Macroeconomics Notes 2 Chapter 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 role of middlemen and sellers 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 Middlemen intermediaries or brokers reduce transaction costs by providing information to buyers 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 Demand Increase Demand Decrease Demand No Change Supply Increase Supply Decrease Supply No Change Equilibrium Price Indeterminate Equilibrium Quantity Increases Unambiguously Equilibrium Price Increases Equilibrium Quantity Uncertain Equilibrium Price Quantity Increase Equilibrium Price Decreases Equilibrium Quantity Uncertain Equilibrium Price Indeterminate Equilibrium Quantity Decreases Unambiguously Equilibrium Price Quantity Decrease Equilibrium Price Quantity Decrease Equilibrium Price Quantity Increase No Change 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 weather 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 All gains from mutually beneficial trade are captured in a freely rationing price system Price rationing leads to the most efficient use of available resources 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 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 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 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 firms may legally pay their workers Minimum Wage A wage floor legislated by government setting the lowest hourly wage rate that 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 that consumers would have been willing to pay for an item and the total amount that they actually pay Producer Surplus The difference between the total amount that producers actually receive for an item and the total amount that they would have been willing to accept for supplying that item Gains from trade The sum of consumer surplus and producer surplus 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 trade Chapter 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 Stock The quantity of something measured at a given point in time for example an inventory of goods Number of unemployed or the number of people in the labor force Flow A quantity measured over time such as the income you make per year or the number of individuals fired every month Number of people who quit got a job etc each year