Econd Study Guide 1
Econd Study Guide 1 1100
Popular in Econs 102 Fund of Macroeconomics
Popular in Economcs
This 25 page Study Guide was uploaded by Stephanie Ellis on Sunday February 1, 2015. The Study Guide belongs to 1100 at Washington State University taught by Lyudmyla Kompaniyets in Spring2015. Since its upload, it has received 77 views. For similar materials see Econs 102 Fund of Macroeconomics in Economcs at Washington State University.
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Chapterl First Principles Individual choice is the decision by an individual of what to do which necessarily involves a decision of what not to do Basic principles behind the individual choices 1 Resources are scarce 2 The real cost of something is what you must give up to get it 3 quotHow muchquot is a decision at the margin 4 People usually take advantage of opportunities to make themselves better off Principle 1 Choices Are Necessary Because Resources Are Scarce A resource is anything that can be used to produce something else Examples land labor capital Resources are scarce the quantity available isn39t large enough to satisfy all productive uses Examples petroleum lumber intelligence Principle 2 The True Cost of an Item ls Its Opportunitv Cos The real cost of an item is its opportunity cost what you must give up in order to get it Opportunity cost is crucial to understanding individual choice Example The cost of attending an economics class is what you must give up to be in the classroom during the lecture Sleep Watching TV Rock climbing Work All costs are ultimately opportunity costs Opportunity Cost In fact everybody thinks about opportunity cost The bumper stickers that say quotI would rather be shing gol ng swimming etcquot are referring to opportunity cost It is all about what you have to forgo to obtain your choice Principle 3 quotHow Muchquot Is a Decision at the Margin You make a tradeoff when you compare the costs with the bene ts of doing something Decisions about whether to do a bit more or a bit less of an activity are marginal decisions Marginal Analysis Making tradeoffs at the margin comparing the costs and bene ts of doing a little bit more of an activity versus doing a little bit less The study of such decisions is known as marginal analysis Examples Hiring one more worker studying one more hour eating one more cookie buying one more CD etc Principle 4 People Usually Respond to Incentives Exploiting Opportunities to Make Themselves Better Off An incentive is anything that offers rewards to people who change their behavior Examples 1 Price of gasoline rises D people buy more fuelef cient cars 2 There are more wellpaid jobs available for college graduates with economics degrees D more students major in economics People respond to these incentives Interaction How Economies Work Interaction of choices my choices affect your choices and vice versa is a feature of most economic situations Principles that underlie the interaction of individual choices 1 There are gains from trade Markets move toward equilibrium Resources should be used as ef ciently as possible to achieve society s goals 2 3 4 5 Markets usually lead to ef ciency When markets don39t achieve ef ciency government intervention can improve society s welfare Principle 5 There Are Gains From Trade In a market economy individuals engage in trade They provide goods and services to others and receive goods and services in return There are gains from trade people can get more of what they want through trade than they could if they tried to be selfsuf cient There Are Gains From Trade Principle 6 Markets Move Toward Equilibrium An economic situation is in equilibrium when no individual would be better off doing something different Any time there is a change the economy will move to a new equilibrium Example What happens when a new checkout line opens at a busy supermarket Principle 7 Resources Should Be Used As Ef cientlv As Possible to Achieve Societv s Goals An economy is ef cient if it takes all opportunities to make some people better off without making other people worse off Should economic policy makers always strive to achieve economic efficiency Equity means that everyone gets his or her fair share Since people can disagree about what39s quotfairquot equity isn39t as wellde ned a concept as ef ciency Ef ciency vs Equity Example Handicappeddesignated parking spaces in a busy parking lot A con ict between equity making life quotfairerquot for handicapped people and ef ciency making sure that all opportunities to make people better off have been fully exploited by never letting parking spaces go unused How far should policy makers go in promoting equity over ef ciency Principle 8 Markets Usually Lead to Ef ciency The incentives built into a market economy already ensure that resources are usually put to good use Opportunities to make people better off are not wasted Exceptions Market failure the individual pursuit of selfinterest found in markets makes society worse off the market outcome is inef cient Principle 9 When Markets Don39t Achieve Ef ciencv Government Intervention Can Improve Society39s Welfare Why do markets fail Individual actions have side effects not taken into account by the market externalities One party prevents mutually bene cial trades from occurring in the attempt to capture a greater share of resources for itself Some goods cannot be ef ciently managed by markets Example freeways in Los Angeles EconomyWide Interactions Principles that underlie economywide interactions Principle 10 Principle 11 One person39s spending is another person39s income Overall spending sometimes gets out of line with the economy39s productive capacity Principle 12 Government policies can change spending 1 SUMMARY All economic analysis is based on a set of basic principles that apply to three levels of economic activity First we study how individuals make choices second we study how these choices interact and third we study how the economy functions overall Everyone has to make choices about what to do and what not to do Individual choice is the basis of economics The reason choices must be made is that resources anything that can be used to produce something else are scarce SUMMARY Because you must choose among limited alternatives the true cost of anything is what you must give up to get it all costs are opportunity costs Many economic decisions involve questions not of quotwhetherquot but of quothow muchquot Such decisions must be taken by performing a tradeoff at the margin by comparing the costs and bene ts of doing a bit more or a bit less Decisions of this type are called marginal decisions and the study of them marginal analysis plays a central role in economics SUMMARY 6 The study of how people should make decisions is also a good way to understand actual behavior Individuals usually respond to incentives exploiting opportunities to make themselves better off 7 The next level of economic analysis is the study of interaction how my choices depend on your choices and vice versa When individuals interact the end result may be different from what anyone intends SUMMARY 8 Individuals interact because there are gains from trade by engaging in the trade of goods and services with one another the members of an economy can all be made better off Specialization each person specializing in the task he or she is good at is the source of gains from trade 9 Because individuals usually respond to incentives markets normally move toward equilibrium a situation in which no individual can make himself or herself better off by taking a different action SUMMARY 10An economy is ef cient if all opportunities to make some people better off without making other people worse off are taken Resources should be used as ef ciently as possible to achieve society s goals But ef ciency is not the sole way to evaluate an economy equity or fairness is also desirable and there is often a tradeoff between equity and ef ciency 11Markets usually lead to ef ciency with some wellde ned exceptions SUMMARY 12When markets fail and do not achieve ef ciency government intervention can improve society39s welfare 13Because people in a market economy earn income by selling things including their own labor one person39s spending is another person39s income As a result changes in spending behavior can spread throughout the economy SUMMARY 140verall spending in the economy can get out of line with the economy39s productive capacity Spending below the economy39s productive capacity leads to a recession spending in excess of the economy39s productive capacity leads to in ation 15Governments have the ability to strongly affect overall spending an ability they use in an effort to steer the economy between recession and in ation Chapter 2 Models in Economics A model is a simpli ed representation of a real situation that is used to better understand reallife situations How By Creating a real but simpli ed economy Simulating an economy on a computer The quotCeteris Paribusquot quotother things equalquot assumption means that all other relevant factors remain unchanged Tradeoffs The Production Possibility Frontier The production possibility frontier PPF illustrates the tradeoffs facing an economy that produces only two goods It shows the maximum duantitv of two goods that an economv can produce The PPF improves our understanding of tradeoffs by considering a simpli ed economy that produces only two goods by showing this tradeoff graphically The Production Possibility Frontier Increasing Opportunity Cost Economic Growth Production Possibilities for Two Countries Production Possibilities for Two Countries Absolute and Comparative Advantage A country has absolute advantage when it can produce more of a good compared to other countries A country has comparative advantage when its opportunity cost for producing a good is lower than that of others ie It can produce more given the same resources Eg US has ABSOLUTE ADVANTAGE over Brazil it can produce more of both large 30gt10 and small jets 40gt30 Does that mean there are no gains from trade No We must look at COMPARATIVE ADVANTAGE whose opportunity cost is lower in producing small vs large jets United States and Brazilian Opportunity Costs Specialize and Trade Both countries are better off when they each specialize in what they are good at and then trade It39s a good idea for Brazil to make the small jets for both of them This is because its opportunity cost of a small jet in terms of large jet not made is only 13 of a large jet versus 34 large jets for the United States Correspondingly it39s a good idea for the United States to make large jets for both of them Comparative Advantage and Gains from Trade How the Two Countries Gain from Trade Comparative vs Absolute Advantage An individual has a comparative advantage in producing a good or service if the opportunity cost of producing the good is lower for that individual than for other people An individual has an absolute advantage in an activity if he or she can do it better than other people given the same resources Having an absolute advantage is not the same thing as having a comparative advantage US vs Brazil Absolute vs Comparative The United States has an absolute advantage in both activities it can produce more output with a given amount of input in this case its time than BrazH But we39ve just seen that the United States can indeed bene t from a deal with Brazil because comparative not absolute advantage is the basis for mutual gain US vs Brazil Absolute vs Comparative So Brazil despite its absolute disadvantage in both small and large jets has a comparative advantage in small jet making Meanwhile the United States despite its absolute advantage in both small and large jets has a comparative disadvantage in small jets Thus the US can use its time better by making large jets and Brazil is better off specializing in small jets PITFALLS Global Comparison Pajama Republic Poor countries have relatively large clothing industries while rich countries have relatively small ones Poor countries have low productivity in the clothing sector but the sector has higher comparative advantage because their productivity in noncothing sectors is even lower Transactions The CircularFlow Diagram Barter when people directly exchange goods or services they have for goods or services they want money not involved So far we explained trade in the form of barter The circular ow diagram is a model that represents the transactions in an economy by ows around a circle The CircularFlow Diagram CircularFlow of Economic Activities A household is a person or a group of people that share their income A rm is an organization that produces goods and services for sale Firms sell goods and services that they produce to households in markets for goods and services Firms buy the resources they need to produce goods and services factors of production in factor markets CircularFlow of Economic Activities Ultimately factor markets determine the economy39s income distribution how total income is divided among the owners of the various factors of production Growth in the US Economy from 1962 to 1988 ECONOMICS IN ACTION Rich Nation Poor Nation Why are some countries so much poorer than we are The immediate reason is that their economies are much less productive Firms in these countries are just not able to produce as much from a given quantity of resources But if the economies of these countries are so much less productive than ours how is it that they make so much of our clothing Why don39t we do it for ourselves ECONOMICS IN ACTION Rich Nation Poor Nation The answer is comparative advantage Just about every industry in Bangladesh is much less productive than the corresponding industry in the United States But the productivity difference between rich and poor countries varies across goods the difference is very large in the production of sophisticated goods like aircraft but smaller in the production of simpler goods like clothing Using Models Positive economics is the branch of economic analysis that describes the way the economy actually works Normative economics makes prescriptions about the way the economy should work A forecast is a simple prediction of the future Using Models Economists can determine correct answers for positive questions but typically not for normative questions which involve value judgments The exceptions are when policies designed to achieve a certain prescription can be clearly ranked in terms of ef ciency It is important to understand that economists don39t use complex models to show quothow clever they arequot but rather because they are quotnot clever enoughquot to analyze the real world as it is When and Why Economists Disagree There are two main reasons economists disagree 1 Which simpli cations to make in a model 2 Values FOR INQUIRING MINDS When Economists Agree Do economists really disagree so much Not according to a classic survey of members of the American Economic Association reported in the May 1992 issue of the American Economic Review So is the stereotype of quarreling economists a myth Not entirely economists do disagree quite a lot on some issues especially in macroeconomics But there is a large area of common ground ECONOMICS IN ACTION Economists Beyond the Ivory Tower One speci c branch of economics nance theory plays an important role on Wall Street not always to good effect But pricing assets is by no means the only useful function economists serve in the business world ECONOMICS IN ACTION Economists Beyond the Ivory Tower Businesses need forecasts of the future demand for their products predictions of future rawmaterial prices assessments of their future nancing needs and more economic analysis is essential for these Financial rms like Goldman Sachs and Morgan Stanley in particular maintain highquality economics departments that produce analyses of forces and events likely to affect nancial markets Other economists are employed by consulting rms like Macro Advisers which sells analysis and advice to a wide range of other businesses ECONOMICS IN ACTION Economists Beyond the Ivory Tower Last but not least economists participate extensively in government According to the Bureau of Labor Statistics government agencies employ about half of the professional economists in the United States ECONOMICS IN ACTION Economists Beyond the Ivory Tower Economists play an especially important role in two international organizations headquartered in Washington DC 1 The International Monetary Fund which provides advice and loans to countries experiencing economic dif culties 2 The World Bank which provides advice and loans to promote longterm economic development VIDEO SUMMARY Almost all economics is based on models An important assumption in economic models is the other things equal assumption which allows analysis of the effect of a change in one factor by holding all other relevant factors unchanged SUMMARY One important economic model is the production possibility frontier lt illustrates opportunity cost ef ciency and economic growth There are two basic sources of growth an increase in factors of production resources such as land labor capital and human capital inputs that are not used up in production and improved technology SUMMARY Another important model is comparative advantage which explains the source of gains from trade between individuals and countries Everyone has a comparative advantage in something This is often confused with absolute advantage an ability to produce a particular good or service better than anyone else SUMMARY In the simplest economies people barter or trade goods and services for one another rather than trade them for money as in a modern economy The circular ow diagram represents transactions within the economy as ows of goods services and money between households and rms These transactions occur in markets for goods and services and factor markets SUMMARY Economists use economic models both for positive economics which describes how the economy works and for normative economics which prescribes how the economy should work Positive economics often involves making forecasts Economists can determine correct answers for positive questions but typically not for normative questions which involve value judgments SUMMARY There are two main reasons economists disagree One they may disagree about which simpli cations to make in a model Two economists may disagree like everyone else about values Chapter 3 Supply and Demand What a competitive market is and how it is described by the supply and demand model What the demand curve and supply curve are The difference between movements along a curve and shifts of a curve How the supply and demand curves determine a market39s equilibrium price and equilibrium quantity In the case of a shortage or surplus how price moves the market back to equilibrium Supply and Demand A competitive market Many buyers and sellers Same good or service The supply and demand model is a model of how a competitive market works Five key elements Demand curve Supply curve Demand and supply curve shifts Market equilibrium Changes in the market equilibrium Demand Schedule Quantitv demanded how much of a good consumers can and want to buy at a particular price Quantity demanded Demand Demand a demand schedule shows how much of a good or service consumers can and want to buy at different prices LAW OF DEMAND As price of a good rises quantity demanded falls Demand Curve A demand curve is the graphical representation of the demand demand schedule It shows how much of a good or service consumers want to buy at any given price DEMAND IS NOT THE SAME AS QUANTITY DEMANDED demand is made up of many quantities demanded at many different prices DEMAND not same as QUANTITY DEMANDED Quantity Demanded maximum number of units buyers are willing and able to buy at that price One point on the demand curve Change in quantity demanded MOVEMENT ALONG the demand curve Change in quantity demanded is caused by PRICE change only Demand is comprised of many quantities demanded at different prices but other factors unchanged The whole demand curve Change in demand SHIFT OF the demand curve Change in demand is caused by changes in factors OTHER THAN PRICE Movement Along the Demand Curve A movement along the demand curve is a change in the quantity demanded of a good that is the result of a change in that good39s price Shifts of the Demand Curve What Causes a Demand Curve to Shift Changes in the Prices of Related Goods substitutescomplements Changes in Income normalinferior goods Changes in Tastes Changes in Expectations Changes in Number of Consumers population What Causes a Demand Curve to Shift Changes in the Prices of Related Goods Substitutes Two goods are substitutes if increase in the price of one good causes increase in the demand for the other good consumers are more willing to buy the other good Eg icecream and frozen yogurt rice and pasta etc What Causes a Demand Curve to Shift Changes in the Prices of Related Goods Complements Two goods are complements if increase in the price of one good causes decrease in the demand for the other good Eg peanut butter and jelly spaghetti and meatballs etc What Causes a Demand Curve to Shift Changes in Income Normal Goods A good is a normal good when a rise in income increases the demand for that good Eg pasta Inferior Goods When a rise in income decreases the demand for a good it is an inferior good Eg Ramen noodles What Causes a Demand Curve to Shift Changes in Tastes Changes in Expectations Changes in Number of Consumers population CAUSES OF DEMAND SHIFTS Demand T means demand curve shifts RIGHT Demand i means demand curve shifts LEFT CAUSES OF DEMAND SHIFTS Price of a substitute T Price of a complement T Income T Tastes change in favor of the good it becomes popular Price is expected to T in the future Number of consumers T Tax on consumers Subsidy for consumers demand for the good T right shift demand for the good I left shift demand for normal good T right shift demand for inferior good I left shift demand T right shift demand T today right shift demand T right shift demand I left shift demand T right shift Individual Demand Curve and the Market Demand Curve An Increase in Demand An increase in pobulation and other factors generate an increase in demand a rise in the quantity demanded at any given price This is represented by the two demand schedules one showing demand in 2007 before the rise in population the other showing demand in 2010 after the rise in population An Increase in Demand A shift of the demand curve is a change in the quantity demanded at any given price represented by the change of the original demand curve to a new position denoted by a new demand curve Supply Schedule Quantity supplied how much of a good producers are willing and able to sell at a particular price Quantity supplied Supply Supply a supply schedule shows how much of a good or service producers can and are willing to supply at different prices LAW OF SUPPLY As price rises quantity supplied increases Supply Curve SUPPLY IS NOT THE SAME AS QUANTITY SUPPLIED supply is made up of many quantities supplied at different prices SUPPLY not the same as QUANTITY SUPPLIED Quantity Supplied maximum number of units sellers are willing and able to sell at that price One point on the supply curve Change in quantity supplied MOVEMENT ALONG the supply curve Change in quantity supplied is caused by PRICE change only Supply shows quantity supplied at different prices other factors unchanged The whole supply curve Change in supply SHIFT OF the supply curve Change in supply is caused by changes in factors OTHER THAN PRICE Movement Along the Supply Curve A movement along the supply curve is a change in the quantity supplied of a good that is the result of a change in that good39s price Shifts of the Supply Curve Changes in input prices An input is a good that is used to produce another good Changes in the prices of related goods and services Producer sells two goods gasoline and heating oil If gasoline price drops producer will supply more heating oil Changes in technology Better technology bigger supply Changes in expectations Heating oil price peaks in winter so if producers know that they will hold off selling it till then Changes in the number of producers More producers in the market larger supply CAUSES OF SUPPLY SHIFTS Supply T means supply curve shifts RIGHT Supply I means supply curve shifts LEFT CAUSES OF SUPPLY SHIFTS Price of an m T Price of a substitute in production T Price of a complement in production T Technology improves Price is expected to T in the future Number of producersT Tax on each unit Sub dy supply of the nal good I left shift supply of the original good I left shift supply of the original good T right shift supply of the good T right shift supply I today left shift supply of the good T right shift supply I by tax amount left shift supply I by subsidy amounts left shift An Increase in Supply The adoption of improved cottongrowing technology generated an increase in supply a rise in the quantity supplied at any given price This event is represented by the two supply schedules and their corresponding supply curves one showing supply before the new technology was adopted the other showing supply afterthe new technology was adopted An Increase in Supply A shift of the supply curve is a change in the quantity supplied of a good at any given price Individual Supply Curve and the Market Supply Curve Supply Demand and Equilibrium Equilibrium in a competitive market quantity demanded of a good quantity supplied of that good The price at which this takes place is the equilibrium price or market clearing price Every buyer nds a seller and vice versa The quantity of the good bought and sold at that price is the equilibrium quantity Market Equilibrium Surplus Shortage Equilibrium and Shifts of the Demand Curve Equilibrium and Shifts of the Supply Curve Technology Shifts of the Supply Curve Simultaneous Shifts of Supply and Demand Simultaneous Shifts of Supply and Demand Simultaneous Shifts of Supply and Demand SUMMARY 1 The supply and demand model illustrates how a competitive market one with many buyers and sellers none of whom can in uence the market price works 2 The demand schedule shows the quantity demanded at each price and is represented graphically by a demand curve The law of demand says that demand curves slope downward that is a higher price for a good or service leads people to demand a smaller quantity other things equal SUMMARY 3 A movement along the demand curve occurs when a price change leads to a change in the quantity demanded When economists talk of increasing or decreasing demand they mean shifts of the demand curve a change in the quantity demanded at any given price An increase in demand causes a rightward shift of the demand curve A decrease in demand causes a leftward shift SUMMARY 4 There are ve main factors that shift the demand curve A change in the prices of related goods or services such as substitutes or complements A change in income when income rises the demand for normal goods increases and the demand for inferior goods decreases A change in tastes A change in expectations A change in the number of consumers SUMMARY 5 The market demand curve for a good or service is the horizontal sum of the individual demand curves of all consumers in the market 6 The supply schedule shows the quantity supplied at each price and is represented graphically by a supply curve Supply curves usually slope upward SUMMARY 7 A movement along the supply curve occurs when a price change leads to a change in the quantity supplied When economists talk of increasing or decreasing supply they mean shifts of the supply curve a change in the quantity supplied at any given price An increase in supply causes a rightward shift of the supply curve A decrease in supply causes a leftward shift SUMMARY 8 There are ve main factors that shift the supply curve A change in input prices A change in the prices of related goods and services A change in technology A change in expectations A change in the number of producers 9 The market supply curve for a good or service is the horizontal sum of the individual supply curves of all producers in the market SUMMARY 10The supply and demand model is based on the principle that the price in a market moves to its equilibrium price or marketclearing price the price at which the quantity demanded is equal to the quantity supplied This quantity is the equilibrium quantity When the price is above its marketclearing level there is a surplus that pushes the price down When the price is below its marketclearing level there is a shortage that pushes the price up SUMMARY 11An increase in demand increases both the equilibrium price and the equilibrium quantity a decrease in demand has the opposite effect An increase in supply reduces the equilibrium price and increases the equilibrium quantity a decrease in supply has the opposite effect SUMMARY 12Shifts of the demand curve and the supply curve can happen simultaneously When they shift in opposite directions the change in equilibrium price is predictable but the change in equilibrium quantity is not When they shift in the same direction the change in equilibrium quantity is predictable but the change in equilibrium price is not In general the curve that shifts the greater distance has a greater effect on the changes in equilibrium price and quantity Chapter 4 Price Controls and Quotas Meddling with Markets The meaning of price controls and quantity controls two kinds of government interventions in markets How price and quantity controls create problems and can make a market inef cient Why the predictable side effects of intervention in markets often lead economists to be skeptical of its usefulness Who bene ts and who loses from market interventions and why they are used despite their wellknown problems Why Governments Control Prices The market price moves to the level at which the quantity supplied equals the quantity demanded But this equilibrium price does not necessarily please either buyers or sellers Therefore the government intervenes to regulate prices by imposing price controls which are legal restrictions on how high or low a market price may go Price ceiling is the maximum price sellers are allowed to charge for a good or service Price oor is the minimum price buyers are required to pay for a good or service Why Governments Control Prices Price ceiling is called a Nonbindingineffective if it is set at or above the equilibrium price b Bindingeffective if it is set M the equilibrium price In order for price ceiling to be bindingeffective it MUST be set below equilibrium price panel b Otherwise price will always be at the equilibrium level so price ceiling did not change anything Eg Why Governments Control Prices Price oor is called a Nonbindingineffective if it is set at or below the equilibrium price b Bindingeffective if it is set above the equilibrium price In order for price oor to be bindingeffective it MUST be set above equilibrium price panel b Otherwise price will always be at the equilibrium level so price floor did not change anything Eg Price Ceilings Price ceilings are typically imposed during crises wars harvest failures natural disasters because these events often lead to sudden price increases that hurt many people but produce big gains for a lucky few Examples US government imposed ceilings on aluminum and steel during World War II Rent control in New York City The Market for Apartments in the Absence of Government Controls The Effects of a Price Ceiling How Price Ceilings Cause lnef ciency lnef ciently low quantity Price ceiling reduces the quantity the sellers are willing to supply This prevents mutually bene cial transactions between buyers and sellers quotmissed opportunitiesquot Inef cient allocation to customers People who badly need a place to live and willing to pay more may not be able to nd an apartment Wasted resources People expend money efforts to cope with the shortages lnef ciently low quality No incentives for sellers to provide a better quality Black markets Eg Illegal subletting bribes money quotunder the tablequot A Price Ceiling Causes lnef ciently Low Quantity So Why Are There Price Ceilings Rent Control in New York Price ceilings hurt most residents but give a small minority of renters much cheaper housing than they would get in an unregulated market those who bene t from the controls are typically better organized and more in uential than those who are harmed by them When price ceilings have been in effect for a long time buyers may not have a realistic idea of what would happen without them Government of cials often do not understand supply and demand analysis Price Floors Sometimes governments intervene to push market prices up instead of down The minimum wage is a legal oor on the wage rate which is the market price of labor Just like price ceilings price oors are intended to help some people but generate predictable and undesirable side effects The Market for Butter in the Absence of Government Controls The Effects of a Price Floor How a Price Floor Causes lnef ciency Very similar to inef ciencies from Price Ceilings These include lnef ciently low quantity Inef cient allocation of sales among sellers those who would be willing to sell the good at the lowest price are not always those who actually manage to sell it Wasted resources Surplus production often just goes to waste lnef ciently high quality sellers offer highquality goods at a high price even though buyers would prefer a lower quality at a lower price Temptation to break the law by selling below the legal price Workers are willing to work off the books quotblack laborquot A Price Floor Causes lnef ciently Low Quantity PITFALLS Ceilings Floors and Quantities A price ceiling pushes the price of a good down A price oor pushes the price of a good up Both oors and ceilings reduce the quantity bought and sold If sellers don39t want to sell as much as buyers want to buy it s the sellers who determine the actual duantitv sold because buyers can39t force unwilling sellers to sell If buvers don39t want to buv as much as sellers want to sell it s the buyers who determine the actual quantity sold because sellers can39t force unwilling buyers to buy Controlling Quantities A quantity control or quota is an upper limit on the quantity of some good that can be bought or sold The total amount of the good that can be legally transacted is the quota limit An example is the taxi medallion system in New York A license gives its owner the right to supply a good The demand price of a given quantity is the price at which consumers will demand that quantity The supply price of a given quantity is the price at which producers will supply that quantity The Market for Taxi Rides in the Absence of Government Controls Effect of a Quota on the Market for Taxi Rides The Anatomy of Quantity Controls A quantity control or quota drives a wedge between the demand price and the supply price of a good that is the price paid by buyers ends up being higher than that received by sellers The difference between the demand and supply price at the quota limit is the quota rent the earnings that accrue to the licenseholder from ownership of the right to sell the good It is equal to the market price of the license when the licenses are traded The Costs of Quantity Controls Some mutually bene cial transactions don39t occur Shortage of 2 million rides quotmissed opportunity ridesquot There are incentives for illegal activities Eg unlicensed cabs SUMMARY Even when a market is ef cient governments often intervene to pursue greater fairness or to please a powerful interest group Interventions can take the form of price controls or quantity controls both of which generate predictable and undesirable side effects consisting of various forms of inefficiency and illegal activity SUMMARY A price ceiling a maximum market price below the equilibrium price bene ts successful buyers but creates persistent shortages Because the price is maintained below the equilibrium price the quantity demanded is increased and the quantity supplied is decreased relative to the equilibrium quantity This leads to predictable problems inef ciently low quantity inef cient allocation to consumers wasted resources and inef ciently low quality It also encourages illegal activity as people turn to black markets to get the good SUMMARY A price oor a minimum market price above the equilibrium price bene ts successful sellers but creates persistent surplus Price oors lead to inef ciencies in the form of inef ciently low quantity inef cient allocation of sales among sellers wasted resources and inef ciently high quality It also encourages illegal activity and black markets The most wellknown price oor is the minimum wage but price oors are also commonly applied to agricultural products SUMMARY Quantity controls or quotas limit the quantity of a good that can be bought or sold The quantity allowed for sale is the quota limit The government issues licenses to individuals the right to sell a given quantity of the good Economists say that a quota drives a wedge between the demand price and the supply price this wedge is equal to the quota rent Quantity controls encourage illegal activity
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