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Chapter 5

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Queen's University
ECON 110
Ian James Cromb

Chapter 5: Markets in Action The Interaction Among Markets  No market or industry exists in isolation from the economy’s many other markets o If the cost of extracting natural gas is reduced, supply curve would shift right and there would be more demand for natural gas from other markets  The price of gas would go up so firms would put more resources into itNatural gas firms would then increase their demand for labourworker’s wages would go up as demand for them increases  The reduction in the equilibrium price of natural gas would generate some substitution away from other fuels and toward the now lower-priced natural gas  would push down the price for substitutes and the producers of those goods would put less resources into their production  A change in one market will lead to changes in other markets – and these changes will then effect the first market o Known as feedback  Partial-equilibrium Analysis: The analysis of a single market in isolation, ignoring any feedbacks that may come from induced changes in other markets. Common in micro. o Used when the specific market is small relative to the entire economy, changes in the market will have relatively small effects from the other markets  General-Equilibrium Analysis: The analysis of all the economy’s markets simultaneously, recognizing the interactions among the various markets. o The study of how all markets function together, taking into account the various relationships and feedback effects among individual markets Government Controlled Prices  In some cases the gov’t will fix the sale price of certain products/services o Price Controls are policies that attempt to hold the price at some disequilibrium value Disequilibrium Prices  When controls hold the price at some disequilibrium value, what determines the quantity actually traded on the market? o Any voluntary market transaction requires both a willing buyer and seller. If any quantity demanded < quantity supplied, demand will determine the amount actually exchanged, while the rest of the supply will remain in the hands of the unsuccessful sellers o Conversely, if quantity demanded > quantity supplied, supply will determine the amount actually exchanged while the rest of the demand will remain unsatisfied  At any disequilibrium, quantity exchanged is determined by the lesser of quantity demanded or quantity supplied Price Floors  A price floor is the minimum permissible price that can be charged for a particular good or service o A floor price that is set at or below the equilibrium price has no effect because the free-market equilibrium remains attainable o If the floor price is set above the equilibrium, it will raise the price, in which case it is said to be binding  Price floors may be established by rules that makes it illegal to sell the product below the prescribed price, as in the case of mini wage o Or the gov’t may establish a price floor by announcing that it will guarantee a certain price by buying an excess supply  They might do this so that the people who succeed in selling their products at the price floor are better off than if they had to accept the lower equilibrium price  Binding floor prices lead to excess supply – either an unsold surplus will exist, or someone must enter the market and buy the excess supply Price Ceilings  This is the maximum price that a good/service can be sold o If the price ceiling is set above the equilibrium price, it has no effect o If it is set below the equilibrium price, the price ceiling lowers the price in which case it is said to be binding  Binding prices may lead to excess demand, with the quantity exchanged being less than the free-market equilibrium Allocating Product in Excess Demand  Free markets eliminate excess demand by allowing prices to rise, thereby allocating the available supply among would-be purchasers o Cannot be happen in the presence of a binding price ceiling – some other method must be adopted  Exp. Suggests what to expect o If stores offer on a first come, first serve basis, people will rush to stores said to have stock – buyers may wait hours to get into store only to find none left o When seller’s decide who to sell to, and who not to, it is called sellers’ preference o Gov’t can chose to ration the product – only makes enough coupons to match the quantity supplied at the ceiling price and then distributes them to purchasers  Need to show coupon in order to buy the product Black Markets  Any market in which goods are sold illegally at prices that violate a legal price control o Bi
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