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Ch 3 Government Control of Prices

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Title: Ch 3 Government Control of Prices


1
Ch 3 Government Control of Prices
  • The free enterprise system is
  • absolutely too important to be left to
  • the competitive forces of the marketplace.
  • A U.S. Senator

2
Ch 3 Govt. Price Controls
  • In market systems, prices result from interaction
    of market forces.
  • In mixed systems, market forces are not always
    allowed to operate unhindered.
  • Some prices are under legal control of government.

Minimum prices are set to benefit sellers of
goods. Maximum prices are set to benefit buyers
of goods.
3
Ch 3 Govt. Price Controls
  • Are these controls effective?
  • Do they achieve the intended results?
  • Do they improve the market, maximize well being?

4
Ch 3 Govt. Price Controls
Price Ceilings
  • Maximum prices allowed by law
  • Must be below equilibrium to be effective.
  • Two main purposes
  • Keep inflation in check
  • Keep prices of certain goods and services within
    reach of lower income people.

5
Ch 3 Govt. Price Controls
Price Ceilings
P
S
PE
D
0
Q
QE
6
Ch 3 Govt. Price Controls
Price Ceilings
P
S
PE
Maximum price
PC
D
Shortage, QDgtQS
0
Q
QE
QS
QD
7
Ch 3 Govt. Price Controls
Price Floors
  • Minimum prices allowed by law
  • Must be above equilibrium to be effective.
  • Main purpose
  • Increase incomes of sellers of the good or
    service.

8
Ch 3 Govt. Price Controls
Price Floors
P
S
PF
PE
D
0
Q
QE
QD
QS
9
Ch 3 Govt. Price Controls
Price Floors
P
S
Surplus, QDltQS
PF
Minimum price
PE
D
0
Q
QE
QD
QS
10
Ch 3 Govt. Price Controls
Price Ceilings Rent Control
  • Households choose how many dollars to allocate to
    housing based on incomes, other expenses.
  • Some larger cities placed ceilings on rent to
    ensure availability of affordable housing for
    lower incomes.
  • Household mobility - If rents increase,
    households move to smaller places, get roommates,
    etc.
  • Produces market shortage of housing.

QE
11
Ch 3 Govt. Price Controls
Effects of Rent Control
  • Housing Shortage
  • Not all households that want housing at that
    price can find it.
  • Housing mobility cannot take place. People dont
    leave home, share when they dont have to, dont
    downsize or upsize when they need to.
  • People live further from employment than they
    would otherwise.
  • Costs Not Kept Down for Everyone
  • Under table payments commonly made for
    available apartments.
  • Black Market
  • Profit Incentives Removed, Supply Does Not
    Increase
  • Other ventures become more profitable than real
    estate.
  • Example Paris almost no new rental housing
    built between 1914 and 1950.
  • Supply decreases in long run as landlords give up
    and change use of property.

12
Ch 3 Govt. Price Controls
Effects of Rent Control (cont.)
  • Housing Quality Deteriorates
  • Lower quality for same price same quality at
    higher price.
  • Landlords cannot afford maintenance.
  • Resource Misallocation
  • Households value housing at higher price.
  • Want MORE resources allocated to housing, not
    less.

13
Ch 3 Govt. Price Controls
  • This is the market for minimum wage labor.
  • Demand for labor is a derived demand (Demand is
    dependent on demand for the product being
    produced).
  • Employers will hire up to the point where MCMB
    (where wage contribution to output)
  • Supply curve represents workers available for
    jobs at various wages.

Price Floors Minimum Wage
P (WAGE)
S
PF
PE
D
0
Q
QE
QD
QS
14
Ch 3 Govt. Price Controls
Effects of Minimum Wage (Some win, some lose)
  • Increased Unemployment in Minimum Wage Jobs
  • Price floor results in surplus of minimum wage
    labor.
  • Qty of labor demanded by employers is less than
    quantity of labor supplied by workers at higher
    wages.
  • When required to pay ALL minimum wage workers a
    higher per person wage, employers will not be
    able to employ as many workers.
  • Workers impacted most young minority males.
  • Higher Incomes for Minimum Wage Workers Still
    Employed
  • Though more workers are unemployed, those that
    remain employed earn higher wages.
  • Does Not Impact Poverty Rates
  • So few of those working for minimum wage are head
    of households, it does not tend to pull families
    out of poverty.

15
Ch 4 Pollution Problems
  • The use of solar energy has not been opened up
    because the oil industry does not own the
    sun. Ralph Nader

16
Ch 4 Pollution Problems
Opie, you havent finished your milk. We cant
put it back in the cow, you know. Aunt
Bee
17
Ch 4 Pollution Problems
  • Pollution clean-up and prevention is one of the
    most hotly debated topics in politics, social
    sciences, natural sciences, AND economics.
  • How much is too much? Should ALL pollution be
    prevented? How do we know where to stop?

18
Ch 4 Pollution Problems
What is Pollution?
  • Services of the Environment
  • Air, water and land for survival
  • Habitat, or environment
  • Resources for production processes by households
    and firms.
  • Three Ways Environment is Affected by Use
  • Exhaustible resources are diminished (coal, oil).
  • Replaceable resources are used (trees, animals).
  • Waste from production and consumption is
    disposed.

19
Ch 4 Pollution Problems
What is Pollution?
  • Pollution comes primarily from waste disposal
  • Recycling
  • Transformation of waste, either naturally or
    mechanically, into raw materials that can be
    used again.
  • Pollution
  • Waste that is either
  • not completely recycled
  • not recycled fast enough, or
  • not recycled at all.
  • Pollution takes place when the capacity of
    environmental services is diminished.

20
Ch 4 Pollution Problems
Economics of Pollution
  • Why is pollution a problem?
  • Property rights are nonexistent or not enforced.
  • Nobody owns air, rivers, sides of highways.
  • If owned, owner is not always around to monitor.
  • Environments services are shared by population

21
Ch 4 Pollution Problems
Externalities
Externality A cost or benefit imposed on a
consumer or a firm by actions taken by others.
The cost or benefit is thus generated externally
to the consumer or firm. Externalities occur
when a third party to the market (someone not
directly in the market) is affected by the
production or consumption of the good or
service. An externally imposed benefit is a
positive externality. An externally imposed
cost is a negative externality.
22
Ch 4 Pollution Problems
Externalities
  • Examples of Externalities
  • Positive
  • A well-maintained property next door that raises
    the market value of your own property.
  • A pleasant cologne or scent worn by the person
    seated next to you.
  • Improved driving habits that reduce accident
    risks.
  • A scientific advance.
  • Negative
  • Air and water pollution
  • Loud parties next door that keep you awake.
  • Traffic congestion.
  • Second-hand cigarette smoke suffered by a
    non-smoker.
  • Increased health insurance premiums due to
    alcohol or tobacco consumption.

23
Ch 4 Pollution Problems
Markets and Resource Allocation
Demand
  • Demand curve represents marginal private benefit
    (MPB) achieved by consumer.
  • If consumer is the only party to achieve benefits
    from transactions in this market, marginal
    private benefit marginal social benefit. (MPB
    MSB)
  • If third parties outside of the market benefit
    from transactions, even though they arent
    consuming or producing the good or service, MPB lt
    MSB.
  • If MPB lt MSB, there are positive (or benefit)
    externalities in consumption in this market.

P
D MPB
Q
24
Ch 4 Pollution Problems
Markets and Resource Allocation
  • EXAMPLE
  • MARKET FOR VACCINATIONS
  • There are benefits to parties other than the
    direct consumers (if you get your shots, I
    benefit, even though I dont get my shots).
  • This demand curve does not measure all of the
    benefits that result from transactions taking
    place in this market.
  • Positive externalities in consumption, so
    MPBltMSB. Difference is the externality.
  • Since market doesnt know about all benefits,
    resources will be underallocated in this market
    (not enough vaccinations will be provided by
    private market).

Demand
P
D MPB
Q
25
Ch 4 Pollution Problems
Markets and Resource Allocation
  • Supply curve represents marginal private cost
    (MPC) paid by producers.
  • If producer is the only party to pay costs from
    transactions in this market, marginal private
    cost marginal social cost. (MPC MSC)
  • If third parties outside of the market also pay
    costs from transactions taking place in this
    market, even though they arent consuming or
    producing the good or service, MPC lt MSC.
  • If MPC lt MSC, there are negative (or cost)
    externalities in production in this market.

Supply
P
S MPC
Q
26
Ch 4 Pollution Problems
Markets and Resource Allocation
  • EXAMPLE
  • MARKET FOR PAPER
  • There are costs to parties other than the
    producers (the process of producing paper creates
    dirty air and water, affecting neighbors of
    plant).
  • Negative (cost) externalities in production, so
    MPCltMSC. Difference is the externality.
  • This supply curve does not measure all of the
    costs associated with transactions taking place
    in this market.
  • Since market doesnt know about all costs,
    resources will be overallocated in this market
    (too much paper will be produced by this factory).

Supply
P
S MPC
Q
27
Ch 4 Pollution Problems
Markets and Resource Allocation
  • EXAMPLE
  • MARKET FOR PAPER
  • These demand and supply curve are measuring only
    the private benefits and private costs associated
    with this market.
  • Consumption and production take place at
    equilibrium point A.
  • However, there are costs being borne by third
    parties in this market (pollution created in air
    and water of neighborhood around factory). These
    are negative externalities of production.

Demand and Supply
P
S MPC
A
PE
DMPB
Q
QE
28
Ch 4 Pollution Problems
Markets and Resource Allocation
  • EXAMPLE
  • MARKET FOR PAPER
  • New supply curve represents
  • MPC externalitiesMSC.
  • Equilibrium in this market SHOULD be at point B.
  • Increase in equilibrium price, decrease in
    equilibrium quantity.
  • Until externalities are internalized and
    reflected in the market, there is an
    overallocation of resources in this market (too
    much paper being produced).

Demand and Supply
MSC
P
S MPC
B
A
PE
DMPB
Q
QE
29
Ch 4 Pollution Problems
Externalities
When externalities exist, equilibrium does not
yield desired resource allocation. Social
well-being is not maximized. (Externalities are
also called social spill-overs) This is Market
Failure ! Government needs to intervene and
correct for market failure by internalizing the
externalities, to ensure proper allocation of
resources
30
Ch 4 Pollution Problems
Economics of Pollution
  • What are appropriate levels of control?
  • Cost-Benefit Analysis
  • Control pollution up to where MSC MSB.

MSC
Cost of Abatement
MSB
Pollution Control
31
Ch 4 Pollution Problems
Pollution Control Policies
  • Direct Controls
  • Ban production
  • Regulate production
  • Indirect Controls
  • Taxation
  • Cost-benefit analysis shows a tax rate that would
    get optimal results (MSCMSB)
  • Pollution Rights Market
  • Firms allowed to buy and sell government issued
    licenses granting right to create certain amount
    of pollution.
  • EXAMPLE
  • Pollution right costs 1000. If Firm A can cut
    pollution for less than 1000, they do so, then
    sell right to pollute to Firm B, who cannot cut
    pollution as cheaply.
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