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ECON 208 Chapter Notes -Conspicuous Consumption

Course Code
ECON 208
Lee Ohanian

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Adrienne Pacini ECON 208 WEEK: October 6, 2009
Chapter 5
The Interaction Among Markets
- No market or industry exists in isolation from the economy’s many other markets
o Feedback: changes in one market that cause changes in another
- Partial-equilibrium analysis: examines a single market in isolation and ignores feedback
effects from other markets
o In general, this is appropriate when the specific market is quite small relative to the
entire economy
o Most of microeconomics uses partial-equilibrium
- General-equilibrium analysis: more complicated because it involves the analysis of all of the
economy’s markets simultaneously
o Recognizing the interactions among the various markets
o Recognizing how events in each market affect other markets
- Market linkages and interactions: linkages exist with mobile demand and supply
o Joint production linkages: when things are produced together; when one product is
the “by-product” of another
o Input/output linkages: when one product is necessary to produce the other
o Linkages through resource constraints: cause links even between largely unrelated
Politicians give subsidy to an industry in order to increase jobs in a specific
region… but where do these jobs come from?
If on the production possibilities boundary, that must mean that
there will be fewer jobs elsewhere
This causes a shift in the resources to the product being subsidised
Government-Controlled Prices
- Sometimes governments fix the price at which a product must be bought and sold in the
domestic market
o This creates shortages or surpluses in the market
Disequilibrium Prices
- When price controls are in place, what determines the quantity actually traded on the
- At any disequilibrium price, quantity exchanged is determined by the lesser of quantity
demanded or quantity supplied
Price Floors
- A minimum possible price at which a product or service can be sold
o Sometimes it is illegal to sell the product below the prescribed price
- Example: minimum wage cannot go below a certain amount
o Shock effect of minimum wage: when firms are hit with a minimum wage, they
must become more efficient so that they will not have to hire as many workers
o This results in a higher demand for jobs
- A binding price floor must be above the free-market equilibrium price
o Therefore, there will be excess supply
Excess supply can result in unemployment when considering minimum wage
price floors
Adrienne Pacini ECON 208 WEEK: October 6, 2009
- Whether spending on the good goes up or down depends on its elasticity of demand
- A black market is any market in which goods are sold at illegal prices
o Example: hiring people for cash at less than minimum wage
o (See Applying Economic Concepts 5-1)
Price Ceilings
- A maximum price at which certain goods and services may be exchanged
o For a price ceiling to have an effect it must be below the market equilibrium price
- Example: rent controls where the price cannot go above a certain amount
- A government has one (or more) of three main objectives in imposing a price ceiling:
o Restrict production
o Keep specific prices down
o Satisfy normative notions of equity (fairness)
- The market price will no longer adjust to eliminate excess demand
- Allocation mechanisms:
o First come, first served (set a price at which demand exceeds supply)
o Seller’s preferences (allocation of commodities in excess demand by decisions of the
o Higher prices from scalping and black markets
o Rationing
In consumption (coupons) or in production by quotas
- Binding price ceilings: lead to excess demand with the quantity exchanged being less than
the free-market equilibrium
Rent Controls
- 1st Generation: fixed price controls
- 2nd Generation: regulated rents, allow rent increases
o In line with increase costs
o In line with inflation
o As get new tenants so need security of tenure legislation
The Predicted Effects of Rent Controls
- A specific form of price ceiling; predicting the following effects:
o A housing shortage (excess demand for housing)
o Alternative allocation schemes in black markets
o Illegal schemes
“Key money”
Poor upkeep
Bribe those who control entry
Basement apartments (not legal dwellings)
- Other effects may also arise:
o Discrimination effect (seller’s preferences of race, gender, religion, pet ownership,
o Scanning “death” notices to jump the queue
- Housing is a durable good: inelastic supply in the short run so little fall in supply and almost
all of the excess demand is from an increase in quantity demanded
o The quantity of apartments can’t be increased extremely quickly
o More elastic in the long run
Reduction in supply now adds to excess demand
Adrienne Pacini ECON 208 WEEK: October 6, 2009
- Problems in the long run:
o Bigger potential for a black market
o Deterioration in quality (people don’t spend the money for the needed upkeep)
o People in controlled apartments are less likely to leave as their income rises
Creates an even bigger shortage for low-income families
o Once controls have been in place long enough to create a big difference between
controlled price and free-market price, it can become difficult to abolish rent
Who Gains and Who Loses?
- Existing tenants in rent-controlled apartments win
o Unless quality deteriorates
- Landlords lose
o They don’t get the rate return they expected on their investments
- Potential future tenants also suffer
o If people don’t move out, they are unable to find housing
Policy Alternatives
- Housing shortages can be reduced if the government provides more housing
o At the tax payer’s expense
o Either subsidise private house production or produce public housing
- The government may also provide lower-income households with income assistance
o Note that no policy is free every policy involves a resource cost
o Rent controls may not be problematic if they are only temporary
Market Efficiency
- Legislated minimum wages make firms and some workers worse off but benefit those who
retain their jobs
- Same with rent controls (some win, some lose)
Demand as “Value” and Supply as “Cost”
- Price corresponding to a specific quantity demanded is the highest price consumers are
willing to pay
o As shown by the height of the demand curve (going vertically up the curve)
o Shows the value that the consumers place on the product (the maximum that they
are willing to pay)
At a lower price, some consumers are paying below the amount that they
would be willing to pay according to the value that they placed on the
Consumer surplus: the extra amount that the consumer would be willing to
Producer surplus: the extra amount that the supplier charges over top of
the lowest price at which they would be willing to sell their product
Economic surplus: maximized at the competitive equilibrium level out
At this point, the market is efficient
The sum of the consumer and producer surplus
- Price corresponding to a specific quantity supplied is the lowest price producers are willing
to accept
o As shown by the height of the supply curve