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Lecture 3

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Economics (Arts)
ECON 208
Irakli Japaridze

Econ 208 Lecture #3 May 6, 2013 Chapter 5: Markets in Actions ▯ What happens in one market effects another ▯ Conflict between today’s benefit versus tomorrows harm ▯ Society is everybody, not just a single group Interaction among Markets ▯ What happens in one market can cause a spillover into another market 120 o Ex: if the Oil Market price of oil increases due to a 100 shortage (S0 to S1) the 80 demand for oil will decrease E S along the demand curve (E 0 E E to E1) and the demand for Price D S (decrease) large cars will decrease thus 40 increasing the demand for D (decrease) 20 smaller vehicles therefore leading to a smaller demand 0 for oil as smaller cars do not 0 20 40 60 80 100 120 hold as much oil (D 0to D 1) Quantity o Continuing with the previous example: smaller cars tend to cost less therefore people have money to spend on other goods (i.e. a nicer home, recreational activities) leading to an impact in those markets ▯ Partial equilibrium analysis: model that deals with a single market in isolation and ignores the feedback effects from other markets o These models can ignore other markets when the market on which they focus are small relative to the entire economy and therefore won’t impact other markets o Most economists use this particular model ▯ General equilibrium analysis: model that looks at how all markets are interconnected o Idealistic and usually does not exist Government Controlled Prices ▯ Disequilibrium prices o If the price is set above the equilibrium price, some sellers won’t find buyers as  demand is less but supply is greater o If the price is set below the equilibrium price, some buyers won’t find sellers as  demand is greater and supply is less ▯ There are innate forces in market to drive the market to equilibrium but these will be hindered if the government intervenes Econ 208 Lecture #3 May 6, 2013 ▯ Government might set price determined by the lesser of quantity demanded and supplied o These will be the actual goods bought and sold ▯ Price floors: government or regulatory agency make it illegal to sell product below a controlled price 120 Non-binding Price Floor o Can either be binding or 100 non-binding 80 \ E ▯ A price floor is 60 D non-binding when it is below the 40 S Price equilibrium price 20 Price Floor ▯ In fact this 0 0 50 100 150 type of price floor actually helps the market since the further you go from the Quantity equilibrium price, the harder it is to achieve equilibrium again and a price 120 Binding Price Floor floor will limit how far you can get from 100 the equilibrium price 80 E ▯ A price floor that 60 D is binding is one that is above the 40 Price S equilibrium price 20 Price Floor ▯ Binding price 0 floors help suppliers by artificially 0 50 100 150 increasing prices thus causing an excess Quantity supply gap in which there are more sellers but fewer buyers o Black market: any market in which goods are skid at illegal prices ▯ Can be insignificant if law enforcement is effective ▯ Ex: social security is only paid out if the funds are made legally o Ex: minimum wage ▯ Can minimum wage lead to unemployment? Yes, if the minimum wage is put above the equilibrium price as there will be people who employers will not want to pay minimum wage and although they may be willing to work for below minimum wage, that would be illegal ▯ Price ceilings: maximum price at which a product may be exchanged o Like price 120 Price Ceilings floors, there are binding 100 D and unbinding price 80 E ceilings 60 S Price 40 Unbinding price 20 ceiling 0 Binding Price 0 50 100 150 Ceiling Quantity Econ 208 Lecture #3 May 6, 2013 ▯ Binding price ceilings are set below the equilibrium price and cause an excess in demand but a shortage in supply o Price ceilings can happen if the government thinks a product is so important that it must be inexpensive ▯ Ex: healthcare in Canada o When price ceilings artificially decrease prices there tends to be a shortage ▯ An alternative is to nationalize the industry meaning to make an industry public o There are three objectives in imposing price ceilings 1. Restrict production ▯ Ex: restrict the production of undesirable goods such as cigarettes or alcohol 2. Keep specific prices down ▯ Ex: oil rich countries may officially keep oil prices low ▯ When people are satisfied in some way, they may be more complacent with policies 3. Satisfy (normative notions of equity ▯ Ex: people believe that those smart enough should be able to go to college in spite of their financial standing o Rent Controls: case study of price ceilings ▯ Binding rent controls are a specific form of price ceilings that can lead to ▯ Housing shortage o The demand for housing is inelastic o Rent control causes a loss for the landlord as they are putting in more than they can receive back and since everyone is aware of rent control the landlord cannot sell the property so instead they rent the housing without reinvesting into it (do not do any repairs) until the property is useless (approximately 10-20 years) ▯ Alternative allocation schemes in the black market o Ex: the landlord might ask for “key money” or other  expenses – this is illegal ▯ Who gains and who loses with rent control? ▯ In the short run, the tenants benefit from rent control ▯ In the long run, rent control will lead to a housing shortage as the rent controlled buildings will deteriorate and no one will repair them/build more therefore tenants suffer ▯ Landlords always lose Econ 208 Lecture #3 May 6, 2013 ▯ Governments might try to reduce housing shortages by either subsidizing housing production or producing public housing directly (at the taxpayers’ expense) ▯ Government subsidizing: ▯ P 0> P1 120 100 Government Subsidies therefore the supplier is losing 80 D money 60 Price ▯ P 0– P1 40 S = Government subsidy (θ) 20 o S 0 Price ceiling 0 50 100 150 (rent control) ometimes the subsidy will be larger (P2 – P1)
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