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Lecture 5

Economics 2151B - Lecture 5.docx

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Western University
Economics 2150A/B
Kristin Denniston

Economics 2151B Monday January 20 Lecture 5 Homework 1 • Due this Wednesday Jan. 22 at midnight • Posted under ‘Tests and Quizzes’ on OWL Example of an algebra problem: Problem 10.5 Given information: d d Q = 100 - P Q = P /3 Government gives $4 per unit subsidy to oil producers The supply curve shifts down because we are willing to accept a lower price in the market for each unit (because of the subsidy from the government) If neither curve is perfectly inelastic, you will see a smaller change in the price than the actual per unit tax. Both consumers and producers benefit from the per unit subsidy. Original P,Q s d Q = Q P/3 = 100 – P P* = 75 Q* = 25 New P,Q d P* 2 P = 74, Q* = 26 Producers receive P = Ps+ $4d 1/3P = 100 - P d d 1/3(P d 4) = 100 - P P = 74 (the new price we observe in the market) s d P = P + 4 = 74 + 4 = 78 Q* 2 Qd = 100 – 74 = 26 (consumers will demand 26 units when the market price is 74) Answer: The price will drop by less than $4 because neither supply nor demand is vertical or perfectly inelastic. The benefit of the subsidy will be shared by both sides of the market. Price Ceilings and Price Floors The two conditions we have to remember: 1. Is the price binding? 2. The DWL from the policy will vary depending on who the producers are supplying the good, and who the consumers are, benefitting from the good. We have a min DWL when either: • The people with maximum willingness to pay get the good (this is a price ceiling that’s binding), or • The producers who produce at minimum marginal cost actually produce the good (this is the price floor) Price Ceilings: If the price ceiling is binding, it is below the natural equilibrium price, and the observed market quantity and price will determined by what people are willing to pay (the demand curve at that price). Example: rent control, OHIP If the price ceiling is not binding, the price ceiling is above the natural equilibrium price (the price ceiling is constraining the price to be low). You would be consuming at the natural equilibrium, P* and Q*. Price Floors: A binding price floor has the price set above P* (the opposite of the price ceiling). The price is not allowed to fall to its natural equilibrium. Quantity demanded is below quantity supplied, which means you end up at a surplus. Example: minimum wage Results from a binding price floor: • Excess supply • Consumer surplus decreases – buy less than normally would in a free market • Producer surplus may increase or decrease • DWL because not all of the lost consumer surplus goes to producer surplus o The DWL depends on who is supplying the good A non-binding price floor means the price is below P*, and the market equilibrium is at the natural equilibrium, P* and Q*. Quantity supplied is less than quantity demanded, which ends up with a shortage. The price floor prevents the price from falling below a certain amount. The key is to identify the new equilibrium under the policy, which is set by the demand curve. Example: Binding Price Floor - Minimum wage in the market for unskilled labour. Min. wage in Ontario is approximately $10.25/hour. If you natural market wage is above this minimum wage, the price floor is not binding. Unskilled workers are workers who lack experience or education (often teenagers or high school dropouts). These people experience a binding minimum wage. This should decrease the quantity of labour in the market, and there would be a surplus in workers who want to work at that wage. When you impose a minimum wage, if the employer can pass the cost on to the public, you wouldn’t see that much of a reduction in employment. (Example: when Tim Hortons raised their minimum wage, the cost of coffee went up) Is minimum wage a good policy for helping those at the lower end of the income distribution? • 40% of the people who benefit from minimum wage are teenagers from middle- income households • Con: The main complaint against the minimum wage is that it’s poorly targeted and doesn’t really help the poor. • Pro: The minimum wage can be set to provide a living wage for people who are actually working. (Example: in Florida where there minimum wage is so low, there are people who are working at Wal-Mart or McDonalds full time and are still on welfare.) Production Quota: A restriction on the amount that producers can sell to the market • The government usually sets the quota on the amount you are legally allowed to sell in t
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