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USC ECON 203 - C7

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Slide 1Knowledge RecapApplication: Policy AnalysisPolicy Analysis: Drug PoliciesPolicy Analysis: Drug PoliciesPolicy Analysis: Drug PoliciesPolicy Analysis: Price ControlsPolicy Analysis: Price ControlsPolicy Analysis: Price ControlsPolicy Analysis: Price ControlsECON 203: Principles of MicroeconomicsClass 7: Applications of Economic Analysis and Government Policies1Knowledge Recap•The demand and supply curves describe the interaction between buyers and sellers in markets.•Market equilibrium occurs when price is at a level where quantity supplied equals quantity demanded.•A shift in either demand or supply leads to movements along the supply and demand curves.•Price elasticity tells us how much Q will change as a response to a change in P.•Price elasticity determines the magnitude and (in some cases) direction of the change in P and Q that occurs due to a shift in demand and supply curves.2Application: Policy Analysis•Use knowledge on market equilibrium and elasticities to evaluate government interventions.•General policy interventions.–Effects of drug interdiction and education programs.•Price controls.–Price floors.–Price ceilings.•Taxes3Policy Analysis: Drug Policies•Drug interdiction programs are implemented to prevent illicit drugs from reaching their destination.•Economic framework used to evaluate effects.–Step 1: evaluate resulting shifts in supply and demand. –Step 2: evaluate the direction of the shift.–Step 3: evaluate the direction of the resulting changes in equilibrium price and quantity.–Step 4: consider price elasticities to evaluate the magnitude of the resulting changes in equilibrium price and quantity.4Policy Analysis: Drug Policies•Economic impacts of drug interdiction:–Increase in costs of selling drugs  effect on supply.–Higher costs decrease the quantity sellers are willing to produce at any price  shift in supply curve to the left. –The shift in supply increases price and decreases quantity.–Since demand for drugs is likely inelastic, the effect on price is strong and the effect on quantity is small.5Policy Analysis: Drug Policies•Consider instead drug education programs.–Increased public awareness  effect on demand.–Awareness of high “costs” of drug addiction  shift in demand curve to the left. –The shift in demand decreases price and quantity.–Since supply of drugs is likely more elastic than demand, the effect on quantity is stronger then with the supply shift.6Policy Analysis: Price Controls•Price ceiling: a legal maximum on the price at which a good can be sold.–When price ceiling is set above market equilibrium price (is “non-binding”) it has not effect on the market outcomes.–When price ceiling is set below market equilibrium price (is “binding”) it creates a shortage in the market and can have unintended social consequences such as black markets.7Policy Analysis: Price Controls•Price ceiling: examples.–Price of gasoline in 1970’s.•Initially non-binding.•When OPEC decreases supply (shift to the left) in 1973 becomes binding creating a shortage.•Long lines that increased the actual cost of gasoline.•Emergence of black markets due to gains from arbitration. 8Policy Analysis: Price Controls•Price ceiling: examples.–Rent control.•Regulation of rent prices in old building in SF.•Small effect in the short-run due to fixed supply of houses and time to move (inelastic supply and demand).•Larger effect in long-run as landlords find alternative uses to houses and people come to SF (elastic supply and demand).•Negative effect on quality of apartments.9Policy Analysis: Price Controls•Price floor: a legal minimum on the price at which a good can be sold.–When price floor is above the market equilibrium (is “binding”) it creates a surplus in the market and can have unintended social consequences.•Example: minimum wage.–Minimum wage in Seattle set at $15.–Labor surplus in the market leading to increase in unemployment.–Possibly stronger effects in the long-run, as demand becomes more elastic (companies move to other


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USC ECON 203 - C7

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