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Module 4 krugman 1
Module 9
Efficiency and Markets
What’s New in the Fourth Edition?
• Updated Economics in Action examples
Module Objectives
• What is total surplus and why is it used to illustrate the gains from trade in a market?
• What accounts for the importance of property rights and economic signals in a well-
functioning market?
• Why can a market sometimes fail and be inefficient?
Teaching Tips
Consumer Surplus, Producer Surplus, and the Gains from Trade
Creating Student Interest
• Ask students to summarize the gains from trade in the used textbook market. What is the
lowest price they would accept for their used economics textbook? How did they arrive at
that price? (Their opportunity cost.) What is the highest price they would (or did) pay for
a used economics textbook? How did they arrive at that maximum price? (The price of a
new textbook.) How would students lose if there were no market for used textbooks?
Presenting the Material
• Use a standard supply and demand graph to identify consumer and producer surplus, and
to identify total surplus and the gains from trade. Explain that the competitive market
equilibrium maximizes total surplus, in that there is no other price that makes both buyers
and sellers better off. Although the competitive market equilibrium is efficient, this does
not mean it is fair or equitable. Discuss the difference between efficient and equitable
using the tutor example. What if there are students who need tutoring and they cannot
afford to pay the going market price? This is a good lead-in to the concept of a price ceiling
in the next Module.
A Market Economy
Creating Student Interest
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• Ask students to raise their hand if, after studying consumer and producer surplus, they
think markets are efficient. Hopefully most or all will have gotten that point. Then ask
them to raise their hand if they think markets are fair. Ask those who don’t raise their hand
why they didn’t. Of course, many may not be willing to raise their hand for anything, but
you should be able find someone who is actually skeptical of markets. Finally, ask students
if they think that markets are always efficient and the best way to allocate resources.
Hopefully the students will mention monopolies, externalities, and individual versus
aggregate welfare (though likely not using those specific terms). Use the discussion to lead
into your presentation of market failures.
• Ask students who owns the air we breathe and the fish in the sea. Have them come up with
other examples of markets where property rights aren’t well defined.
Presenting the Material
• Emphasize that there are two main points in this Module: (1) Markets, when they have
certain characteristics, are efficient. (2) Markets sometimes fail (i.e., sometimes they do
not have those certain characteristics).
• Discuss the importance of property rights by getting students to think about what happens
when property rights do not exist, or are not well defined. What happens, for example, if
after you buy a good you do not have the right to resell it? Many mutually beneficial
Module Outline
I. Consumer surplus, producer surplus, and the gains from trade
A. The gains from trade
1. Both consumers and producers gain in a specific market—there are gains from trade.
This is why everyone is better off participating in a market economy than they would
be if each individual tried to be self-sufficient. This is illustrated in text Figure 9-1,
shown here.
Module 4 krugman 3
Figure 9-1
B. The efficiency of markets: A preliminary view
1. Markets are usually efficient. Typically, there is no way to make anyone better off
without making someone else worse off.
2. The market equilibrium achieves the maximum possible total surplus. It does this
because the market
a. allocates the good to potential buyers who value it the most, indicated by the
willingness to pay.
C. Equity and Efficiency
1. Although a market is efficient, it isn’t necessarily fair.
2. Markets can sometimes fail.
3. Even when a market maximizes total surplus, it is not necessarily best for every
individual producer and consumer.
II. A Market Economy
A. An economy is made up of many interrelated markets
B. Why markets typically work so well
1. Property rights allow owners to use and dispose of goods as they see fit.
2. Prices are economic signals.
C. A few words of caution
1. Markets can be inefficient.
Module 4 krugman 4
2. Market failure occurs when a market fails to be efficient.
Case Studies in the Text
Economics in Action
A Great Leap—Backward—This EIA considers the inefficiency of command economies using the
example of China’s “Great Leap Forward.”
Ask students the following questions:
1. How are consumption and production decisions made in market economies? How are they
economies, based on the decisions of a central planner.)
2. Why do you think the plan instituted in China in the late 1950s did not lead to an efficient
Activity
Understanding Property Rights (15–25 minutes)
Use something to represent a good—for example, paper clips or small plastic fish (if you want to represent
a real-world common property resource). You also can do this with pennies or nickels, if you are willing
to provide them! Spread the paper clips out on the floor or a desk. Ask for five student volunteers to
assume the roles of paper clip harvesting companies. Tell them that they are profit-maximizing companies.
Their goal is to be the student that earns the most money from harvesting paper clips. Their grade for the
day will be based on how well they achieve this goal. Make sure they know that they want to harvest and
This exercise sets up a “tragedy of the commons” scenario. Tell them that there will be two harvests, each
lasting 30 seconds. For any paper clips they harvest from the first period, you will pay them one fictitious
dollar. For any paper clip they harvest from the second period, you will pay them two fictitious dollars.
Now, take back the paper clips and put them back on the floor/table. Take some masking tape and mark
an X within the paper clip distribution—that is, dividing the paper-clip area into quadrants. Make sure no
paper clips are on the tape—all paper clips should be within one of the quadrants defined by the masking
Module 4 krugman 5
the students to delay the harvest to the second, more lucrative period. Ask students about their behavior—
and be sure to get the views of the student who didn’t “own” any paper clips. Why did they do what they
did? When did they earn more—with or without property rights? (With, if the students tried to achieve the
