POM CH6 Supply Demand and Government Policies Price ceilings the legislated maximum a price is not allowed to rise above Price floor the legislated minimum a price is not allowed to fall below When a price ceiling is placed below the equilibrium price it is a binding constraint When a government imposes a binding price ceiling on a competitive market a shortage of the good arises and sellers must ration the scarce goods among the large number of potential buyers A binding price floor will cause a surplus in the market Not all sellers will be able to sell the amount they want to Economists usually oppose price ceilings and price floors because of the recurring theme markets are usually a good way to organize economic activity The invisible hand will do its job Tax incidence refers to how the burden of a tax is distributed among the various people who make up the economy Taxes levied on buyers and taxes levied on sellers affect each equally The higher tax for sellers causes them to supply less The higher tax on buyers causes them to demand less Lawmakers can decide whether a tax comes from the buyer s pocket or from the seller s but they cannot legislate the true burden of a tax Rather tax incidence depends on the forces of supply and demand A tax burden fall more heavily on the side of the market that is less elastic Lecture notes Quantity control rationing The government only issues a certain amount of products Taxicab licenses in New York they only issue a certain amount at a time Bar exam more applicants higher standards fewer applicants lower standards Import quota Can create dead weight loss market inefficiency Can minimize consumer surplus Ex Foreign producer lose domestic consumers lose domestic producers win Price control price ceiling protects the consumer from paying too much City rent control policies to keep living within an affordable range PC price ceiling QC quantity ceiling Consumers who can retain apartments win landlords lose consumers who can t get apartments because of supply shortage lose Creates dead weight loss Creates inefficiency Price and quantity control will almost always cause market inefficiency unless you put a control outside of market equilibrium that doesn t distort the market situation Price floor for the price floor to make the market inefficient the price floor has to be above equilibrium price Minimum wage Minimum wage ex Employers lose workers who keep jobs wins workers Price supports keeping agriculture in business who lose or can t get jobs lose POM Ch 7 Consumers Producers and the Efficiency of Markets Welfare economics is the study of how the allocation of resources affects economic well being For buyers and sellers Willingness to pay a measure of how much a buyer values a good and the maximum they will pay If the price were exactly the same as the value the buyer places on the product he would be equally happy buying it or keeping his money If the price were less than his willingness to pay the buyer would be eager to buy the good Consumer surplus is the amount the buyer is willing to pay for a good minus the amount the buyer actually pays for it Willing 100 Pays 80 Surplus 20 Closely related to the demand curve Total consumer surplus the amount the would be highest paying consumer saved as a surplus plus the amount another consumer saved in a surplus as a result of both consumers being able to purchase 1 of 2 of the same good Marginal buyer the buyer who would leave the market first if the price was any higher Willingness to sell a measure of how much a seller values their goods services and the minimum they will except for A seller would be eager to sell their services for greater than their cost and refuse to sell their services for lower than their minimum price A seller would be indifferent about selling services goods if the price exactly matched their cost Producer surplus is the amount a seller is paid minus the cost of production Cost 500 price 600 producer surplus 100 Closely related to supply curve Marginal seller the seller who would leave the market first if the price was any lower Consumer surplus and producer surplus are the basic tools that economists use to study the welfare of buyers and sellers in a market Total surplus value to buyers cost to sellers Insights about market outcomes 1 Free markets allocate the supply of goods to the buyers who value them most highly as measure by their willingness to pay 2 Free markets allocate the demand for goods to the sellers who can produce them at the least cost 3 Free markets produce the quantity of goods that maximizes the sum of consumer and producer surplus Lecture Notes Market is efficient if 1 There is no additional transaction that makes a buyer seller or an affected third party better off 2 Producer surplus plus consumer surplus is maximized 3 No dead weight loss Consumer surplus CS the area below the demand curve and above the price Producer surplus PS the area below the price and above the supply curve Efficiency is NOT the same as Equity Is splitting the pie so everyone gets an equal piece efficient Or will some complain they did more work to make the pie so they deserve a bigger piece than others POM Ch 8 The cost of Taxation Per unit tax Distorts the market causing the CS to decrease and the PS to decrease which causes a dead weight loss in the market Market is inefficient due to dead weight loss not the tax revenue which comes back as consumer surplus or producer surplus Subsidies take the tax money out but put it back into the market Figure 3 on page 162 of the text is a great diagram which simply explains dead weight loss Deadweight loss the fall in total surplus that results when a tax or some other policy distorts a market outcome Taxes result in deadweight losses A deadweight loss is not offset by an increase in government revenue The government collects no revenue from two parties in a market not being able to agree on prices that benefit the both of them Taxes cause deadweight losses because they prevent buyers and sellers from realizing some of the gains from trade The price elasticities of supply and demand determine whether the deadweight loss from a tax is large or small The greater the elasticities of supply and demand the greater the deadweight loss of a tax POM CH10 Externalities Externality arises when a person engages in an activity that influences the well being of a bystander and yet neither pays nor receives any compensation for that effect