Lecture 7Outline of Last Lecture Chapter 4- What consumer surplus is and its relationship to the demand curve- What producer surplus is and its relationship to the supply curve- What total surplus is and how it can be used both to measure the gains from trade and illustrate why markets work so wellOutline of Current Lecture Chapter 4- Efficiency of Markets- Ways in which government might try to (unsuccessfully) increase total surplus - How market equilibrium maximizes total surplus- Why markets typically work so wellChapter 5- The meaning of price controls an quantity controls, two kinds of government intervention in markets- How price controls work and can make a market inefficient- What deadweight loss is- Price Ceilings: How it causes inefficiencies- Why Price Ceilings Exist- Definition of Price FloorCurrent LectureEfficiency of Markets:  The market equilibrium allocates the consumption of the good among potential consumers and sales of the good among the potential sellers in a way that achieves the highest possible gain to society. By comparing the total surplus generated by the consumption and production choices in the marketequilibrium to the surplus generated by a difference set of production and consumption choices, wecan show that any change from the market equilibrium reduces total surplus. Three Ways in which you might try to increase total surplus:1.) Reallocate consumption among consumers2.) Reallocate sales among sellers3.) Change the quantity traded ECON 2106 1st EditionMarket Equilibrium Maximizes Total Surplus: It allocates consumption of the good to the potential buyers who value it the most as indicated by the fact that they have the highest willingness to pay. It allocates sales to the potential sellers who most value the right to sell the good as indicated by the fact that they have the lowest cost It ensures that every consumer who makes a purchase values the good more than every seller who makes a sale so that all transactions are mutually beneficial. It ensures that every potential buyer who doesn’t make a purchase values the good less than every potential seller who doesn’t make a sale so that no mutually beneficial transactions are missed.Why Markets Typically Work so Well? Property Rights- are the rights of owners of valuable items, whether resources or goods, to dispose of those items as they choose. Economic signal- any piece of information that helps people make better economic decisions.Why Good Economic Signals Matter: -Prices translate complex information into an easy signal for producers: -Profits rise in industries when consumers want more of that industry’s products.-Profits decline in industries when consumers want less of that industry’s products.-The high price of ice in post-Katrina New Orleans made it more attractive for firms to provide ice where society needed it most.Chapter 5Why Governments Control Prices The market price moves to the level at which the quantity supplied equals the quantity demanded. However, this equilibrium price does not necessarily please either buyers or sellers. Thus, the government intervenes to regulate prices by imposing price controls Price controls: legal restrictions on how high or low a market price may go Price Ceiling: is the maximum price sellers are allowed to charge for a good or service Price floor: is the minimum price buyers are required to pay for a good or service.Price Ceilings: are typically imposed during crises because these events often lead to sudden price increases that hurt many people but produce big gains for a lucky few.Market Without Gov’t InterventionMarket with Price Ceiling-If a price ceiling is set above EQ, it will have no effect (nonbinding)-Only a price ceiling that forces price below EQ will have any effect (binding)Obtained from “Microeconomics by Krugman and Wells, 3rd Edition.”Without government intervention, the market for apartments reaches equilibrium at point E with a market rent of $1,000 per month and 2 million apartments rented.The black horizontal line represents the government-imposed price ceiling on rents of $800 per month. This price ceiling reduces the quantity of apartments supplied to 1.8 million, point A, and increases the quantity demanded to 2.2 million, point B. This creates a persistent shortage of 400,000 units: 400,000 people who want apartments at the legal rent of $800 but cannot get themObtained from “Microeconomics by Krugman and Wells, 3rd Edition.”How Price Ceilings Cause Inefficiency 1.) Inefficiently Low Quality: When prices are held below the market price, shortages are created. The lower the controlled price relative to the market equilibrium, the larger the shortage-Deadweight Loss: the loss in total surplus that occurs whenever an action or a policy reduces the quantity transacted below the efficient market EQ quantity.2.) Inefficient Allocation to Consumers: People who want the good badly and are willing to pay a high price for it do not get it whereas those who care relatively little about the good and are willing to pay a low price do get the good.3.) Wasted Resources: People expend money, effort and time to cope with the shortages caused by the price ceiling4.) Inefficiently low quality: sellers offer low-quality goods at a low price even though buyers would prefer a higher quality good at a higher price.5.) Black Market: is a market in which goods or services are bought and sold illegally. Either because it isillegal to sell them at all or because the prices charged are legally prohibited by a price ceiling.Why do Price Ceilings Exist? They benefit some people. These people are typically better organized and more vocal than those who are harmed by them. If the price ceiling is longstanding, buyers may not have a realistic idea of what would happen without it Government officials often do not understand supply and demand analysis.Price Floors: Sometimes governments intervene to push market prices up instead of down. The minimum wageis a legal floor on the wage rate, which is the market price of labor. Price floors are intended to help some people but generate predictable and undesirable side