pizza in the example) is finely
divisible so that the whole triangle is (approximately) the consumer surplus. (Note: You will look at
consumer surplus again if you cover marginal utility theory.)
3. Cost, Price, and Producer Surplus
A similar issue about the shapes of the areas arises here too. You might want to emphasize that the
total revenue of the producer is the rectangle whose corners are (0, 0) and (P, Q). This total revenue
divides into cost and producer surplus and the supply curve (the marginal cost curve) marks the
boundary for the division.
The issue is not likely to arise at this point in the course, but you might like to keep this up your
sleeve for later when explaining the relationship between producer surplus and economic profit. The
textbook doesn’t spend any time on this relationship because for most students, it is too esoteric. But
a few thoughtful students want to know. You can explain that producer surplus equals total revenue
minus total variable cost; economic profit equals total revenue minus total cost; so producer surplus
equals economic profit plus total fixed cost. Don’t try to explain this point now. Wait until you get a
question when you’re in Chapter 9, 10, 11, or 12.
4. The Efficiency of the Competitive Market
a) The Astonishing Market Machine: Although done just with words and a graph, this section
explains the so-called “first fundamental theorem of welfare economics” that under appropriate
conditions, competitive equilibrium is Pareto efficient (what this textbook calls an efficient
allocation). You might want to provide your students with more background to this astonishing
result. It begins with Adam Smith’s invisible hand conjecture. Some progress was made by Vilfredo
Pareto (1848–1923), an Italian economist (see http://cepa.newschool.edu/het/profiles/pareto.htm),
who defined an efficient allocation as one in which it is not possible to rearrange the use of
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resources an make someone better off without making someone else worse off. But Adam Smith’s
conjecture did not receive formal proof until the 1950s. John Hick, Kenneth Arrow, and Gerard
Debreu are credited with the major contributions to welfare economics and received the Nobel Prize
in Economic Sciences for their work (see http://www.nobel.se/economics/laureates/1972/index.html,
http://www.nobel.se/economics/laureates/1983/index.html). Lionel McKenzie (University of
Rochester) is also credited with a major independent statement of the theorem and some economists
refer to it as the Arrow-Debreu-McKenzie theorem.
The A-D-M proof is deeper and more restricted that the arm waving words and diagrams of a
principles text. But we do not mislead our students by being enthusiastic and amazed at the
astonishing proposition. Selfish people all pursuing their own ends and making themselves as well
off as possible end up allocating resources in such a way that no one can be made better off
(qualified by the exceptions that we quickly note in the chapter.)
b) Don’t get too hung up on the mechanics of how the obstacles to efficiency work. Just note at
this stage that they bring either underproduction or overproduction and emphasize the deadweight
loss that they generate. You will go into the details in later chapters. The list is guide to what is
coming.
In the overproduction case, you might like to bring the PPF back into the story and point out that
the overproduction of one good means the underproduction of some other good. If you’re brave, you
might want to explain that in the two-goods world of the PPF, you get the complete efficiency
analysis by looking at only one of the markets. If you use guns and butter again, the overproduction
of guns implies the underproduction of butter. You can measure the deadweight loss in either the
market for guns (overproduction like Figure 5.7b) or in the market for butter (underproduction like
Figure 5.7a). Make this extension only with bright students in an honors section.
5. Is the Competitive Market “Fair”?
You could spend the rest of the course talking about and discussing equity, fairness, or distributive
justice as it is sometimes called.
This material is not standard and you’ll be hard pressed to find it in any other principles text. It is
included here because students are very curious about just what is “fair.” And the news media writes
and talks of little else when it discusses economic issues.
Some years ago, Jim Tobin told Michael Parkin a nice test of whether a person is a liberal or a
conservative. It also generates a good classroom discussion. Here’s how it goes. Give the students
the following scenario and question: You are at an oasis in a large desert and you have some ice
cream in an unmovable refrigerator. (Ice cream is the only food available). The people in the next
oasis some miles away have no ice cream (and no other food) and are too old and infirm to travel.
You have plenty of ice cream and you can transport it to the next oasis, but on the journey, some of
it will melt. Now the question: How much of the ice cream would have to survive the journey for it
to be worth transporting to the next oasis?
Your students will not agree. The most liberal would transport if only the smallest percentage
survived the journey. The most conservative would want a large proportion to survive before
undertaking the redistribution.
You can point out that different people choose different points on the big tradeoff.
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The Big Picture
Where we have been
This chapter develops a more concise discussion of efficiency introduced in Chapter 2, and
develops a deeper understanding of how the demand and supply model introduced in Chapter 3
influences resource allocations in an economy. It also explains the situations in which a
competitive market does and does not allocate resources efficiently.
Where we are going
Chapter 6 applies the concepts of efficiency and deadweight loss to market regulation policies
such as rent ceilings and minimum wage laws. Students should understand these concepts well
to appreciate applying demand and supply to important markets in our economic world. The
concepts of efficiency and deadweight loss also recur in Chapters 11 and 12, which examine
perfect competition and monopoly, and in Chapters 14, 15, and 16, which cover more complex
government regulatory policies, social issues, public goods, and externalities.
O ve r h e a d Tr a n s pa r e n c i e s
Transparency
Text figure
Transparency title
26
Figure 5.1
The Efficient Quantity of Pizza
27
Figure 5.3
A Consumer’s Demand and Consumer Surplus
28
Figure 5.5
A Producer’s Supply and Producer Surplus
29
Figure 5.6
An Efficient Market for Pizza
30
Figure 5.7
Underproduction and Overproduction
Electronic Supplements
MyEconLab
MyEconLab provides pre- and post-tests for each chapter so that students can assess their
own progress. Results on these tests feed an individualized study plan that helps students
focus their attention in the areas where they most need help.
Instructors can create and assign tests, quizzes, or graded homework assignments that
incorporate graphing questions. Questions are automatically graded and results are tracked
using an online grade book.
PowerPoint Lecture Notes
PowerPoint Electronic Lecture Notes with speaking notes are available and offer a full
summary of the chapter.
PowerPoint Electronic Lecture Notes for students are available in MyEconLab.
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Instructor CD-ROM with Computerized Test Banks
This CD-ROM contains Computerized Test Bank Files, Test Bank, and Instructor’s Manual
files in Microsoft Word, and PowerPoint files. All test banks are available in Test
Generator Software.
Additional Discussion Questions
1. After the “Perfect Storm”: Do price controls help or hurt disaster victims? The author
introduces the compelling dilemma of whether price controls should be imposed following a
natural disaster. Engage the students in a careful discussion on this theme, as it opens their eyes
to the complexities involved with trying to improve upon the competitive market allocation of
scarce resources, even under times of economic duress.

Should “price gouging” and “profiteering” be considered criminal acts? Price controls are
often imposed for weeks after the devastating event occurs. Goods such as bottled drinking
water, bags of ice, batteries, electrical generators, plywood sheets (to seal broken windows),
and chain saws (to remove downed trees from roadways) are typical objects for which sellers
are not allowed to raise their sale price above pre-disaster levels. Ask students to critically
examine the claim that such price restrictions protect the interests of disaster victims who are
trying to get their lives back to normal as quickly as possible.
What happens to the demand curve for these goods? Ask the students to use the supply and
demand model to reflect changes in the market for these goods immediately after the disaster
has struck. Clearly the radical change in the local environment causes a rightward shift in the
demand curve, sharply raising equilibrium market price. A price ceiling results in a heartwrenching shortage.
What happens to the supply curve for these goods? Emphasize that the devastation that creates
trauma for the consumers also significantly increases the cost of replacing the goods sold in a
timely fashion. Replacement of these items needs to be rather quick if the victims want to
minimize any future damage to the community (continued water damage from damaged homes,
illnesses from contaminated drinking water supplies, etc.). The increase in the opportunity cost
of supplying these goods pushes the supply curve to the left, aggravating the shortage. Motivate
the students to consider how the goods will ultimately be distributed.
Distribution under price regulation: There is much pain, but is there any gain (in efficiency
or in fairness)? Point out to students that in an unregulated market, only those victims who
value the goods at least as much as the unregulated equilibrium price would receive the scarce
goods. Under price controls, it is uncertain how the goods will be allocated. Consumers with
relatively low valuation of the goods are just as likely end up with the goods as those who have
a relatively high valuation, decreasing total consumer surplus. Also, point out that if private
resale prices are not closely monitored, then those victims with a relatively low value for their
goods would engage in arbitrage by selling the goods at a high price to victims with a relatively
high valuation for the goods. This simply transfers producer surplus from sellers to low
valuation consumers, the fairness of which would be difficult to justify.
Can price regulation contribute to undesirable seller behavior? Since the price control action
erases the opportunity cost that suppliers would normally face if they fail to sell their scarce
goods to the highest bidder, these sellers may consider any number of non-monetary benefits
when they determine who will ultimately receive their goods: Friends and well-networked
acquaintances of the suppliers will likely receive consideration over strangers who would
otherwise be willing to pay a higher price. Emphasize that a price ceiling effectively erases any
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opportunity cost that suppliers would otherwise bear for engaging in socially undesirable
actions, such as practicing racial, gender, or religious discrimination when selling their goods.
Can price regulation actually prolong victims’ suffering? Point out that for suppliers to
quickly replace their depleted inventory they must be willing to bid away the goods from other
areas not devastated by the disaster. Also, special deliveries of these goods to the disaster area
must be arranged, meaning transportation resources must also be bid away from their usual
employment. Both realities increase the cost of inventory replacement. Under a price ceiling
there is insufficient incentive for goods to be quickly redistributed to where they are needed the
most.
2. The big tradeoff: How can economic analysis makes us more informed citizen voters? How
to properly address the big tradeoff in society is the heart of current debates over proposed
changes to the federal income tax code between candidates (and their political party platforms)
running for federal offices.
• Should tax rates be decreased in order to spur greater economic activity and increase
total production of goods and services in the economy? Get the students to identify and
describe the opportunity cost of this proposal. Would income inequality increase? Would
the “social fabric” change?
• Should the tax rates be increased to fund greater government services and income
redistribution programs? This chapter has shown that the economic pie would decrease if
income were redistributed. How much decrease in economic activity is worth the greater
equality? Greater knowledge of economic analysis lets people weigh these opportunity
costs more carefully and thoughtfully.
3.
Does the concept of decreasing marginal benefits actually imply that rich people will lose
fewer benefits from an income transfer than the gain in benefits to the poor? Emphasize to
the students that many social policies (both private and public) that favor the poor at the
expense of the rich are justified on utilitarian grounds. Marginal income tax rates that rise with
income is one obvious example. A business discount for seniors (who are presumed to be
poorer than the general population) is another example. Yet the students should understand that
the ability to make a direct comparison of benefits lost for one person against the benefits
gained by another is not implied by the concept of diminishing marginal benefits. Explain to
them that the assumption of decreasing marginal benefits allows us to compare the marginal
benefits across different levels of consumption for the same person, but it says nothing about
comparing the marginal benefits across different people at different consumption levels. To
clarify this, ask them the following question:
Can we truly measure and compare the happiness from a rich person’s consumption level to a
poor person’s consumption level for the same good? Have the students assume that the quantity
of income taken away from a rich mother means that she is now able to send only one, rather
than both, of her children to college. Assume also that the same quantity of income given to a
poor mother enables her to send one of her two children to college when she otherwise couldn’t
have afforded to send either child to college. Ask the students, “Does this imply that the
happiness, or perceived value, lost by the rich mother is somehow smaller than the happiness,
or perceived value gained by the poor mother?” Ask the students if anyone can honestly claim
to know that one mother’s concern about providing for her second child is smaller in magnitude
than another mothers’ concern about providing for her first child. Obviously not! Explain that if
this claim is false for this example, then it is false for all examples comparing benefit gains and
losses across people at different levels of in income.
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Answ ers to the Review Quizzes
Page 103
1.
If the marginal benefit of pizza exceeds the marginal cost of pizza, we are producing too
little pizza and too much of other goods. The marginal benefit reveals how much other things
people are willing to give up for the last unit of pizza consumed, while the marginal cost
reveals what people must give up in order to produce it. This means if more resources were
devoted to producing one more unit of pizza, the benefits that unit of pizza will generate will
be higher than the lost benefits of the next best alternative good that could have been
produced by those resources. The result will be a net increase in benefits for society.
2.
If the marginal cost of pizza exceeds the marginal benefit of pizza, we are producing too
much pizza and too much of some other good. The marginal benefit reveals what people are
willing to give up for the last unit of pizza consumed, while the marginal cost reveals what
people must give up in order to produce it. This means the resources that were used to
produce the last unit of pizza could have been used to make one more unit of the highest
valued alternative good. The lost benefits of that last unit of pizza forgone will be less than
the additional benefits provided by consuming the additional unit of the alternative good.
The result will be a net increase in benefits for society.
3.
The marginal benefit of pizza and the marginal cost of pizza are equal when we are
producing the efficient quantity of pizza. At this level of pizza, changing the quantity
produced cannot increase net benefits to society. If one less unit of pizza is produced, the
marginal benefit of the previous unit would be relatively higher (due to decreasing marginal
benefits) and the marginal cost of that unit would be relatively lower (due to increasing
marginal cost). In this case, the marginal benefit of consuming last unit of pizza would
exceed the marginal cost of producing it, which means that society could enjoy a net increase
in benefits by producing one more unit of pizza. On the other hand, if one more unit of pizza
is produced, the marginal benefit of that unit would be relatively lower and the marginal cost
of that unit would be relatively higher. In this case, the marginal cost of producing the last
unit of pizza would exceed the marginal benefit of consuming it, which means that society
could enjoy a net increase in benefits by producing one less unit of pizza.
1.
The value, or marginal benefit, of a good or service is measured by the maximum amount
that consumers are willing to pay for one more unit of a good or service.
2.
The demand curve for a good shows the quantity demanded by consumers at each price. The
demand curve is the same as the marginal benefit curve because the demand curve shows the
maximum price consumers are willing to pay for the last unit of the good purchased at each
quantity.
3.
Consumer surplus is the marginal benefit of a good minus the sale price paid, summed over
the quantity of the good purchased. The sale price per unit of a good is assumed to equal for
all units of the good purchased. The quantity purchased is determined by equating the
marginal benefit the sale price paid. This means that the consumer surplus can be measured
as the area under the demand curve and above the sale price paid, summed over the entire
quantity purchased.
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1.
The minimum supply price for a producer of a good or service is the marginal cost of
producing that unit of the good or service. The producer must receive a price that at least
meets that cost in order to produce the good or service.
2.
The supply curve for a good shows the quantity provided by producers at each price. The
supply curve is the same as the marginal cost curve because the supply curve shows the
minimum price producers are willing to receive for the last unit of the good produced at each
quantity.
3.
Producer surplus is the sale price received for each unit of a good minus the cost of
producing it, summed over all units produced. The sale price per unit of a good is assumed to
be the same for all units of the good sold. The quantity purchased is that quantity where the
marginal cost is equal to the sale price received. This means that the producer surplus can be
measured as the area under the sale price and above the supply curve, summed over the
entire quantity sold.
1.
In the absence of the obstacles mentioned earlier in the chapter, competitive markets use
society’s resources efficiently. For resources to be used efficiently they must be allocated to
produce the quantity of a good or service where the marginal cost of the last unit produced in
the market is equal to the marginal benefit. This condition will be met in a competitive
market because equilibrium quantity occurs where the demand curve (which equals the
marginal benefit curve) intersects the supply curve (which equals the marginal cost curve).
2.
Markets with price ceilings or floors, taxes, subsidies, quotas, monopoly power, public
goods or externalities will not produce the efficient quantity of a good or service. In each of
these situations, the market prices charged or quantities produced and sold will not result in
the efficient allocation of resources. Efficiency requires that the marginal benefit of the last
unit produced to be equal to the marginal cost, and the intersection of the demand and supply
curves in the competitive market create that result. When the market sales price or quantity is
pulled away from the normal market equilibrium, the marginal benefit of the last unit
produced does not equal its marginal cost.
3.
The deadweight loss is the disappearance of realized gains from production and exchange
between producers and consumers. This is a net decrease in potential consumer and/or
producer surplus relative to the allocation of resources resulting from the normal market
equilibrium price and quantity.
4.
No, there is no deadweight loss in a competitive market when the quantity produced equals
the equilibrium quantity and the resource allocation is efficient. At the competitive market
equilibrium, the quantity demanded equals the quantity supplied, which implies the marginal
benefit is equal to the marginal cost at that quantity. This quantity is the efficient quantity of
the good since there is no other allocation of resources that can create any higher valued
quantity of the good or service.
1.
The two big approaches to thinking about fairness are:
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2.

“It’s not fair if the result isn’t fair,” or utilitarianism.

“It’s not fair if the rules aren’t fair,” or equal economic opportunity.
The utilitarian idea of fairness implies that equality of incomes is necessary for the allocation
of resources to be “fair.” There should be income transfers from the rich to the poor until
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equality is achieved, because the marginal benefit of the last dollar of income is the same for
everybody. There are two problem with utilitarianism:

It ignores the cost of implementing the income transfers, which will decrease the total
goods and services that the finite resources of society can produce. The size of the
economic pie will be smaller.

It assumes that the existence of decreasing marginal benefits allows us to make interpersonal comparisons about value gained and lost at different levels of consumption of a
good or service. While one can compare the marginal benefits from consuming different
levels of a good or service for an individual, this is not the same as comparing the marginal
benefits from consuming different levels of a good or service across individuals.
3.
The big tradeoff is the tradeoff between equality and efficiency. Redistributing incomes
changes the incentives facing producers and consumers. Taxing income decreases producer
surplus and taxing purchases decreases consumer surplus. Producers produce less and
consumers consume less, and total economic activity declines, such that the size of the
economic pie decreases.
4.
The fair rules idea of fairness is that of providing equality of opportunity is necessary for the
allocation of resources to be “fair.” This is the economic application of the symmetry
principle, that people in similar situations be treated similarly. Equality of opportunity can be
achieved if two rules are obeyed:

The government must enforce laws that establish and protect rights to private property that
are held by individuals in society, and

Private property may be transferred from one person to another only by voluntary exchange
and without fraudulent representation.
EFFICIENCY AND EQUITY
117
Answ ers to the Problems
1.
a.
b.
c.
d.
e.
f.
2.
a.
b.
c.
d.
e.
f.
3.
a.
Equilibrium price is $1.00 a floppy disc, and the equilibrium quantity is 3 floppy discs a
month.
Consumers paid $3.
The amount paid equals quantity bought multiplied by the price paid. That is, the amount
paid equals 3 floppy discs multiplied by $1.00 a disc.
The consumer surplus is $2.25.
The consumer surplus is the area of the triangle under the demand curve above the market
price. The market price is $1.00 a disc. The area of the triangle equals (2.50  1.00)/2
multiplied by 3, which is $2.25.
Producer surplus is $0.75.
The producer surplus is the area of the triangle above the supply curve below the price.
The price is $1.00 a disc. The area of the triangle equals (1.00  0.50)/2 multiplied by 3,
which is $0.75.
The cost of producing the discs sold is $2.25.
The cost of producing the discs is the amount received minus the producer surplus. The
amount received is $1.00 a disc for 3 discs, which is $3.00. Producer surplus is $0.75, so
the cost of producing the discs sold is $2.25.
The efficient quantity is 3 floppy discs a month.
The efficient quantity is the quantity that makes the marginal benefit from the last disc
equal to the marginal cost of producing the last disc. The demand curve shows the marginal
benefit and the supply curve shows the marginal cost. Only if 3 floppy discs are produced
is the quantity produced efficient.
Equilibrium price is $10.00 a CD, and the equilibrium quantity is 100 CDs a month.
Consumers paid $1,000.
The amount paid equals quantity bought multiplied by the price paid. That is, the amount
paid equals 100 CDs multiplied by $10 a CD, which equals $1,000.
Consumer surplus is $500.
The consumer surplus is the area of the triangle under the demand curve above the market
price. The market price is $10.00 a CD. The area of the triangle equals (20  10)/2
multiplied by100, which is $500.
Producer surplus is $250.
The producer surplus is the area of the triangle above the supply curve below the market
price. The market price is $10.00 a CD. The area of the triangle equals (10  5)/2
multiplied by 100, which is $250.
The cost of producing the CDs sold is $750.
The cost of producing the CDs is the amount received minus the producer surplus. The
amount received is $10 a CD for 100 CDs, which is $1,000. Producer surplus id $250, so
the cost of producing the CDs sold is $750.
The efficient quantity is 100 CDs a month.
The efficient quantity is the quantity that makes the marginal benefit from CDs equal to the
marginal cost of producing CDs. The demand curve shows the marginal benefit and the
supply curve shows the marginal cost. Only if 100 CDs are produced is the quantity
produced efficient.
The maximum price that consumers will pay is $3.
The demand schedule shows the maximum price that consumers will pay for each
sandwich. The maximum price that consumers will pay for the 250th sandwich is $3.
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CHAPTER 5
b.
c.
d.
e.
f.
4.
a.
b.
c.
d.
e.
f.
5.
a.
The minimum price that producers will accept is $5.
The supply schedule shows the minimum price that producers will accept for each
sandwich. The minimum price that produces will accept for the 250th sandwich is $5.
250 sandwiches exceed the efficient quantity.
The efficient quantity is such that marginal benefit from the last sandwich equals the
marginal cost of producing it. The efficient quantity is the equilibrium quantity—200
sandwiches an hour.
Consumer surplus is $400.
The equilibrium price is $4. The consumer surplus is the area of the triangle under the
demand curve above the price. The area of the triangle is (8  4)/2 multiplied by 200,
which is $400.
Producer surplus is $400.
The producer surplus is the area of the triangle above the supply curve below the price.
The price is $4. The area of the triangle is (4  0)/2 multiplied by 200, which is $400.
The deadweight loss is $50.
Deadweight loss is the sum of the consumer surplus and producer surplus that is lost
because the quantity produced is not the efficient quantity. The deadweight loss equals the
quantity (250  200) multiplied by (5  3)/2, which is $50.
The maximum price that consumers will pay is $6.00.
The demand schedule shows the maximum price that consumers will pay for each bottle of
sunscreen. The maximum price that consumers will pay for the 300th bottle is $6.00.
The minimum price that producers will accept is $3.00.
The supply schedule shows the minimum price that producers will accept for each bottle of
sunscreen. The minimum price that produces will accept for the 300th bottle is $3.00.
300 bottles is less than the efficient quantity.
The efficient quantity is such that marginal benefit from sunscreen equals the marginal cost
of producing it. The efficient quantity is the equilibrium quantity—450 bottles a day.
Consumer surplus is $1,012.50
The equilibrium price is $4.50 a bottle. The consumer surplus is the area of the triangle
under the demand curve above the market price. The area of the triangle is (9.00  4.50)/2
multiplied by 450, which is $1,012.50.
Producer surplus is $1,012.50.
The producer surplus is the area of the triangle above the supply curve below the market
price. The market price is $4.50. The area of the triangle is (4.50  0)/2 multiplied by 450,
which is $1,012.50.
The deadweight loss is $225.
Deadweight loss is the sum of the consumer surplus and producer surplus that is lost
because the quantity produced is not the efficient quantity. The deadweight loss equals the
quantity (450  300) multiplied by (6  3)/2, which is $225.
Ben’s consumer surplus is $122.50. Beth’s consumer surplus is $22.50, and Bo’s consumer
surplus is $4.50.
Consumer surplus is the area under the demand curve above the price. At 40 cents, Ben
will travel 350 miles, Beth will travel 150 miles, and Bo will travel 30 miles. To find Ben’s
consumer surplus extend his demand schedule until you find the price at which the quantity
demanded by Ben is zero—the price at which Ben’s demand curve cuts the y-axis. This
price is 110 cents. So Ben’s consumer surplus equals (110  40)/2 multiplied by 350,
which equals $122.50. Similarly, Beth’s consumer surplus equals (70  40)/2 multiplied by
EFFICIENCY AND EQUITY
b.
c.
6.
a.
b.
c.
119
150, which equals $22.50. And Bo’s consumer surplus equals (70  40)/2 multiplied by 30,
which equals $4.50.
Ben’s consumer surplus is the largest because he places a higher value on each unit of the
good than the other two do.
Ben’s consumer surplus falls by $32.50. Beth’s consumer surplus falls by $12.50, and Bo’s
consumer surplus falls by $2.50.
At 50 cents a mile, Ben travels 300 miles and his consumer surplus is $90. Ben’s consumer
surplus equals (110  50)/2 multiplied by 300, which equals $90. Ben’s consumer surplus
decreases from $122.50 to $90, a decrease of $32.50. Beth travels 100 miles and her
consumer surplus is $10, a decrease of $12.50. Bo travels 20 miles and her consumer
surplus is $2.00, a decrease of $2.50.
Ann’s consumer surplus is $2,250. Arthur’s consumer surplus is $500, and Abby’s
consumer surplus is $250.
Consumer surplus is the area under the demand curve above the market price. At $20, Ann
will travel 300 miles, Arthur will travel 200 miles, and Abby will travel 100 miles. To find
Ann’s consumer surplus extend her demand schedule until you find the price at which the
quantity demanded by Ann is zero—the price at which Ann’s demand curve cuts the y-axis.
This price is $35 a passenger mile. So Ann’s consumer surplus equals (35 20)/2
multiplied by 300, which equals $2,250. Similarly, Arthur’s consumer surplus equals (25 
20)/2 multiplied by 200, which equals $500. And Abby’s consumer surplus equals (25 
20)/2 multiplied by 100, which equals $250.
Ann’s consumer surplus is the largest because she places a higher value on each unit of the
good than the other two do.
Ann’s consumer surplus rises by $1,750. Arthur’s consumer surplus rises by $1,500, and
Abby’s consumer surplus rises by $750.
At $15 a mile, Ann travels 400 miles and her consumer surplus is $4,000. Ann’s consumer
surplus equals (35  15)/2 multiplied by 400, which equals $4,000. Ann’s consumer
surplus increases from $2,250 to $4,000, an increase of $1,750. Arthur travels 400 miles
and his consumer surplus is $2,000, an increase of $1,500. Abby travels 200 miles and her
consumer surplus is $1,000, an increase of $750.
Additional Problems
1.
The table gives the demand and supply schedules for spring water.
Price
(dollars per bottle)
0
0.50
1.00
1.50
2.00
2.50
3.00
3.50
4.00
Quantity demanded
(bottles per day)
80
70
60
50
40
30
20
10
0
Quantity supplied
(bottles per day)
0
10
20
30
40
50
60
70
80
a.
What is the maximum price that consumers are willing to pay for the 30th bottle?
b.
What is the minimum price that producers are willing to accept for the 30th bottle?
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CHAPTER 5
2.
c.
Are 30 bottles a day less than or greater than the efficient quantity?
d.
What is the consumer surplus if the efficient quantity of spring water is produced?
e.
What is the producer surplus if the efficient quantity is of spring water is produced?
f.
What is the deadweight loss if 30 bottles are produced?
The table gives the demand and supply schedules for bus travel for Joe, Jean, and Joy.
Price
(cents per
Quantity demanded
passenger mile)
(passenger miles)
Joe
Jean
Joy
10
50
600
300
20
45
500
250
30
40
400
200
40
35
300
150
50
30
200
100
60
25
100
50
70
20
0
0
a.
If the price of train travel is 50 cents a passenger mile, what is the consumer surplus of
each consumer?
b.
Which consumer has the largest consumer surplus? Explain why.
c.
If the price of train travel falls to 30 cents a passenger mile, what is the change in consumer
surplus of each consumer?
EFFICIENCY AND EQUITY
121
Solutions to Additional Problems
1.
a.
b.
c.
d.
e.
f.
2.
a.
b.
c.
The maximum price that consumers will pay is $2.50.
The demand schedule shows the maximum price that consumers will pay for each bottle of
spring water. The maximum price that consumers will pay for the 30th bottle is $2.50.
The minimum price that producers will accept is $1.50.
The supply schedule shows the minimum price that producers will accept for each bottle of
spring water. The minimum price that produces will accept for the 30th bottle is $1.50.
30 bottles is less than the efficient quantity.
The efficient quantity is such that marginal benefit from the last bottle equals the marginal
cost of producing it. The efficient quantity is the equilibrium quantity—40 bottles a day.
Consumer surplus is $40.
The equilibrium price is $2. The consumer surplus is the area of the triangle under the
demand curve above the price. The area of the triangle is (4  2)/2 multiplied by 40, which
is $40.
Producer surplus is $40.
The producer surplus is the area of the triangle above the supply curve below the price.
The price is $2. The area of the triangle is (2  0)/2 multiplied by 40, which is $40.
The deadweight loss is $5.
Deadweight loss is the sum of the consumer surplus and producer surplus that is lost
because the quantity produced is not the efficient quantity. The deadweight loss equals the
quantity (40  30) multiplied by (2.50  1.50)/2, which is $5.
Joe’s consumer surplus is $9. Jean’s consumer surplus is $20, and Joy’s consumer surplus
is $10.
Consumer surplus is the area under the demand curve above the price. At 50 cents, Joe will
travel 30 miles, Jean will travel 200 miles, and Joy will travel 100 miles. To find Joe’s
consumer surplus extend his demand schedule until you find the price at which the quantity
demanded by Joe is zero—the price at which Joe’s demand curve cuts the y-axis. This
price is 110 cents. So Joe’s consumer surplus equals (110  50)/2 multiplied by 30, which
equals $9. Similarly, Jean’s consumer surplus equals (70  50)/2 multiplied by 200, which
equals $20. And Joy’s consumer surplus equals (70  50)/2 multiplied by 100, which
equals $10.
Jean’s consumer surplus is the largest because she places a higher value on each unit of the
good than the other two do.
Joe’s consumer surplus rises by $7. Jean’s consumer surplus rises by $60, and Joy’s
consumer surplus rises by $30.
At 30 cents a mile, Joe travels 40 miles and his consumer surplus is $16. Joe’s consumer
surplus equals (110  30)/2 multiplied by 40, which equals $16. Joe’s consumer surplus
increases from $9 to $16, an increase of $7. Jean travels 400 miles and her consumer
surplus is $80, an increase of $60. Joy travels 200 miles and her consumer surplus is $40,
an increase of $30.