ECON 200 Week 7 Notes
ECON 200 Week 7 Notes ECON 200
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This 5 page Class Notes was uploaded by Rachel Pollard on Friday February 19, 2016. The Class Notes belongs to ECON 200 at University of Washington taught by Haideh Salehi-Esfahani in Winter2015. Since its upload, it has received 7 views.
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Date Created: 02/19/16
Session 12 Tuesday, February 16, 2016 10:24 AM The analysis of effects of a subsidy paid to sellers Suppose the market equilibrium for natural gas is shown below. The market price is $3 per unit • The government wants to subsidize natural gas. • Now the government provides a $1 subsi dy per unit sold to sellers. o For every unit sold, the sellers receive a check for $1. • The supply behavior is being effected because the subsidy goes to the seller. o The MC changes thus shifting the supply curve. o The supply curve will shift to the right o It goes down by $1 • The price falls by $.80 • The new market price is at $2.20. (how much consumers will pay) • How much of this subsidy is being received by the consumers? o The subsidy is $1. o MP went from $3 to $2.20 o $3.00-$2.20=$0.80 • The suppliers get the new pric e plus the subsidy • $.20 is received by the sellers • Consumers get the most of the subsidy because the demand is relatively inelastic and falls by $.80 Analysis of a $1 subsidy • Why does the market price not fall to $2 per unit? o Because the Q demanded is reacting and so they don't allow the price to fall to $2 • Price paid by the consumers after the subsidy is • Price received by the seller after the subsidy is • So, from the original price, sellers receive 20 cents of the $1 subsidy. • Consumers receive 80 cent s of the $1 subsidy • The lost gains from trade is the triangle between Q=80 million and Q=100 million: (20*$1)*1/2=$10 million. o Shown with green arrow • A subsidy by the government may be justified and in fact may enhance economic efficiency. • Positive externality Clicker: in the demand and supply for hybrid cars a government subsidy paid to the consumers of these cars will shift the demand curve for hybrid cars to the right and the consumers and producers will share the subsidy. • Now suppose demand for a good is perfectly inelastic as in graph below: who - the buyers or the sellers - receive the subsidy that is paid by the government to the sellers? • $2 subsidy to the sellers from the government. • The MC drops by $2 • The P falls by $2. • The buyers receive all of the subsidy that is paid by the government. • Buyers used to pay $4 and now they pay only $2, so save $2, thus receiving the $2 subsidy. • So, when the demand is perfectly inelastic, the buyers receive all of the subsidy. • The sellers receive $4 in total, $2 (the price) + $2 (the subsidy) = $4 Shortages and Surpluses • The effect of direct government control: setting price ceilings or price floors! Section 5.4 • Competition by Price • Free market: a market made of purely forces of supply and demand • Competition by price: the price will change to eliminate problems in the market, includin g shortages and surpluses o The price will adjust to make problems go away Example 1: the mysterious process of rail ticket purchases in Iran in the late 1980s. The Market for Rail Tickets in Iran: • The price of tickets was $5. • There was a shortage. • There were more people who wanted the seats so there's now a competition among the buyers. • This price is called a price ceiling: because the price wants to go up due to the shortage o The shortage meant that if you really wanted the ticket, you had to go earlier. Example 2: Market for Chickens in Moscow prior to 1989: • Markets weren't supposed to be operating; the government set the prices. • What are the unintended consequences of a government imposed price ceiling? What are the effects on the level of consumer wel fare? • At P=$1, 200 chickens were available but 400 chickens were demanded so there's a shortage • Price competition isn't taking place here. • Shortage of 200 chickens Example • In the market for chickens in Moscow, suppose a buyer shows up at 8 am to queue up to purchase chicken. • She is paid $5 an hour at her job. • She values the first chicken at $6 and the price set by the government is $1. • Her consumer surplus is $5. • However, she has to wait in line for 1 h our and she loses 1 hour of work. • What is the true cost of one chicken? • It really costs her $6. Her wage ($5) and the price of the chicken ($1) • She doesn't have any consumer surplus left. Forms of non-price competition when a price ceiling is enacted: • Lines at the store- waiting in line (a costly process that leads to "dissipation" of mutual gains of trade) • Competition by knowing the seller personally and promising that you would do something for him if he gives you the chickens (bribing, influence pedd ling, and discrimination). • Chickens disappearing form "state stores" with controlled prices and sold in the back alleys for a high price to those who know and have "under -the-table agreements" with the seller (corruption). o Managers of bread factories in Uzbekistan would steal bread from the bread factories by car loads (the bread was more valuable than its nominal controlled price). • There is also "rationing" of the good in shortage where "coupons" are issued to consumers, each coupon giving the consumers the right to buy one unit of the good in shortage. Usually, a market for coupons develops where some people establish businesses in purchasing and reselling the coupons. Session 13 Thursday, February 18, 2016 10:30 AM The consequences of a price floor (pri ce support) in agriculture: • $3 is the equilibrium price • At $3, 150 is demanded and produced. • The price is now $5 • $5 is the price floor • 100 is what is purchased o Too little is being traded o There are lost gains from trade o Blue triangle shows the lost gains from trade • An inbalance • There's now a surplus • The price wants to fall so there's no surplus but it hits a floor • In order for the floor to stay, the government has to promise to promise the purchase the surplus • The losses to consumers: o The usual lost gains from trade o The lost/spoiled excess of goods produced Costs and Production (Chapter 6) • The principle of comparative advantage - example: o Tom can catch 4 fish, or pick 4 coconuts a day or, any combination in between. • What is the opportunity of catc hing a fish? o 1 coconut foregone • What is the marginal cost of catching an additional fish? o 1 coconut • What is the marginal cost of picking an additional coconut? o 1 fish foregone Now suppose Don appears on the island. Don can either catch 5 fish, or pick 10 coconuts. He is better than Tom in every activity. • If Don wants to catch an extra fish, how many coconuts does he have to give up? Therefore, the marginal cost of a dish for Don is: 2 coconuts foregone. • The MC of an additional fish is 2 coconuts foregone • The MC of an additional coconut is 1/2 fish foregone. Important Insights here so far: • Don is better in everything. At the end of the day, he has higher amounts of fish and coconut (higher income) than Tom. The whole PPF of Tom can be placed inside the PPF set for Tom. • One of them has a lower opportunity cost for catching fish. Tom o Tom would have to give up 1 coconut o Don would have to give up 2 coconuts • We say that Tom (worse at every good) has no netheless comparative advantage in the production of fish. • Don has comparative advantage in the production of coconuts. Now consider each individual alone: In this case each will produce some coconuts and some fish Suppose: • Tom decides to produce 2 fi sh and 2 coconuts • Don decides to produce 1 fish and 8 coconuts Alone, the total amount produced and consumed by Tom and Don are 3 fish and 10 coconuts. Now suppose they decide to cooperate: specialize in what they have comparative advantage in and trade with each other. Joint Production Possibility Frontier: • If both produce only fish and no coconuts, then all in all 9 fish will be produced. • If they only produce coconuts and no fish, then 14 coconuts will be produced. • If each specializes in their comparative advantage good, Tom produces 4 fish and Don produces 10 coconuts. • This is economic growth: more is produced with the same resources • How does this possibility (4 fish and 10 coconuts) compare with their total production when they acted alone? • Interpreting the various choices of fish and coconuts production on the join PPF for Tom and Don: • What is the MC of coconut production at A? o .5 fish foregone • What is the MC of coconut production at B? o 1 fish foregone • As more a good is produced, we run out of the "suitable" resources. Therefore, the production of additional units of this good become more costly (in terms of other goods and services foregone). • Therefore MC of production of a good rises as more of the good is produced. • The MC rises due to our inability to replicate the resources suitable for production of increasing amounts of a good. • The benefits of specialization and exchange extend to international trade. • If specialization and trade (free international trade) are so good, why are there peo ple who oppose free trade? • The main argument against free international trade: we lose our jobs to lower wage countries. Deriving the economy's PPF with many producers • First, remember the PPF with Tom and Don: • Up to 10 coconuts, the MC of coconut is: .5 fish. • If we want more than 10 coconuts, the MC of an additional coconut is 1 fish. • • Now suppose we add one more person: Kathryn to this island economy.
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