5.3: Efficient market outcomes

Last updated
Save as PDF

Page ID: 108386

$ \newcommand{\vecs}[1]{\overset { \scriptstyle \rightharpoonup} {\mathbf{#1}} } $ $ \newcommand{\vecd}[1]{\overset{-\!-\!\rightharpoonup}{\vphantom{a}\smash {#1}}} $$\newcommand{\id}{\mathrm{id}}$ $ \newcommand{\Span}{\mathrm{span}}$ $ \newcommand{\kernel}{\mathrm{null}\,}$ $ \newcommand{\range}{\mathrm{range}\,}$ $ \newcommand{\RealPart}{\mathrm{Re}}$ $ \newcommand{\ImaginaryPart}{\mathrm{Im}}$ $ \newcommand{\Argument}{\mathrm{Arg}}$ $ \newcommand{\norm}[1]{\| #1 \|}$ $ \newcommand{\inner}[2]{\langle #1, #2 \rangle}$ $ \newcommand{\Span}{\mathrm{span}}$ $\newcommand{\id}{\mathrm{id}}$ $ \newcommand{\Span}{\mathrm{span}}$ $ \newcommand{\kernel}{\mathrm{null}\,}$ $ \newcommand{\range}{\mathrm{range}\,}$ $ \newcommand{\RealPart}{\mathrm{Re}}$ $ \newcommand{\ImaginaryPart}{\mathrm{Im}}$ $ \newcommand{\Argument}{\mathrm{Arg}}$ $ \newcommand{\norm}[1]{\| #1 \|}$ $ \newcommand{\inner}[2]{\langle #1, #2 \rangle}$ $ \newcommand{\Span}{\mathrm{span}}$$\newcommand{\AA}{\unicode[.8,0]{x212B}}$

The definition and measurement of the surplus is straightforward provided the supply and demand functions are known. An important characteristic of the marketplace is that in certain circumstances it produces what we call an efficient outcome, or an efficient market. Such an outcome yields the highest possible sum of surpluses.

An efficient market maximizes the sum of producer and consumer surpluses.

To see that this outcome achieves the goal of maximizing the total surplus, consider what would happen if the quantity Q=48 in the taxi example were not supplied. Suppose that the city's taxi czar decreed that 50 units should be supplied, and the czar forced additional drivers on the road. If 2 additional units are to be traded in the market, consider the value of this at the margin. Suppliers value the supply more highly than the buyers are willing to pay. So on these additional 2 units negative surplus would accrue, thus reducing the total.

A second characteristic of the market equilibrium is that potential buyers who would like a cheaper ride and drivers who would like a higher hourly payment do not participate in the market. On the demand side those individuals who are unwilling to pay $42/hour can take public transit, and on the supply side the those drivers who are unwilling to supply at $42/hour can allocate their time to alternative activities. Obviously, only those who participate in the market benefit from a surplus.

One final characteristic of surplus measurement should be emphasized. That is, the surplus number is not unique, it depends upon the economic environment. We can illustrate this easily using the taxi example. A well recognized feature of Uber taxi rides is that the price varies with road and weather conditions. Poor weather conditions mean that there is an increased demand, and poor road or weather conditions mean that drivers are less willing to supply their services – their reservation payment increases. This situation is illustrated in Figure 5.3.

Figure 5.3 The taxi market

The curves represented by

and

represent the curves for bad weather: Taxi rides are more highly valued on the demand side, and drivers must be paid more to supply in less favourable work conditions.

The demand curve has shifted upwards and the supply curve has also changed in such a way that any quantity will now be supplied at a higher price. The new equilibrium is given by rather than E.2 There is a new equilibrium price-quantity combination that is efficient in the new market conditions. This illustrates that there is no such thing as a unique unchanging efficient outcome. When economic factors that influence the buyers' valuations (demand) or the suppliers' reservation prices (supply) change, then the efficient market outcome must be recomputed.