Question

1. private markets are the best way to allocate scarce resources, where best implies they maximize total surplus to society. For each give an example of a product that fails that condition and thus there is a market failure.
2. Draw the market for apartments in California. Make the supply relatively inelastic. Draw the demand roughly at a 45-degree angle. Indicate the equilibrium price and quantity. Then add to your graph what it would look like if a price ceiling was set below the equilibrium price. Indicate how consumer, producer and total surplus changes. Under what social welfare functions may social welfare improve with this policy

Answer 1

First part:

Private market has one potential problem and that is 'racing too hard behind the profit maximization'. There is no doubt that private markets worldwide have proven more resource-efficient and cost-efficient than state owned players, but we cannot say the this efficiency necessary results into 'maximising the total surplus to society' always. You see, often, private markets like the idea of creating and maintaining, to the extent of their absolute or fractional monopoly power, the artificial shortage by intentionally supplying lesser quantity and charge higher prices in order to maximise their profits.

Example: All products which bears the tag of exclusivity i.e. it's a matter of social prestige if you own it.


Second part:

Check the graph below:

• P0 is the market equilibrium price
• Q0 is the market equilibrium units of apartment
• P1 is the price ceiling
• Earlier consumer surplus = BEP0
• Earlier producer surplus = CEP0
• Earlier total surplus = BCE
• After price ceiling, reduction in consumer surplus is the triangle occupied by F
• After price ceiling, reduction in producer surplus is the triangle occupied by G
• After price ceiling, reduction in total surplus is the triangle occupied by F+G

Q: Under what social welfare functions may social welfare improve with this policy?
Answer: Public distribution system or Rationing. We can also call it 'Allotment under quota system'.