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Chapter 5

Chapter 5 - Markets in Action.docx

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University of British Columbia
ECON 101
Robert Gateman

5.1 The Interaction Among Markets 10-03-2012  No market or industry exists in isolation from the economy’s many other markets.  Feedback – change in one market  change in multiple markets o Assume that the prices of all other goods are constant  Partial equilibrium analysis – analysis of a single market in situations in which the feedback effect from other markets are ignored  When partial equilibrium analysis is a legitimate method of analysis: when the specific market is quite small relative to the entire economy. o Changes in that market will be small; therefore, the effects on other markets (feedback effect) will be even smaller.  General equilibrium analysis – study all markets together; how events in each market affect all the other markets o How all markets function together taking into account the various relationships and feedback effects. 5.2 Government-Controlled Prices 10-03-2012  Governments fix the price at which a product must be bought and sold  Government price controls – hold the price at some disequilibrium value o When below its Eq value, shortage o When above its Eq value, surplus Disequilibrium Prices  Voluntary market transaction requires both a willing buyer and a willing seller  In disEq, quantity exchanged is determined by the lesser of Qs and Qd. Price Floors  Price floor – minimum possible price  Binding – when it’s set above the Eq price  Raise the price  Government guarantees the producers that they will buy any excess supply – usually with agricultural support (or else population will have nothing to eat if the farmers decide to stop working)  Binding price floors lead to excess supply (surplus). Either an unsold surplus will exist or someone (usually government) must enter the market and buy the excess supply.  Consequences of excess supply o If there’s a surplus of labour (from minimum wage price floor)  unemployment o If there’s a surplus of wheat (agriculture)  accumulate in government warehouses (grain elevators, stock piling) o Inevitable in a competitive market  Why would the government put up with these consequences? o Producers could actually be better off with the price floor than if they had to accept the lower Eq price. o Workers & farmers are politically active o Demand of agricultural products is (usually inelastic), so producers earn more in total (See ch. 4) Price Ceilings  Price ceiling – maximum price  Binding – when it is set below the Eq price  Binding price ceilings lead to excess demand (shortage) with the quantity exchanged being less than in the free market equilibrium. Allocating a Product in Excess Demand o Adjustment cannot happen with the price ceiling, so there must be another method of allocation used. o First come, first served basis – consumers rush to stores, stand in long lines (ex. Concerts, sporting events) o Seller’s Preferences – seller sets aside products for family members, friends, etc. o Rationing of the product – gov’t distributes rationing coupons to match the Qs at the price ceiling; consumers would need those coupons & the money to purchase the product o Black markets – goods sold illegally at prices that violate the legal price control o Binding price ceilings always create the potential for a black market because profit can be made by buying at the controlled price and selling at the black- market price. Goals Governments Often Have When Imposing A Price Ceiling o [1] Restrict production (release close resources for other uses, reallocation of resources) o [2] Keep specific prices down o [3]Satisfy notions of equity in a consumption of a product that’s in short supply o To the extent that binding price ceilings give rise to a black market, it is likely that the government’s objectives motivating the imposition of the price ceiling will be thwarted. o [1] If producers can sell illegally above the price ceiling, nothing’s stopping them from producing more (as long as it’s sold at a price above the price ceiling – which is their incentive to increasing their production). o [2] Actual prices are not kept down when it’s sold on the black market. o [3] Products on the black market will probably only be sold to those who can afford those black market prices (no equity in the distribution). 5.3 Rent Controls: A Case Study of Price Ceilings 10-03-2012  Shortages of rental accommodations  Housing shortages  Varied short and long term effects  First-generation rent control – holding the price of housing below Eq price  Second-generation rent control – regulating the rental housing market Predicted Effects of Rent Controls  Housing shortage; Qd > Qs  Alternative allocation schemes – by sellers’ preference, government’s security-of-tenure laws (protects old tenants from eviction, no place to stay for new tenants)  Black markets – “key money” = Eq price – price ceiling (large security deposits, parking passes, or monthly dues) Because apartments are highly durable goods that provide services to consumers
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