some AS economics review notes for chapter 2 of the ocr specification

1. Objective:
• Define efficiency
• Distinguish between value and price and define consumer surplus
• Distinguish between cost and price and define producer surplus
• Explain the conditions under which markets move resources to their highest-valued
uses and the sources of inefficiency in our economy
• Explain the main ideas about fairness and evaluate claims that markets
result in unfair outcomes
Efficiency:
• Resources are said to be used efficiently when the most highly valued goods and services are
produced at the lowest possible cost. In other words, an economy is producing efficiently
when the limited resources we have are used so that the products and services the y produce
provide the greatest amount of value possible.
The benefit we enjoy from each unit ADDITIONAL unit of consumption is the marginal
benefit (for firms their marginal benefit is called marginal revenue). The marginal benefit
can also be thought of as the value of the good, the maximum amount you would be willing
to pay for the product or service. Clearly the actual price and the value will be different if
the price is lower than you are willing to pay (in your mind you are getting a bargain in this
case). When the maximum price you are willing to pay for a good (the value of the good) is
higher than the market price for the good (the price) you have a surplus called consumer
surplus.

2. The marginal benefit decreases with each additional unit that we consume. The first
slice of cake is fantastic, however each additional slice of cake might add less and less joy.
Marginal costs are the costs from each ADDITIONAL unit of consumption/production. It
could technically increase or decrease, but if your marginal costs are decreasing then you
might as well continue to produce, so we focus on the range where our marginal costs are
increasing. Ie. Cost of producing goods in a factory.
Graphically:
• The efficiency output level is where the marginal cost (MC) = Marginal Benefit (MB).
•
• Why? If we produced 5 units instead of 10 units (the efficient output level in the graph) we
can see that at 5 unites the marginal benefit is greater than the marginal cost, therefore there
is still some net benefit to be gained by increasing output. Notice that beyond 10 units the
marginal cost is greater than the marginal benefit, so it’s as if each additional unit you
produce beyond 10 units is adding a negative overall utility.
•
The cost is the amount of money or amount of resources that a producer must give up to produce
a good. Of course the price is what the producer receives when they sell the good. If the producer

3. sells their goods or services for a price higher than their costs, then they make a surplus, this
surplus is called producer surplus.
Since the cost curve graphs amount/quantity producers are willing to supply at each price level,
the supply curve and the marginal cost curve are the same. Why? Because the marginal cost
curve shows the minimum cost for each quantity level and the producer would be willing to
supply quantity that in a worst case, results in their costs being equal to the price they receive.
Therefore, if the market price for a good is $3 then producers would be willing to supply a
quantity where their marginal cost is also $3. Therefore, the marginal cost curve is the same as
the supply curve.

4. Markets may not always be efficient:
5 Obstacles to efficiency:
• Price ceilings (maximum price) and price floors (minimum price) – government
regulations that set a maximum price or a minimum price for goods or services.
• Taxes, subsidies and quotas. Taxes increase prices paid by consumers and decrease
revenues received by businesses. Subsidies increase the revenue/funds businesses
receive (thus encouraging greater production). And quotas directly impose some
production amount, and this production quantity may or may not be efficient.
• Monopoly: A monopoly is a firm that is the only firm in a market. Monopolies usually
decrease production below the efficient level so that they can charge a higher price.
• Public goods: A public good is a good that can be consumed by all people who are part
of a community whether paid for or not. Examples: fresh air and parks. This can mean
the marginal costs to using the public good is so low that people overconsume the good
because they don’t take into account the cost to the community as a whole when making
their individual decisions.
• Externalities – external costs or benefits that not directly included in cost revenue
calculations. Pollution can be an external cost that might mean companies produce
higher quantities than they would produce if they had to pay to reverse these
environmental costs/externalities. A positive externality might greater profits for a local
mall after a bunch of houses are built in an area. Property developers will not take the
profits of the retailers in the mall into account when making their building decision s.
This can mean property developers should produce more homes because the marginal
benefit to all entities affected is higher, hence we may underproduce property, thus
being inefficient.

5. • Inefficiency creates a deadweight loss:
• This is the lost consumer and producer surplus (it is combined, so it is the loss to society as a
whole) from any production that is inefficient, that is any production that does not equate
marginal cost to marginal benefit results in a deadweight loss.