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UT Knoxville ECON 201 - Price Controls and Taxes

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ECON 201 1st Edition Lecture 12Outline of Last Lecture I. Exam RemindersII. Consumer Theorya. Definition of consumer theoryb. Definition of total utilityc. Definition of marginal utilityIII. Producer Theorya. Definition of producer theoryIV. Costs and Profitsa. Definition of explicit costsb. Definition of implicit costsc. Definition of economic profitd. Definition of accounting profitV. Market Structurea. Definition of market structureb. Definition of perfect competitionc. Definition of monopolistic competitiond. Definition of oligopolye. Definition of monopolyVI. Why Monopolies Arisea. Definition of natural monopolyVII. Public Policy toward MonopoliesOutline of Current Lecture I. What’s in a Price? a. Definition of priceII. Price Controlsa. Definition of price ceilingb. Definition of price floorIII. How Price Ceilings Affect Market OutcomesIV. Shortages and RationingV. How Price Floors Affect Market OutcomesVI. Taxesa. Definition of taxesThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.Current LectureI. What’s in a Price? Prices are signals that guide the allocation of society’s resources. The higher the price, the greater the value to sellers and the greater cost to consumers, and vice versa. Should there be a price? Michael Sandel has the answer to this question: “Once we see that markets and commerce change the character of the goods they touch, we have to ask where markets belong—and where they don’t….We can’t answer this question without deliberating about the meaning and purpose of goods, and the values that should govern them….”-Michael SandelIn other words, the value of the price should depend on the amount of meaning and purpose a person places on a particular good. The price signals that the particular good is important and that we want more resources to go into it. In this way, market and commerce change the character of the goods they touch.II. Price ControlsDictating the prices of a good brings us to price controls. These are governmental policies that affect the market outcome. There are two types of price controls: price ceilings and price floors. A price ceiling is a legal maximum price a government places on a good while a price floor is a legal minimum price a government places on a good. III. How Price Ceilings Affect Market OutcomesThe diagram below shows how price ceilings affect market outcome if the price ceiling is $500.In the diagram, the red line shows the price ceiling, also known as the binding constraint. Because of this restraint, the price of the goods drops $300, resulting a shortage of 50 items ofthe amount of goods. Price ceilings, then, result in shortages and are advantageous to the consumers. However, price ceilings are only binding below the equilibrium. In the long run, price ceilings tend to flatten demand and supply curves.IV. Shortages and RationingWith shortages comes rationing mechanisms – how to decide who gets the goods sold since there is not enough for every individual. Without price as a rationing mechanism, then a multitude of other mechanisms can appear, such as lines (who has been waiting in line the longest), lottery (random winning), or discrimination according to the sellers’ biases. If you cannot use the price as the rationing mechanism, then a window opens for discrimination basedon bias. This is both unfair and inefficient. Ultimately, price is the best rationing mechanism. V. How Price Floors Affect Market OutcomeThe diagram below shows how price floors affect market outcome if the price floor is $5.In the diagram, the red line shows the price floor, also known as the binding constraint. Becauseof this restraint, the price of the goods increases $1, resulting a surplus of 50 items of the amount of goods. Price floors, then, result in surpluses and are advantageous to the producers. However, a surplus of goods also results in a surplus of labor, leading to unemployment. Price floors are like the “bottom” of a market.VI. TaxesTaxes are the amount that buyers and sellers pay on a specific good sold. The government leviestaxes on many goods and services to raise revenue for areas such as national defense and publicschools. The government can make buyers or sellers pay the tax, and this tax can be a percentage of the good’s price or a specific amount for each unit


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