This week we will be wrapping up unit 1.1 from the IB Economics syllabus here in Zurich. The final topic to cover from this section of the course is the relationship between equilibrium in a competitive market and allocative efficiency. The video below explains why the most efficient result a market can hope to achieve occurs when the price and quantity are determined by the intersection of supply and demand. Any price and quantity combination other than that found at equilibrium will reduce overall efficiency and lead to a loss of societal welfare.
Discussion Questions about Efficiency:
- “The invisible hand of the competitive market results in a more efficient allocation of resources than prices set by a government can ever hope to achieve.” Explain the economic reasoning behind this statement.
- Why does the marginal benefit to consumers of a good decrease the greater the quantity of the good becomes available on the market? Why does the marginal cost to producers increase?
- How do competitive market forces assure resources will be efficiently allocated towards the provision of various goods and services? In other words, if the quantity in a market is not at equilibrium, why is it likely to move towards equilibrium over time?
1)“The invisible hand of the competitive market results in a more efficient allocation of resources than prices set by a government can ever hope to achieve.” Explain the economic reasoning behind this statement.
If a government were to set prices in a market, there is very high chance of inefficiency as it is highly unlikely that the government will set the prices exactly at the respective market clearing prices. If the prices in a market are not at equilibrium, there is instead a disequilibrium resulting in a loss of total welfare and an under or over allocation of resources depending if the prices of goods/services are set too low or too high. The “invisible hand” on the other hand however, will naturally cause prices in the market to move towards the price equilibrium at which no one can be made better off without making someone else worse off
2) Why does the marginal benefit to consumers of a good decrease the greater the quantity of the good becomes available on the market? Why does the marginal cost to producers increase?
Marginal benefit to consumers decreases the greater the quantity of a good becomes available on the market because the more of a good is consumed, the less additional benefit will be enjoyed at each additional unit consumed
Marginal cost increases as the greater the quantity of a good becomes available as the resources to produce this good become more and more scarce with each unit of the good that is produced
3) How do competitive market forces assure resources will be efficiently allocated towards the provision of various goods and services? In other words, if the quantity in a market is not at equilibrium, why is it likely to move towards equilibrium over time?
If the quantity in a market is not at equilibrium over time the invisible hand of the market will naturally shift the quantity to equilibrium. For example if the quantity of a good available on the market is below the equilibrium quantity, the marginal benefit is greater than the marginal cost meaning that resources are under allocated. Society would be better off if more of the good was available so the rational decision making of producer to produce more and the consumers to consume more is what will bring the market to equilibrium
1. “The invisible hand of the competitive market results in a more efficient allocation of resources than prices set by a government can ever hope to achieve.” Explain the economic reasoning behind this statement.
The free market consists of two components; consumers who wish to increase their material wealth and producers who are primarily seeking profit. This system naturally establishes an equilibrium price which is beneficial for both the producer and the consumer. At this price resources are allocated efficiently and there is neither a surplus nor a shortage.
However in a free market this price can allow fluctuations in demand and supply that could shift this price whereas in a command economy the price is set and therefore when the equilibrium price shifts; misallocation of resources will result and a disequilibrium between marginal cost and marginal benefit.
2. Why does the marginal benefit to consumers of a good decrease the greater the quantity of the good becomes available on the market? Why does the marginal cost to producers increase?
With increase in quantity of a good available in the market, the marginal benefit decreases because producers’ cost will increase to supply more additional units and are therefore forced to increase their prices. As the price increases quantity demanded for it will decrease as the Law of Demand states. This result in a surplus of product and therefore will again have to be altered to sell the excess (decreasing the price) until it reaches a new equilibrium.
3. How do competitive market forces assure resources will be efficiently allocated towards the provision of various goods and services? In other words, if the quantity in a market is not at equilibrium, why is it likely to move towards equilibrium over time?
The invisible hand of a competitive market will naturally drive the price back to equilibrium over time. If the price is too high it will result in a surplus and if too low into a shortage. When a surplus results the invisible hand increases a producer’s incentive to decrease the price to sell all its access and if there is a shortage it will drive the produce’s to increase their prices decreasing the quantity demanded and eventually reaching equilibrium
Discussion Questions about Efficiency:
1. “The invisible hand of the competitive market results in a more efficient allocation of resources than prices set by a government can ever hope to achieve.” Explain the economic reasoning behind this statement.
The invisible hand (a term coined by Adam Smith), basically controls the market. If the price of a consumer product is too high – the producer will not sell enough of said product, and therefore has to lower the prices. If a good is sold at a too small price, there will be a shortage in supply of said good, and therefore the producer can (and will) sell the good for a higher price. This basic principle of the invisible hand shows how it would efficiently allocate the markets resources.
2. Why does the marginal benefit to consumers of a good decrease the greater the quantity of the good becomes available on the market? Why does the marginal cost to producers increase?
The marginal benefit to consumers decreases because each additional use/purchase of a good does not result in the same satisfaction/happiness as of the purchase of the previous good. For example a consumer might be very happy about buying and eating a chocolate bar, but when he starts to buy and eat 3 chocolate bars he will not enjoy the third chocolate bar like he enjoyed the first chocolate bar.
A producer has to pay for the goods that he uses to create a certain consumer product. As he sells more of said consumer product, he also has to buy more of the resource that he needs to produce the good. Therefore the marginal benefit for the producer decreases.
3. How do competitive market forces assure resources will be efficiently allocated towards the provision of various goods and services? In other words, if the quantity in a market is not at equilibrium, why is it likely to move towards equilibrium over time?
If the quantity of a good in a market is not at equilibrium, over time to will return to equilibrium. This is because the price of the certain good will be either too high or too low. Therefore the invisible hand rule will move the product to its Price equilibrium over time.
1. What is the relationship between the value of the PED coefficient and the responsiveness of consumers to price changes?
The higher the PED the higher will be the responsivness of consumers to price changes, the lower the PED the lower the responsiveness.
2. The video explains how to interpret the various possible results of the PED calculation. But it does not explain what is meant by a PED coefficient of ZERO. How could PED = 0, and how could we interpret such a result?
When PED is = 0 it’s perfectly inelastic, this means that consumers don’t respond at all at price changes. This might happen with drugs, since consumers are so addicted they will not care if the price of what they want increase or decreases because they need it and they will buy it regardless of the cost.
3. For which good would you expect consumers to be more responsive to price changes: table salt or bottled mineral water? Why?
Table salt because water is something that all the people need to live, if water goes up a couple of CHF it doesn’t mean that we will stop buying water. But with the salt we might start to use it less if the price goes up.
Discussion Questions about PED:
1. The higher the PED coefficient is for a product, the greater consumer responsiveness of consumers to price changes. A PED of 4 signals a much greater consumer responsiveness to price changes, for example, than does a PED of 1.
2. At a PED coefficient of 0, consumers would be completely insensitive to price changes meaning that the quantity demanded would remain constant no matter the price of the good. PED could equal 0 with a good that no one wants. Diseases, for example, are something that no one wants and all consumers are consistently willing to pay nothing for diseases no matter what they cost.
3. I would expect consumers to be more responsive to price changes in bottled mineral water than in table salt. There are alternatives to bottled water, such as drinking from the tap, that consumers could shift to when the price of bottled mineral water increases. There is however, really no alternative to table salt which consumers could shift to if it became more expensive.
Discussion Questions about Efficiency:
1. The competitive market system matches supply and demand in order to arrive at an equilibrium price and equilibrium quantity. The government can not possibly select the correct price (and adjust it when it changes) more efficiently than a government.
2. The more there is of a good, the less value each additional unit carries. iPhones were very valuable when they were first released and there were very few of them. Now that seemingly everyone has an iPhone, there is less benefit to consumers for new iPhones. The marginal cost to producers increases because, as more of a good is produced, the resources needed for production become more scarce. Resources that become more scarce will also become more expensive, resulting in a higher cost for manufacturers wanting to buy them and use them to manufacture.
3. Quantity in a market, if it is not at equilibrium, will move towards equilibrium over time because it is the most efficient point for all the participants in the market. At equilibrium, the quantity supplied matches the quantity demanded, minimizing excesses and shortages for firms.
1. What is the relationship between the value of the PED coefficient and the responsiveness of consumers to price changes?
The relationship between the PED coefficient and the responsiveness of consumers to price changes is a direct one. When the PED coefficient increases, the responsiveness of the consumer to price changes will also increase, resulting in a relatively high price elasticity. On the contrary, if the PED coefficient is low, the responsiveness will also be low, resulting in little to no elasticity.
2. The video explains how to interpret the various possible results of the PED calculation. But it does not explain what is meant by a PED coefficient of ZERO. How could PED = 0, and how could we interpret such a result?
A PED coefficient of zero is only attainable if the quantity demanded of the good or service never changes at all, no matter how much of a price change it has undergone. If a good/service/resource has a PED coefficient of zero, it is completely inelastic in all ways. There is no way that there can be an increase or decrease in the responsiveness of demand.
3. For which good would you expect consumers to be more responsive to price changes: table salt or bottled mineral water? Why?
I would think that a consumer would be much more responsive to price changes in bottled mineral water rather than table salt. Bottled mineral water is more of a luxury rather than an necessity, since tap-water is also drinkable, in countries similar to Switzerland of course. Therefore, if the price of mineral water were to alter, consumers would increase or decrease their demand for it respectively. If price were to increase, people would no longer demand the luxury, due to the fact that it is simply not as necessary.
On the other hand, table salt is much more of a necessity. Beyond adding to flavor and taste, it is also a very essential nutrient and contains minerals crucial for the human body. It is impossible to survive without salt. Therefore, whether the price of salt increases or decreases, consumers will continue to demand and consume it. Understandably, if there is a very large increase in price, the demand might slightly decrease, but essentially, there would be much less response to a price change.
Discussion Questions about PED:
1. What is the relationship between the value of the PED coefficient and the responsiveness of consumers to price changes?
If the PED coefficient is greater than zero and smaller than one, it is considered inelastic, and therefore the responsiveness of the consumers to price changes is not very high. If the PED coefficient is equal to one, it is considered unit elastic, and thus the responsiveness of consumers changes to price changes according to the percentage change in price. An example of this would be if the percentage of a price of a good increases by one unit, the quantity demanded will decrease by one unit. If the PED coefficient is over one, it is considered elastic – the responsiveness of consumers to price changes is greater, and more elastic.
2. The video explains how to interpret the various possible results of the PED calculation. But it does not explain what is meant by a PED coefficient of ZERO. How could PED = 0, and how could we interpret such a result?
PED would equal zero if the consumers are not at all affected by changes in price; the good will still be demanded. This could possibly happen if related to a good that is necessary, one which people would be willing to pay any amount of money for. Medication can in some cases be an example of this.
3. For which good would you expect consumers to be more responsive to price changes: table salt or bottled mineral water? Why?
This would really depend on which country one is situated in – if you are in a country where good tap water is readily available, there is less need for bottled mineral water, whereas table salt is a good that is used frequently in cooking, and also needed to maintain good health. However, if you were in a country with no easily accessible and drinkable water, bottled mineral water would have a lower price elasticity, because people would be willing/able to pay more for good, drinkable water than they would table salt.
1. What is the relationship between the value of the PED coefficient and the responsiveness of consumers to price changes?
The relationship between the value of the PED coefficient and the responsiveness of consumers to price changes is direct. When the PED coefficient is high, the responsiveness of consumer to price changes will be high as well, as a high PED coefficient indicates considerable price elasticity.
2. The video explains how to interpret the various possible results of the PED calculation. But it does not explain what is meant by a PED coefficient of ZERO. How could PED = 0, and how could we interpret such a result?
A PED coefficient of zero could only be achieved if the QD of a good or service never alters, regardless of the price changes it suffers. A good or service with a PED coefficient of zero is considered to be perfectly inelastic. However, very few if any goods have this PED coefficient.
3. For which good would you expect consumers to be more responsive to price changes: table salt or bottled mineral water? Why?
I would expect consumers to be more responsive to price changes in table salt than bottled mineral water. This is because table salt is a commodity that is not necessary to survive, and thus if the price of salt goes up or down, people will decrease or increase their purchase of table salt respectively. Bottled mineral water on the other hand is a human necessity, and thus if prices of bottled mineral water change, the quantity demanded will not change immensely.
1. What is the relationship between the value of the PED coefficient and the responsiveness of consumers to price changes?
The relationship between the value of the PED coefficient and the responsiveness of the consumers to price changes is direct, because as the PED coefficient changes, so does the responsiveness of consumers to price changes, as that is what the PED coefficient represents. The PED coefficient determines how elastic a product is, and therefore, how responsive they are to the price changes of that product.
2. The video explains how to interpret the various possible results of the PED calculation. But it does not explain what is meant by a PED coefficient of ZERO. How could PED = 0, and how could we interpret such a result?
When the PED is 0, there is a perfectly inelastic demand. This means, that no matter what the price of a good is, the demand for the good will not change. At perfectly inelastic demand, the quantity demanded of the substance will also not change, no matter if the price of the good fluctuates. For example, for certain products, such as medicinal products, since they are a matter of life or death, no matter the price of the product, consumers will attempt to be able to afford them. The medicine they use is also usually constant, so the quantity demanded also remains stagnant, no matter the price. Therefore, when the PED is 0, there is a perfectly inelastic demand.
3. For which good would you expect consumers to be more responsive to price changes: table salt or bottled mineral water? Why?
I think, in a country like Switzerland, a consumer would be more responsive to price changes in bottled mineral water rather than table salt. Bottled mineral water in Switzerland, and many other countries, is a luxury, not a necessity, since the tap-water is drinkable. Therefore, if the price of mineral water were to fluctuate, consumers would either consume more or less mineral water. If the price were to go up, people would no longer consume this luxury, as it is not necessary. And if prices were to decrease, maybe more people would allow themselves this luxury, as it would become more affordable.
Table salt, however, is a necessity. Table salt is not just to add flavor, but it is also made of minerals that are extremely important to the human body. It is not possible to survive without an intake of salt. Therefore, no matter if the price of salt increases or decreases, people will still buy salt, and therefore will not be responsive to price changes.
Economy Homework on Blog:
1. “The invisible hand of the competitive market results in a more efficient allocation of resources than prices set by a government can ever hope to achieve.” Explain the economic reasoning behind this statement.
The reasoning above, states that once a government sets its prices, it may be tough to regulate the accurate price at which the market will be efficient. This results in a loss of welfare especially if the price is fixed at either a too high or too low amount. Therefore there would be an excess in either the supply or demand. The resources will not be allocated as efficient as before, it should also be taken into consideration that none of the individuals in the society will be better off, without making another worse off.
2. Why does the marginal benefit to consumers of a good decrease the greater the quantity of the good becomes available on the market? Why does the marginal cost to producers increase?
The marginal benefit made to consumers decrease the greater the quantity of a good on the market becomes because the more of a good is consumed, the less the additional benefit will come from consuming additional units of the good. Therefore as a greater quantity of the product is available on the market, it also becomes more exclusive and expensive to produce additional units, because as more of the good is produced by the market, the more the resources required to produce it become scarcer.
3. How do competitive market forces assure resources will be efficiently allocated towards the provision of various goods and services? In other words, if the quantity in a market is not at equilibrium, why is it likely to move towards equilibrium over time?
After a while, “the invisible hand” of the market will shift the price only towards the equilibrium price. One example would be that if the price would be set too high, then this will result in the supply being greater than the demand, and the producers will also be left with the excess goods. This indicates to producers that in order to increase the quantity demanded by consumers, they must also have a decrease in the price, moving towards the equilibrium price in which the quantity demanded equals the amount supplied. Resources will now be allocated more efficiently and there should not be loss of welfare.
Discussion Questions:
1. “The invisible hand of the competitive market results in a more efficient allocation of resources than prices set by a government can ever hope to achieve.” Explain the economic reasoning behind this statement.
In a command economy, the government controls the prices but in a free market there is an “invisible hand” which controls the prices. This “invisible hand” is pretty much the fact that when there is a shortage of a good, because it is demanded more than there is supply, the price has to be too low, therefore, the price will soon shift upwards otherwise there will be no supply for this product. The fact that the product gets more expensive due to a shortage is so that the Demand and the Supply go more towards their equilibrium supply and demand. This is what the invisible hand does, it shifts the demand and supply more towards its equilibrium supply and demand. Therefore, when the invisible hand brings the supply and demand towards its equilibrium, there is less possibility of a shortage or a negative surplus compared to a government who just sets the prices, in its best interest, the producers or the consumers best interest, whereas the invisible hand equally divides the consumers and the producers best interest.
2. Why does the marginal benefit (demand) to consumers of a good decrease the greater the quantity of the good becomes available on the market? Why does the marginal cost to producers increase?
If more of a good is being produced (the supply is larger) the marginal benefit decreases because the good is not as scarce anymore and because the consumer has less and less consumer satisfaction the more the good is produced. The more the producers produce of the good the more scarce the resources become, which it takes to produce the product. If the resources become more scarce the resources rise in costs therefore resulting in a higher cost for the producer of the product.
3. How do competitive market forces assure resources will be efficiently allocated towards the provision of various goods and services? In other words, if the quantity in a market is not at equilibrium, why is it likely to move towards equilibrium over time?
Whenever there is a negative surplus or a shortage the market and the “invisible hand” that Adam Smith talked about will reallocate the resources so they are not under allocated or over allocated. In the competitive market, it is important to have a price, which draws in enough consumers, but which also brings a high profit to the producer. If a company has their price too high, so that they don’t make as much profit as another company they will change their price, closer to the equilibrium price so they have a higher profit.
1. “The invisible hand of the competitive market results in a more efficient allocation of resources than prices set by a government can ever hope to achieve.” Explain the economic reasoning behind this statement.
The free market is made up of consumers, interested in satisfying their personal need. Any changes within the free market would best be noticed and identified by the consumers themselves as they make up the market. A government setting the price on a good would be less accurate. With less accurate prices, there is a higher chance that the market would be inefficient as there would either be a surplus or a shortage of goods being supplied. Instead if Adam Smith’s invisible hand was given control over the market, the price of a good would strive to equal the equilibrium price where total social welfare is at its maximum potential.
2. Why does the marginal benefit to consumers of a good decrease the greater the quantity of the good becomes available on the market? Why does the marginal cost to producers increase?
If an ice cream lover ate 1 scoop of ice cream, some amount of satisfaction would be gained. If another scoop was added, then the amount of satisfaction gained would be slightly less than the initial. If this consumer keeps on eating more scoops, then the marginal benefit received with each scoop would reduce. Thus in the market, when the quantity available increases, the marginal benefit for the consumer decreases.
Resources available for a producer are scarce. To produce more of a certain good, more resources must be consumed by the producer to produce that good. With more resources being consumed and becoming scarcer, the price at which this good is sold must increase. Thus in the market, when the quantity available increases, the marginal costs to producers increases.
3. How do competitive market forces assure resources will be efficiently allocated towards the provision of various goods and services? In other words, if the quantity in a market is not at equilibrium, why is it likely to move towards equilibrium over time?
Adam Smith’s invisible hand is a market force that will thrust any price, other than the equilibrium price, back to the equilibrium price. If the price is too high, then there may be a surplus of supply of a good in the market. In such a case, the invisible hand exerts pressure on the producers to sell their product at a cheaper price. Similarly, if the price is too low, then there is a shortage of supply of a good to the market. In such a case, the invisible hand exerts pressure on the producers to sell their product at a more expensive price. In both cases, the price will return back to the equilibrium price, as this is the price at which the quantity supplied equals the quantity demanded. Also, at this price, social welfare and thus efficiency of the market is at its peak.
1.“The invisible hand of the competitive market results in a more efficient allocation of resources than prices set by a government can ever hope to achieve.” Explain the economic reasoning behind this statement.
The invisible hand of the competitive market ensures a more efficient allocation of resources since if the government were to set prices, it would not be not be efficient since the price set may not necessarily be the equilibrium price, resulting in shortages or surpluses. A government encourages perfect competition as that would result in consumer sovereignty, and consumers will be buying their goods at the best possible price and both the producers and consumers would be better off.
2.Why does the marginal benefit to consumers of a good decrease the greater the quantity of the good becomes available on the market? Why does the marginal cost to producers increase?
The marginal benefit decreases as the quantity of a good increases because each additional unit of something consumed doesn’t result in the same satisfaction as the first time the product was consumed. The marginal cost to producers increases because as additional units of product are produced, resources get scarcer, resulting in increased costs.
3.How do competitive market forces assure resources will be efficiently allocated towards the provision of various goods and services? In other words, if the quantity in a market is not at equilibrium, why is it likely to move towards equilibrium over time?
If the quantity in a market is not already at equilibrium, it is likely to move towards equilibrium over time since the equilibrium price benefits both the consumer and the producer, and whenever a product is not selling at the equilibrium price, shortages or surpluses occur, which are inefficient. If a firm is not selling at the equilibrium price, the price will either be too high, resulting in not enough goods being sold (surplus), and if the price is too low, it will result in not enough supply to meet the demands of the consumers (shortage). Therefore, the equilibrium price is the one price that benefits both consumers and producers, and ensures efficiency in allocation of goods.
Efficiency:
1.“The invisible hand of the competitive market results in a more efficient allocation of resources than prices set by a government can ever hope to achieve.” Explain the economic reasoning behind this statement.
If the government sets a price that is either too high or too low, there will be an excess in either supply or demand, and resources will not be allocated efficiently in a way that no individual in society can be made better off without making another worse off. Because the price is fixed, the market, through means of the “invisible hand”, will not be able to adjust itself to an equilibrium price at which all goods are allocated efficient and the quantity demanded meets the quantity supplied. Thus, when prices are set by the government, more likely than not, there will be an inefficient allocation of resources.
2. Why does the marginal benefit to consumers of a good decrease the greater the quantity of the good becomes available on the market? Why does the marginal cost to producers increase?
With an increase in quantity available of a good to the market, the marginal benefit decreases because there is less happiness granted with each subsequent ticket bought. The marginal cost increases with an increase in quantity available to the market because supplying more will cost more. More resources must be allocated to increase production, and thus, as more goods are allocated, it grows more scarce, raising its price.
3. How do competitive market forces assure resources will be efficiently allocated towards the provision of various goods and services? In other words, if the quantity in a market is not at equilibrium, why is it likely to move towards equilibrium over time?
If the price is too high, the quantity demanded will not meet the quantity supplied; it is too high. Thus, since an excess of resource are being a supplied, there is inefficiency in the market, and the price must be lowered to meet the quantity demanded by the consumers. The same concept applies to a situation in which the price is too low and too little quantity is supplied. The competitive market, for the reasons explained above, will always naturally drift the price of a good back to equilibrium price in order to maximize efficiency.
1. What is the relationship between the value of the PED coefficient and the responsiveness of consumers to price changes?
The greater the value of the PED coefficient, the more responsive consumers are to price changes.
2. The video explains how to interpret the various possible results of the PED calculation. But it does not explain what is meant by a PED coefficient of ZERO. How could PED = 0, and how could we interpret such a result?
PED would equal zero if consumers were not at all responsive to changes in price; this would occur if demand was constant regardless of price. This might be the case for a good that is necessary: despite higher prices, people would still buy it if they needed it. An example could be water, or medication for someone with chronic illness.
3.For which good would you expect consumers to be more responsive to price changes: table salt or bottled mineral water? Why?
The situation would be different depending on the location. In Switzerland, where clean water is available free from the tap, table salt would have a lower price elasticity. People consume salt regularly and it is necessary for cooking, so would not change their quantity demanded if the price increased. However, if bottled mineral water became more expensive, the quantity demanded would change much more quickly as people would switch to alternatives such as tap water.
In a country where water is not a readily available, the two might be reversed, if bottled water was the more necessary good.
Efficiency:
1. “The invisible hand of the competitive market results in a more efficient allocation of resources than prices set by a government can ever hope to achieve.” Explain the economic reasoning behind this statement.
Although it seems very illogical at first, many economists, such as the one quoted above, believe that a competitive market in which all members are trying to make themselves better off is superior to a command economy for example, where all prices are set by the government to the fairest extent possible. The reason the system works is that it establishes a price for all products that are beneficial to both consumer and producer by default. At this equilibrium price, all resources are being allocated efficiently and there are no negative surpluses or shortages. This equilibrium price is then subject to change when external factors change the demand and supply of a good, resulting in a change in the price of the good as well. In a command economy, where prices are set indefinitely, shortages and surpluses become a problem, and are far more difficult to deal with than in a living system based on feedback in which both consumers and producers are benefiting as much as possible.
2. Why does the marginal benefit to consumers of a good decrease the greater the quantity of the good becomes available on the market? Why does the marginal cost to producers increase?
When a greater quantity of a good is available in the market than the equilibrium quantity, producers will need more money to supply more units and thus be forced to increase their prices. Then as stated in the Law of Demand, the demand will decrease as less people are willing and able to purchase the products the firm is offering. Thus, the producers are left with a surplus of product and can only get rid of it by decreasing their prices once more.
3. How do competitive market forces assure resources will be efficiently allocated towards the provision of various goods and services? In other words, if the quantity in a market is not at equilibrium, why is it likely to move towards equilibrium over time?
The price of a good is likely to move towards equilibrium over time, because it is the point at which the firms are using their resources as efficiently as possible. Setting the good or service at any other price would not make sense, as when it is not at equilibrium, there will be either excess demand or excess supply for the good or service. Then the firm will not be acting in the most efficient manner possible, as they could be selling more units and gaining more revenue by increasing or reducing their price to equilibrium once more.
Discussion Questions about Efficiency:
1. “The invisible hand of the competitive market results in a more efficient allocation of resources than prices set by a government can ever hope to achieve.” Explain the economic reasoning behind this statement.
If the government determines the prices of goods and controls towards what resources are being allocated, the economy will be quite inefficient as the economy will not be able to reach its full production possibility capacity. A government deciding on behalf of the free market, the factors that control an economy is not ideal, because it will :
a) Be unable to determine the equilibrium price (in hopes for an efficient economy)
b) either over allocate or under allocate the nation’s resources
This will result in a constant disequilibrium between: marginal benefit and marginal cost, consumer surplus and producer surplus. On the other hand, it is expected that in the free market, the equilibrium price is always reached through natural means, as it adapts itself with no help other than the gentle push of the producers and consumers. This equilibrium price picked out by the invisible hand will ensure efficiency by all means, keeping the consumer surplus and producer surplus balanced; after all, no one can be made better off without making someone else worse off.
2. Why does the marginal benefit to consumers of a good decrease the greater the quantity of the good becomes available on the market? Why does the marginal cost to producers increase?
The marginal benefit of consumers decrease when the quantity produced of a good is increased, because with more units being supplied, the satisfaction obtained from each additional unit is less and less.
The marginal cost of producers increase when the quantity produced of a good is decreased, because to produce more of a good costs the producer more. As more of the good is produced, the resources used in making that good become more scarce (limited yet highly desired). This, in turn, causes the marginal cost for producers to increase as the cost of resources increase.
3. How do competitive market forces assure resources will be efficiently allocated towards the provision of various goods and services? In other words, if the quantity in a market is not at equilibrium, why is it likely to move towards equilibrium over time?
The free market will naturally ensure that if the market is somehow not at equilibrium that it reaches equilibrium. This is accomplished through the interactions of producers and consumers, all tied to the common denominator of the price mechanism. Producers adjust the quantity supplied of a product according to the price mechanism signals until the amount produced and the amount consumed are equal (everything on the market is “cleared” at the market clearing price). E.g If the demand for irons is high among consumers, the producers will see the opportunity to raise the prices and increase the quantity of the good supplied. This would cause the demand for that good to fall, returning it back to an equilibrium at a new price.
1. “The invisible hand of the competitive market results in a more efficient allocation of resources than prices set by a government can ever hope to achieve.” Explain the economic reasoning behind this statement.
If the government determines the allocation of resources and the prices of goods, they cannot know for sure at which price the resources will be best allocated; however, if the market is instead guided by the invisible hand, prices will eventually reach equilibrium on their own and thus be efficient.
2. Why does the marginal benefit to consumers of a good decrease the greater the quantity of the good becomes available on the market? Why does the marginal cost to producers increase?
As more of a good is consumed, the additional benefit from consuming said good decreases, causing the marginal benefit to consumers decrease.
The marginal cost to producers increases due to more resources having to be allocated towards the increased production of a good, as the resources become more scarce the more of a good is being produced.
3. How do competitive market forces assure resources will be efficiently allocated towards the provision of various goods and services? In other words, if the quantity in a market is not at equilibrium, why is it likely to move towards equilibrium over time?
If the quantity of a good in a market is not at equilibrium, it will eventually reach this naturally, because if there is too much of a good being produced, this will lead to a surplus, causing the producer to lower the price of a good, in order to get rid of the excess supply. This will in turn lead to the price of the good moving towards or to equilibrium, where the quantity demanded will equal the quantity supplied.
1. “The invisible hand of the competitive market results in a more efficient allocation of resources than prices set by a government can ever hope to achieve.” Explain the economic reasoning behind this statement.
If a government sets prices, it may be hard to determine the correct price at which the market will be efficient, causing a welfare loss if the price is set too high or too low. Instead, if the government does not intervene, economics reasons that the market will naturally move towards efficient allocation of resources — an equilibrium price and quantity where no one can be made better off without someone else being made worse off.
2. Why does the marginal benefit to consumers of a good decrease the greater the quantity of the good becomes available on the market? Why does the marginal cost to producers increase?
Marginal benefit to consumers decreases the greater the quantity of a good on the market because the more of a good consumed, the less additional benefit will come from consuming additional units of the good.
As a greater quantity of the good is available on the market, it also becomes more expensive to produce additional units, because as more of the good is produced, the resources required to produce it become more scarce.
3. How do competitive market forces assure resources will be efficiently allocated towards the provision of various goods and services? In other words, if the quantity in a market is not at equilibrium, why is it likely to move towards equilibrium over time?
Over time, “the invisible hand” of the market will shift the price towards the equilibrium price. For example, if the price is set too high, supply will be greater than demand, and producers will be left with excess goods. This signals to producers that in order to increase the quantity demanded by consumers, they must decrease the price, moving towards the equilibrium price where quantity demanded equals quantity supplied. Resources are now allocated efficiently and there is no loss of welfare.