Question

An exchange between a buyer and seller occurs usually when the exchange creates both a consumer surplus and a supplier surplus. Market efficiency occurs when consumer and supplier surplus are maximized. However, in exchanges between buyers and sellers, should society be only concerned with market efficiency?

a) Describe a personal experience of when you purchased a product or service whereby you feel you maximized surplus as a consumer but the supplier surplus was not maximized.

b) The lesson notes describe both positive and negative externalities. An interesting situation occurs when there is a positive externality. This is interesting because economists state this is a result of market inefficiency or failure. Combine the lesson notes with some of your own research and your own experiences to describe when you were part of a transaction that resulted in a positive externality and why the transaction would be considered inefficient. To answer this question, a) describe the transaction, b) describe the positive externality, and c) state why, from an economist’s viewpoint, this would be considered market inefficiency.

Answer 1

a) The Consumer surplus and the supplier surplus are equal or maximized at the market equilibrium when demand is equal to supply and the price is at equilibrium. But when price is below equilibrium than the consumer surplus increases and supplier surplus decreases.

So when we purchase any commodity whose price is below market equilibrium, than the consumer surplus is maximized but the supplier surplus is not maximized. This may happen in the case when the supplier is selling a product below equilibrium price so as to eliminate competitors. So you can give example of any such good or service.

b) An interesting situation occurs when there is a positive externality. This is interesting because economists state this is a result of market inefficiency or failure. This can be understood with the help of the following example -

Suppose a transaction is taking place, let's say I bought some plants and planted on an empty land near my house for fruits, flowers and the fresh oxygen. I have incurred cost of $100 in this transaction which includes money I paid to the Nursery for plants and the cost of land and effort and equipments needed in planting them in return I will get some benefits as stated above.

There is a positive externality associated with my transaction as though I may dense that area and prevent others to take my fruits and flowers but still I can't prevent them from taking the fresh and purified air and the high level of oxygen which is released from my plants and trees. So my neighbours enjoy some of the benefits but they do not pay for it so it is called positive externality.

Though there is a benefit to the society from my transaction, but still from an economist point of view this will be considered as a market inefficiency, this is because here the marginal private cost is greater than the marginal social cost and marginal private benefit is smaller than the marginal social benefit. In economics a market is considered efficient when prices reflects all relevant information but here the price of fresh oxygen looks free to society but it is not actually the case because I incurred a cost for it.