OSU ECON 2002.01 - Chapter 4: Extensions of Demand and Supply Analysis

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Macroeconomics Notes 2Chapter 4: Extensions of Demand and Supply Analysis The Price System and Markets Price System or Market System: An economic system in which relative prices are constantly changing to reflect changes in supply and demand The prices are signals as to what is relatively scarce and relatively abundant Prices provide information to individuals and businesses Voluntary Exchange: An act of trading between individuals in the price system Makes both parties to the trade subjectively better off Transaction Costs: All of the costs associated with exchange Including:- The informational costs of finding out the price and quality, service record, and durability of a product- The cost of contracting and enforcing that contract The role of middlemen Middlemen (intermediaries) or brokers reduce transaction costs by providing information to buyersand sellers- Examples: Internet!! Real estate brokers, Stock brokers, Consignment shops, Car dealerships Changes in Demand and Supply Changes in supply and demand create disequilibrium. The market price and quantity adjust to a new equilibrium. Price Flexibility Prices quite flexible in some markets can be less flexible in other market scenarios.- May take the form of subtle adjustments such as hidden payments, quality changes- May not reach equilibrium right away Adjustment speed Market characteristics influence adjustment speed Markets may overshoot in the adjustment process Markets are subject to energy shocks, labor strikes, severe weatherSupply Increase Supply Decrease Supply No ChangeDemandIncreaseEquilibrium Price:IndeterminateEquilibrium Quantity:Increases UnambiguouslyEquilibrium Price: IncreasesEquilibrium Quantity:UncertainEquilibrium Price & Quantity:IncreaseDemandDecreaseEquilibrium Price: DecreasesEquilibrium Quantity:UncertainEquilibrium Price:IndeterminateEquilibrium Quantity:Decreases UnambiguouslyEquilibrium Price & Quantity:DecreaseDemand No ChangeEquilibrium Price & Quantity:DecreaseEquilibrium Price & Quantity:IncreaseNo Change The Rationing Function of Prices Synchronization of decisions of buyers and sellers that leads to equilibrium is called the rationing function of prices Methods of non-price rationing  Rationing by queues (waiting in line) Rationing by random assignment or coupons The essential role of rationing  Implied by the presence of scarcity Price vs. non-price rationing mechanism:- Price rationing leads to the most efficient use of available resources- All gains from mutually beneficial trade are captured in a freely rationing price system The Policy of Government-Imposed Price Controls Price Controls: Government-mandated minimum or maximum prices Price Ceiling: A legal maximum price Below Equilibrium  Rent control in New York Price Floor: A legal minimum price (Price Support) Above Equilibrium  Minimum wage or agriculture  Price ceiling and black markets A price ceiling may prevent the equilibrium price from being achieved if it is above the ceiling price A price ceiling that is set below the market clearing price creates a shortage Non-Price Rationing Devices: All methods used to ration scarce goods that are price-controlled- Black Market: A market in which price-controlled goods are sold at an illegally high price The Policy of Controlling Rents The functions of rental prices 1. Promote the efficient maintenance and construction of housing 2. Allocate existing housing 3. Ration the use of housing Rent controls and construction Controls discourage construction- With a 16% vacancy rate and no controls, Dallas recently built 11,000 new rental units- With a 1.6% vacancy rate and controls, San Francisco recently built 2,000 new rental units Effects on the existing supply of housing and current use of housing Property owners cannot recover costs- Maintenance, repairs, capital improvements Rations the current use of housing- Reduces mobility, e.g., New York’s “housing gridlock” Attempts to evade rent controls Forcing tenants to leave Tenants subletting apartments Housing courts Who wins and who loses from rent controls? Losers: Property owners, Low-income individuals, Winners: Upper-income professionals Price Floors in Agriculture Support Price: The government chooses a price floor for a product and then acts to ensure that the price of the product never falls below the support level Associated with many agricultural products A price floor that is set above the market clearing price results in a surplus.  Price Floors in the Labor Market Minimum Wage: A wage floor, legislated by government, setting the lowest hourly wage rate that firms may legally pay their workers  Quantity Restrictions Governments can impose quantity restrictions, most obvious—banning ownership or trading of a good Human organs, Drugs, Hospital beds, Gold from 1933 to 1973 Government Prohibitions and Licensing Requirements Some commodities cannot be purchased at all legally; others require a license Import Quota: Supply restriction that prohibits the importation of more than a specified quantity of a particular good Appendix B Consumer Surplus: The difference between the total amount thatconsumers would have been willing to pay for an item and the totalamount that they actually pay Producer Surplus: The difference between the total amount thatproducers actually receive for an item and the total amount thatthey would have been willing to accept for supplying that item  Gains from trade: The sum of consumer surplus and producersurplus How do price controls affect gains from trade? Consumer surplus and producer surplus are both lower Either a price ceiling or a price floor reduces gains from tradeChapter 7: The Macroeconomy: Unemployment, Inflation, and Deflation Unemployment Unemployment: Total number of adults (aged 16 years or older) willing and able to work and who are actively looking for work but have not found a job Unemployment creates a cost to the entire economy in terms of lost output – often ranging in the billions of dollars Labor Force: Individuals aged 16 years or older who either have jobs or who are looking and available for jobs; the number of employed plus the number of unemployed  The unemployment rate is the percentage of the measured labor force that is unemployed


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OSU ECON 2002.01 - Chapter 4: Extensions of Demand and Supply Analysis

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