Week 2: Market Failures and Public Goods (Market Equilibrium)

Question 1

Define market equilibirum

Answer 1

The condition that holds when a market is cleared of any shortage or surplus. Hence, it occurs at the price where the quantity demanded for a product is equal to the quantity supplied.

Question 2

When does market equilibrium occur?

Answer 2

Occurs when the quantity demanded for a product is equal to the quantity supplied of the product

Question 3

Equilibrium price

Answer 3

Established at the point where the demand for a product matches the supply of the product in the market at a given point in time.

At the equilibrium price, there is neither excess quantity demanded, nor excess quantity supplied

Question 4

Market disequilibrium

Answer 4

Occurs when the quantity demanded for a product is either higher or lower than the quantity supplied.

Market = inefficient - as there is either a shortage (excess demand) or surplus (excess supply) in the market.

Question 5

Excess supply (surplus) occurs when

Answer 5

The price is above the market equilibrium price. Surplus exists because at this higher price, supply exceeds the quantity demanded – there is an incentive for firms to supply more at higher prices, but less of an incentive for customers to demand the product.

Question 6

Excess demand (shortage) occurs when

Answer 6

The price is set below the market equilibrium price. A shortage exists because at a price below the equilibrium price, demand exceeds the quantity supplied – consumers are more willing and able to buy more at lower prices, but there is less of an incentive for firms to supply the product.

Question 7

Define consumer surplus

Answer 7

Refers to the gain or benefit to buyers who can purchase a product at a price lower than what they are willing and able to pay for the product.

Question 8

Consumer surplus is shown by…

Answer 8

The difference between what consumers are willing to pay for a product and the amount they actually pay. Hence, a consumer’s marginal utility of consumption is greater than the market price.

Question 9

Define producer surplus

Answer 9

Refers to the gain or benefit to firms who receive a price that is higher than that which they are willing and able to supply.

Question 10

Producer surplus occurs when…

Answer 10

Firms are able to charge a higher price than they are willing and able to. Thus, they are able to earn abnormal profits.

Question 11

Social (community) surplus

Answer 11

The sum of consumer and producer surplus at a given market price and output.

Question 12

Allocative efficiency

Answer 12

Is a situation where resources are allocated in an optimal way such that changing the price would result in consumers and/or producers being worse off.

This means that consumers cannot be better off (they cannot increase their level of utility) by purchasing different quantities of goods and services, nor can firms gain more sales revenue or profits from the current combination of goods and services being supplied and sold.

Question 13

Allocative efficiency and social surplus

Answer 13

Allocative efficiency occurs at the market equilibrium because both consumer and producer surplus are maximised at this point.

Question 14

How can allocative efficiency be increased?

Answer 14

Allocative efficiency can be increased if producing or buying more of something results in a greater marginal benefit to society than marginal cost. This means that allocative efficiency is achieved at the price where the marginal benefit and marginal cost of an economic transaction are equal.

Question 15

What happens if efficiency is not met?

Answer 15

1. Market Failure
2. Public Goods/Common Pool Resources
3. Externalities
4. Monopolies & Oligopolies

Question 16

neoclassical economics

Answer 16

Synthesis of different approaches and insights operated by Alfred Marshal
W. S. Jevos  Marginal utility
L. Walras  How producers interact with consumers and the role of prices