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Chapter 5

Chapter 5 - Markets in Action.docx

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Economics (Arts)
ECON 208
Mayssun El- Attar Vilalta

Chapter 5 - Markets in Action Sept.19.12 Interaction among markets: - Individual markets don’t exist in isolation - Changes in one market affect other markets (feedback) - partial-equilibrium analysis: analysis of a single market in isolation, ignoring any feedbacks that may come from induced changes in other markets - general-equilibrium analysis: analysis of all the economy’s markets simultaneously, recognizing different markets’ interactions - Small markets won’t cause major effects on other markets (use partial analysis) Government controlled prices: - Governments sometimes fix the price that a product must be sold/bought in the domestic market (i.e. MA water crisis in Boston, May 2010) - In free markets: equilibrium price equates quantity demanded and quantity supplied - Government price controls are policies that attempt to hold the price at a disequilibrium value - Some controls hold the market price below its equilibrium value to create a shortage at the controlled price - Some controls hold the market price above its equilibrium value to create a surplus at the controlled price Disequilibrium prices: - what determines the quantity actually traded on the market? - determining is irrelevant in a free market because supply/demand are self- regulating - any voluntary market transaction requires a willing buyer and a willing seller - if QD < QS, demand will determine the amount actually exchanged and the rest of the unsold commodities will remain with the unsuccessful suppliers - if QD > QS, supply will determine the amount actually exchanged, the rest of the demand will represent unsatisfied demand of would-be buyers - at any disequilibrium price, quantity exchanged is determined by the less of the QD or QS Price floors: - minimum permissible price that can be charged for a particular good or service - seen with minimum wage and agriculture (disadvantages: government has to pay for storage of goods, more unemployment) - one set at/below the equilibrium price has no effect because the free-market equilibrium remains attainable - if the price floor is set above the equilibrium it will raise the price (aka binding) - may make it illegal to sell the product below the prescribed price (i.e. minimum wage) - government may establish a price floor by guaranteeing to buy excess supply - binding price floors lead to excess supply - there will be unsold surplus whereby usually the government will have to purchase it - consequences of excess supply differ from product to product: - min. wage: excess supply = unemployed people - non-perishable foods: storage needed to house surplus - consequences may or may not be worthwhile - still inevitable in a competitive market whenever a price floor is set above the equilibrium price - why governments want to incur the consequences: - people who succeed in selling products at the price floor are better off than if they had to accept the lower equilibrium price - when demand is inelastic producers earn more income, the losses are spread across the large and diverse set of purchasers Price ceilings: - maximum price at which certain goods and services may be exchanged - see with oil, natural gas, and rent (disadvantage: excess demand, allocate excess with first-come-first-serve basis) - if the ceiling is set above the equilibrium price it has no effect because free market equilibrium remains attainable - if its set below the free market equilibrium, the price is lowered (aka binding) - binding prices lead to excess demand with the quantity exchanged less than in the free market equilibrium - allocating a product in excess demand: - prices cannot rise to eliminate excess demand with binding prices - when sellers decide to whom they will and will not sell their scarce supplies to, allocation = sellers’ preferences - if the government dislikes this allocation it can chose to ration the product, prints ration coupons to match the quantity supplied at the price ceiling and distributes the coupons (equally or to a category of people) - minimum wages and unemployment: - employment = x-axis - hourly wage rate = y-axis - without government implemented min. wage: equilibrium is at point w0, e0 - with a min. wage that’s greater than w0 (wage increases): unemployment - unemployment = area above equilibrium point - minimum wage reduces employment and increases labor supply - m
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