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Week 4: Chapter 5 Notes

by: Alex

Week 4: Chapter 5 Notes Econ 1011

GPA 4.4
Principles of Economics: Microeconomics
Henry Terrell

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These are the notes for Chapter 5: Price Controls and Quotas: Meddling with Markets. They are highlighted in two different colors in order to emphasize the key words you should know as well as the ...
Principles of Economics: Microeconomics
Henry Terrell
Class Notes
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This 5 page Class Notes was uploaded by Alex on Wednesday September 30, 2015. The Class Notes belongs to Econ 1011 at George Washington University taught by Henry Terrell in Spring 2015. Since its upload, it has received 24 views. For similar materials see Principles of Economics: Microeconomics in Economcs at George Washington University.


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Date Created: 09/30/15
Econ 101 1 Chapter 5 IV Price Controls and Quotas 92315 Meddling with Markets Why Governments Control Prices A Equilibrium prices do not necessarily please either buyers or sellers 1 Buyers would always like to pay less 2 Sellers would always like to get more money a Ex what if equilibrium among apartment rates in major cities leads to rental rates that the average working person can t afford b Ex what if equilibrium among less skilled workers leads to wage rates that produce an income below poverty level There is often a strong political demand for government interference in markets Price controls when a government intervenes to regulate prices Price ceiling government interference in the form of an upper limit Price floor government interference in the form of a lower limit When price controls are enforced in an inefficient market they can help move the market closer to efficiency 1 In reality price controls are usually enforced on efficient markets causing many problems Price Ceilings A Price ceilings are imposed during a crisis because these events can lead to price increases that hurt many people but benefit just a few 1 War harvest failures natural disasters a Rent control in New York was imposed because during WWII wartime production produced an increase demand for apartments Modelling a Price Ceiling A In New York imagine all apartments are exactly the same and would rent for the same price in an unregulated market 1 The quantity of apartments is shown on the xaxis 2 Monthly rent per apartment is shown on the yaxis 3 In an unregulated market the equilibrium would be 2 million apartments being rented out at 1000 a month B Suppose the government imposes a price ceiling where rent can be no more than 800 a month 1 At this rate landlords have less incentive to offer apartments They won t be willing to supply as many as they would at the equilibrium rate of 1000 2 At the same time though more people will want to rent apartments due to the lower price 3 There is now a constant shortage of rental housing C If a price ceiling is set above the equilibrium price it has no effect 1 The price ceiling will not be binding it won t restrict the market behavior How a Price Ceiling Causes lnefficiency A Can be very harmful due to the fact that they lead to inefficiency B There are gains from trade that go unrealized C Ex Rent control creates inefficiency in four distinct ways 1 Reduces the quantity of apartments rented 2 Leads to an inefficient allocation of apartments 3 Leads to wasted time and effort as people look for apartments 4 Causes landlords to maintain apartments in low quality or condition TWP Econ 101 1 Chapter 5 D Price Controls and Quotas 92315 Meddling with Markets May also lead to illegal behavior V lnefficiently Low Quantity A B Market equilibrium leads to the quotrightquot quantity the quantity that maximizes the sum of producer and consumer surplus Deadweight loss lost surplus associated with the transactions that no longer take place due to market intervention 1 Deadweightloss triangle Loss to society reduction in total surplus a loss in surplus that goes to no one as a gain 1 Not the same as a loss in surplus to one person that then goes to someone else as a gain a Transfer in surplus VI Inefficient Allocation to Consumers A D Misallocation of apartments available people who badly need an apartment may not be able to find one but people who do not necessarily needthe apartment may be able to occupy one 1 Some want an apartment so badly they are willing to pay more than the price ceiling 2 Others do not have this urgency and therefor would not pay above the price ceiling Inefficient distribution of apartments occurs when some people who are not very anxious to find an apartment find one but those who are very anxious and desperate will not Inefficient allocation to consumers when goods services are provided to people who are not very desperate for the product leaving those who desperately need the product unable to find a buyer Price ceilings can lead to illegal behaviors such as subletting VII Wasted Resources A W B Wasted resources people expend money effort and time to cope with the shortages caused by the price ceiling 1 The opportunity cost spent constitutes wasted resources from the point of view of consumers and of the economy There is an opportunity cost associated with consumers desperately looking but unable to find sellers at the set price ceiling lnefficiently Low Quality lnefficiently low quality sellers offer lowquality goods at a low price even though buyers would rather have higher quality and would be willing to pay a higher price 1 Landlords of apartments in New York have no incentive to provide better conditions within their apartments because they can only charge a maximum price regardless 2 Any additional payments by the tenants towards improvements to the apartment would be legally considered a rent increase which goes against the restrictions of the price ceiling a This leads to notoriously poorly maintained apartments in New York Causes missed opportunities some tenants would be happy to pay more money for better living conditions and landlords would be happy to provide them for a higher price 1 This exchange would only occur if the market were allowed to operate freely IX Black Markets A B C Black markets a market in which goods services are bought and sold illegally 1 Price ceilings provide an incentive for illegal activities such as black markets This encourages disrespect for the law Illegal activities worsen the situations of those who are honest Econ 101 1 Chapter 5 Price Controls and Quotas 92315 Meddling with Markets X So Why Are There Price Ceilings XI XII H0 A E Pri A W quotquotU0 F A B X XIV Th Three common results 1 Persistent shortage of the good 2 lnefficiency arising from this persistent shortage in the form of inefficiently low quantity inefficient allocation of the goods to consumers wasted resources and the inefficiently low quality of the goods being sold 3 Emergence of black markets Most price ceilings hurt most consumers but give a small number of people great gains and opportunities Those who benefit form the controls are usually better organized and more vocal than those who are harmed Buyer may not have a realistic idea of what would happen without the price controls 1 They may have heard about black market transactions and did not realize that black market prices are much higher than they would be in a unregulated market Government officials usually do not understand supply and demand analysis ce Floors Price floors are widely used for agricultural products such as wheat and milk in order to support the incomes of farmers 1 Legal minimum wages are also price floors Minimum wage governments maintain a lower limit on the hourly wage rate of a worker39s labor Price floors lead to a persistent surplus If the price floor is below the market equilibrium price it becomes irrelevant not binding The unwanted surplus created by a binding price floor can be bought by the government 1 Other countries may pay exporters to seltzer products overseas 2 They may even decide to destroy the surplus destruction A price floor causes wouldbe sellers to be unable to find buyers w a Price Floor Causes lnefficiency Persistent surplus creates missed opportunities Price floors create inefficiency in four specific ways 1 Creates deadweight loss by reducing the quantity transacted to below the efficiency level Inefficient allocation of sales among sellers Waste of resources Sellers provide an inefficiently highquality level ey can also lead to illegal behaviors lnefficiently Low Quantity Price floors raise the price of a product and therefore reduce the quantity of the product demanded Reduces the quantity of the product bought and sold at the regulated price leads to deadweight loss 1 This is the same effect as the price ceiling a Both have the effect of reducing the quantity of a good bought and sold Price floors that reduce the quantity below the equilibrium quantity reduces total surplus Total surplus sum of the area above the supply curve and below the demand cure Inefficient Allocation of Sales Among Sellers 2 3 4 Econ 101 1 Chapter 5 A B XV W A XVI XVII XVIII XIX 093 quotquotU Price Controls and Quotas 92315 Meddling with Markets Inefficient allocation of sales among sellers sellers who are willing to sell at the lowest price are unable to makes sales while sales go to sellers who are only willing to sell at a higher price 1 Unemployment and black market labor among young people in Europe such as France Spain Italy and Greece 2 Those unable to find jobs tend to be young between the ages of 18 and 30 a They are eager for jobs and willing to accept less than minimum wage It is illegal for sellers to sell below the price floor asted Resources The government purchases unwanted surpluses of agricultural products sometimes destroying them which is waste sometimes products are stored for later use but go bad at must be disposed of this too is a waste Time and effort is also wasted in terms of minimum wage wouldbe workers spend time searching for jobs that are willing to pay minimum wage lnefficiently High Quality lnefficiently high quality sellers offer highquality goods at a high price even though buyers would prefer a lower quality at a lower price Sellers spend more money to make highquality goods but this quality isn39t worth mooch to consumers who would rather receive the lowerquality good at a lower price Missed opportunities occur suppliers and buyers could make a deal where buyers got the goods of lowerquality for a much lower price Illegal Activity In the case of minimum wage workers are desperate for employment and are willing to work off the books for employers who conceal their employment from the government 1 In Europe this practice is known as black labor So Why Are There Price Floors Government officials usually disregard warnings about the consequences of price floors 1 They either believe that the market is being poorly described or the don39t understand the supply and demand model Price floors benefit a few influential sellers Controlling Quantities Quantity control quota the government regulates the quantity of a good that can be bought and sold rather than the price at which it is transacted 1 The New York medallion system in which a taxi cab driver must own a medallion in order to legally pick up passengers there is only a set number of medallions available in the system Quota limit total amount of the good that can be transacted under the quantity control Licenses issued by the government in order to limit quantity in a market as well as the number of people legally able to supply the good These set upper limits on the quantity of a good that can be transacted Quantity controls that are implemented to fix a temporary economic problem end up becoming politically hard to remove later because the beneficiaries don39t want them removed even though the initial reason for their existence is long gone XXThe Anatomy of Quantity Controls A B C Demand price price at which consumers want to buy a given quantity As the demand for a good rises the price of the good decreases Supply price price at which suppliers will supply a given quantity Econ 101 1 Chapter 5 D XXI Price Controls and Quotas 92315 Meddling with Markets In New York medallion owners may either choose to use their medallion in order to operate a taxi or lease their medallion to another eager taxi driver 1 In this case out of the money the taxi driver leasing the medallion makes a certain percentage or amount must be paid to the owner of the medallion as rent 2 There are two transactions occurring the transactions in taxi rides and the transactions in medallions Wedge whenever the supply of a good is legally restricted this occurs between the demand price of the quantity transacted and the supply price of the quantity transacted Quota rent the earnings that accrue to the licenseholder from ownership of a valuable commodity 1 If the medallion is not rented out there is an opportunity cost of not renting it out and the quota rent becomes the rental income given up by driving the tax themselves Quotas don39t always have a real effect 1 If it is set above the equilibrium quantity it would have no effect it is not binding The Costs of Quantity Controls lnefficiency due to missed opportunities 1 Quantity controls create deadweight loss by preventing wouldbe transactions form occurring transactions that would benefit both buyers and sellers Only when the market has reached the unregulated market equilibrium quantity are there no quotmissed opportunitiesquot As long as the demand price of a given quantity exceeds the supply price there is a deadweight loss Create incentive to evade them or break the law 1 In the case of New York taxis prearranged pickups do not require a medallion they provide much of the service that might otherwise be provided by a taxi 2 There are also many unlicensed cabs in New York that pick up passengers even though it is illegal to do so without a medallion Quantity controls usually create the following unwanted side effects 1 Deadweight loss 2 Incentives for illegal activities


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