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ECON 101

by: Samantha jose

ECON 101 101

Samantha jose
GPA 3.2

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About this Document

Market Efficiency & Price Controls
Dr. Love
75 ?




Popular in Microeconomics

Popular in Economcs

This 6 page Bundle was uploaded by Samantha jose on Saturday February 6, 2016. The Bundle belongs to 101 at Washington State University taught by Dr. Love in Fall. Since its upload, it has received 49 views. For similar materials see Microeconomics in Economcs at Washington State University.


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Date Created: 02/06/16
Market Efficiency Measuring Market Efficiency • Markets are (usually) efficient: we can measure their benefits to society by measuring: o Consumer surplus o Producer surplus Consumer Surplus • The difference between market price and what consumers (as individuals are the market) would be willing to pay Producer Surplus • The difference between market price and the price at which firms are willing to supply the produce o The total producer surplus from sales of a good at a given price is the area above the supply curve and below the price The Gains from Trade • Markets are remarkably efficient and beneficial most of the time… Measuring consumer and producer surplus proves it. Total Surplus is Maximized at Market Equilibrium • Total Surplus: the sum of the producer and consumer surpluses 3 ways you might (unsuccessfully) try to increase the total surplus • 1. Reallocate consumption among consumers • 2. Reallocate sales among sellers • 3. Change the quantity traded The Efficiency of Markets • Competitive markets are usually efficient: o 1. They allocate consumption of the goods to the potential buyers who most value it. o 2. They allocate sales to the potential sellers who most value the right to sell the good (e.g., who has the lowest cost) o 3. They ensure that all transactions are mutually beneficial: every consumer who makes a purchase values the good more than every seller who makes a sale. o 4. They ensure that no mutually beneficial transactions are missed (that no-one who fails to trade would have benefited) Equity and Efficiency • Efficiency is important, but society also cares about equity. • Sometimes societies choose to have governments intervene in markets to increase equity (even though it reduces) Why Markets Typically Work So Well • Well-functioning markets are effective because of: o Property rights o Economic signals Why Private Property Matters • Private property rights create and protect incentives to trade with others – and to innovate Why good economic signals matter • Equilibrium prices signal to resources exactly where they are most values • Prices translate complex information into an easy signal for producers: o Profits rise in industries when consumers want more of that industry’s products o Profit decline in industries when consumers want less of that industry’s products o The high price of ice in post-Katrina New Orleans made it more attractive for firms to provide ice where society needed it most A few words of caution • Markets aren’t always efficient; sometimes they fail Inefficient: opportunities are missed. Some people could be made better off without making other people worse off. Price Controls 2/6/16 6:07 PM Interference in Markets has Consequences • Distorted price signals cause resources to be misallocated • If prices are distorted, they cannot signal good information to buyers and sellers Price Controls • Price Controls: legal restrictions on how high or low a market price may go. There are two main types: o Price Ceiling: a maximum price sellers are allowed to charge for a good or service (usually set BELOW equilibrium) o Price Floor: a minimum price buyers are required to pay for a good or service (usually set ABOVE equilibrium) Price Ceilings Cause Inefficiency • Price ceilings cause predictable side effects: o Inefficiently low quantity o Inefficient allocation to customers o Wasted resources o Inefficiently low quality o Black markets Binding, or Effective, Price Ceilings • If a price ceiling is set ABOVE equilibrium, it will have no effect (called nonbinding) • Only a price ceiling that forces price below equilibrium will have any effect (called binding or effective) Inefficiently Low Quantity • When prices are held below the market price, shortages are created. o The lower the controlled price relative to the market equilibrium price, the larger the shortage Price Controls • Deadweight Loss: the loss in total surplus that occurs whenever an action or a policy reduces the quantity transacted below the efficient market equilibrium quantity Inefficient Allocation to Customers • Price controls distort signals that would help the goods get allocated their highest-valued uses. o Consumers who value a good most don’t necessarily get it o So producers have no incentive to supply the good to the “right” people first Wasted Resources • Price controls that create shortages lead to bribery and wasteful lines o Shortages: not all buyers will be able to purchase the good o Normally, buyers would compete with each other by offering a higher price o If price is not allowed to rise, buyers must compete in other ways (waiting in line, illegal bribes and favors) Inefficiently Low Quality • As the controlled price, sellers have more customers than goods o In a free market, this would be an opportunity to profit by raising prices o BUT when prices are controlled, sellers cannot. • Sellers respond to this problem in two ways: o Reduce quality o Reduce service Black Markets • A black market is a market in which goods or services are bought and sold illegally – either because they are prohibited or because the equilibrium price is illegal. Price Floors • Sometimes governments intervene to push market prices up instead of down. Binding, or Effective, Price Floors • If a price floor is set below equilibrium, it will have no effect (called nonbinding) • Only a price floor that forces price above equilibrium will have any effect (binding, or effective) Price Floor Causes Inefficiency • Price floors cause predictable side effects: o Deadweight loss from inefficiently low quantity o Inefficient allocation of sales among sellers o Wasted resources o Inefficiently high quality o Temptation to break the law by selling below the legal price Inefficient Allocation of Sales Among Sellers • Price floors misallocate sales by: o Allowing high-cost firms operate o Preventing low-cost firms from entering the industry • Price floors and regulation prevented Southwest (and 79 other firms) from entering the national market Wasted Resources • Price floors encourage waste • To deal with the surplus generated by agricultural price floors, the US government sometimes buys back the excess and donates or destroys it. Inefficiently High Quality • Higher quality raises costs and reduces sellers’ profit. • Buyers get higher quality but would prefer a lower price • Price floors encourage sellers to waste resources: o High quality than buyers are willing to pay for Illegal Activity • Price floors encourage black markets • There are willing sellers (and buyers) at illegal prices, so they are tempted to break the law and trade with each other. Do not be confused: • Price ceilings, floors, and quotas all decrease the amount traded and therefore create deadweight loss. o A price ceiling pushes the price of a good down; fewer sellers will want to sell o A price floor pushes the price of a good up; fewer buyers will want to buy o A quota, by definition, reduces sales Controlling Quantities • Governments sometimes control quantity instead of price o Quota: an upper limit, set by the government, on the quantity of some good that can be bought or sold; also referred to as a quantity control o Quota Limit: the total amount of a good under a quota or quantity control that can be legally transacted o License: The right, conferred by the government to supply a good Demand price: • The price of a given quantity at which consumers will demand that quantity Supply price: • The price of a given quantity at which producers will supply that quantity The Wedge, or Quota, rent: • The difference between the demand price and the supply price at the quota limit. Equal to the market price of the license when the license is traded The Costs of Quantity Control • Like price controls, quotas impose losses on society o Deadweight loss (some mutually beneficial transactions don’t occur) o Incentives for illegal activities


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