Slide 1Slide 2OVERVIEW / Questions of the DayI. Price controlsI. Price FloorsI. Price Floors: Non-bindingI. Price Floor: BindingSlide 8I. Application: Agricultural Price SupportsI. Application: Minimum WageI. Price CeilingsI. Price Ceilings: Non-bindingI. Price Ceilings: BindingI. Price Ceiling: General OutcomeI. Application: Rent CeilingsBIG IDEA IN ECONOMICSSlide 17II. Market failure!II. Market Failure: What is it?II. Market Failure: Some CausesRecall: Markets and AllocationII. Market Failure: A Perfect ExampleII. Market Failure: Lack of CompetitionII. Market Failure: Lack of CompetitionII. Market Failure: ExternalitiesII. Market Failure: Negative ExternalitiesII. Market Failure: Negative ExternalitiesII. Market Failure: Public GoodsPrivate or Public Good?Free Markets and the Economic ‘Pie’Free Markets and the Economic ‘Pie’II. Market Failure: Income InequalitySlide 33BIG IDEA IN ECONOMICSKey Concepts and TermsSummer Olympics, 2004Market Failure: Income InequalitySUPPLY, DEMAND, MARKETS AND APPLICATIONSUnderstanding How Markets Work1Topic IV: Supply and DemandTopic V: We Love Markets!Topic VI: Sometimes We Don’t!Topic VII: Elasticity and ApplicationsTOPIC VI:GOVERNMENT POLICY & MARKET FAILUREHow can government policies affect the market?When does the market do a bad job?2OVERVIEW / Questions of the DayWhat happens when we ‘interfere’ with markets?•Can the government control the price of a product/good/service?•How?•How do buyers and sellers respond?•What does that do to price, quantity and allocation?What happens if the market doesn’t do its job well?•What if the market doesn’t do what we as a society want?•What if the market fails to allocate resources the way we want?•Why does this occur?•Can we help to fix it?3I. PRICE CONTROLSWhat are price controls?Why do we have them?4I. Price FloorsPrice Floor: (also known as: price supports); a legal minimum price for a good or service•This makes it illegal to buy/sell the good for less than the price floor•Essentially, the government attempts to maintain a price higher than P* (called a “binding” price floor) •If the price floor is set lower than P*, it is “non-binding”•Who is the government trying to help?•SELLERS56I. Price Floors: Non-bindingSP*PQDPfloorA price floor essentially blocks off the market below itThis area of the market is no longer accessible to buyers or sellersSo what?7I. Price Floor: BindingSP*PQDPfloorThis price floor is effective…It prevents the buyers and sellers from reaching equilibrium price P*8SP*PDQPfloorI. Price Floor: General OutcomeQd9I. Application: Agricultural Price SupportsS3P ($)DQ (bushels of corn)430 40Pf10I. Application: Minimum WageS (of labor)w*w (P of labor)D (of labor)L (Q of labor)WminI. Price CeilingsPrice Ceiling: a legal maximum price for a good or service•This makes it illegal to buy/sell the good for more than the price ceiling•Essentially, the government attempts to maintain a price lower than P* (called a “binding” price ceiling)•If the price ceiling is set higher than P*, it is “non-binding”•Who is the government trying to help?• BUYERS1112I. Price Ceilings: Non-binding SP*PQDPceilingThe ceiling effectively shuts off this part of the marketSo what?13I. Price Ceilings: Binding SP*PQDPceiling14I. Price Ceiling: General OutcomeSP*PDQPcShortageQsQd15I. Application: Rent CeilingsSrent*Rent DQ (apts)rent ceiling(P of Apts.)BIG IDEA IN ECONOMICS•Economists, in general, are not in favor of price controls•Binding price floors•set the price above the equilibrium market price • cause surpluses•In general, hurts buyers and helps some sellers •Binding price ceilings•set the price below the equilibrium market price•cause shortages•In general, hurts sellers and helps some buyers 16Below is the market for blue jeans. Suppose the government wanted to set a price floor. In order to be effective (binding), where must it be set?17$80$70$90$100PBlue jeansQBlue jeans / day(thousands)20 28354555SDII. MARKET FAILURE!18II. Market Failure: What is it?For the majority of goods / services / inputs / resources / labor / etc., markets do a ‘good job’ for society•Markets allocate goods and services effectively and efficiently•However, sometimes they don’t…Market Failure: A situation where the market equilibrium results in too few or too many resources used in productionSometimes, government policies can help improve the situation19II. Market Failure: Some Causes•When might the market do a bad job?•What are the results?•How can government policy help improve the situation?1. Lack of Competition2. Externalities3. Public Goods4. Income Inequality2021Recall: Markets and Allocation8Q (do-dads/month)9Market SupplyMarket DemandAt P = $9, buyers wish to buy a total of 8 do-dads: K wants 3 L wants 4 M wants 1At P = $9, sellers wish to supply a total of 8 do-dads: Bud sells 4Coors sells 4PII. Market Failure: A Perfect Example22What does a ‘Perfect Market’ look like?1. Demand is composed of lots of buyers•Buyers compete and can’t direct the outcome 2. Supply is composed of lots of sellers•Sellers compete and can’t direct the outcome 3. The market finds the ‘correct’ price•P* accurately reflects the value of the product4. The market finds the ‘correct’ quantity•We as a society actually want this much of the product•We want to use resources to make only this muchP*Q*SDII. Market Failure: Lack of CompetitionThe Problem•Sometimes firms get greedy•Several competitors will ‘collude’•They reduce output and drive up prices to buyers•This increases their profits •Buyers end up paying more for product•Resources are NOT allocated efficientlyThe Solution•The government has passed several antitrust laws•It is illegal for firms to ‘restrict trade’ (fix the market)•Corporations can be fined •Individuals perpetrators can be fined and sent to jail 23II. Market Failure: Lack of Competition24P*Q*SDWhen firms collude, they generally agree to collectively reduce their outputThis works like a decrease in market supplyThe reduction in supply makes the product more scarce and valuableAs a result firms can raise the price and earn higher profitsII. Market Failure: ExternalitiesSome goods have unique properties whereby people not represented in the market are affected by the decisions / actions of those in the marketExternality: A cost or benefit imposed on people (third parties) other