Markets in Action
Reading: Chapter 4 of Tucker
Overview:
Market Equilibrium
Suppose that the competitive market for electric washers and dryers is in equilibrium, and then the price of electricity permanently falls. What will happen in the market for electric washers and dryers?
Initial impact: "Shortage" describes the condition where at any price the quantity supplied is LESS than the quantity demanded.
What happens to price when there is a shortage?
How do suppliers react to the increase in price?
In the new equilibrium there is no longer a shortage. An INCREASE in demand leads to a new equilibrium with a HIGHER price for electric washers and dryers, and a HIGHER quantity produced and purchased.
Now suppose that the competitive market for kiwi fruit is in equilibrium, and then the price of apples (a consumer substitute) permanently falls. What will happen in the market for kiwi fruit?
Initial impact: "Surplus" describes the condition where at any price the quantity supplied is GREATER than the quantity demanded.
What happens to price when there is a surplus?
How do suppliers react to the decrease in price?
In the new equilibrium there is no longer a surplus. A DECREASE in demand leads to a new equilibrium with a LOWER price for kiwi fruit, and a LOWER quantity produced and purchased.
Suppose that the competitive market for computer hardware is in equilibrium, and then a technological innovation sweeps across the industry that reduces the cost of producing computer chips and increases their clock speed. How will this affect the market for computer hardware?
Initial impact: Is there a shortage or a surplus of computer hardware at the old equilibrium price?
What is the impact of this surplus on market price?
A permanent INCREASE in supply leads to a new market equilibrium with a LOWER price and a LARGER quantity produced and consumed.
Now suppose that the competitive labor market for skilled technology workers is in equilibrium, and the U.S. government doubles the number of foreign workers with technology skills who are allowed to work in the U.S. How will this affect the labor market for skilled technology workers?
Suppose instead that the U.S. government cut in half the number of foreign workers with technology skills who are allowed to work in the U.S. How will this affect the labor market for skilled technology workers?
Initial impact: A decrease in supply will lead to a temporary shortage of labor. What is the effect of a shortage on the prevailing wage rate paid to technology workers?
How do buyers of labor services respond to the increase in equilibrium wages? Will the increase in wages induce an increase in the quantity of labor supplied? Why?
In the new equilibrium there is no longer a shortage. A DECREASE in supply leads to a new equilibrium with a HIGHER wage and FEWER workers employed.
Repealing the laws of supply and demand
Can we repeal the laws of supply and demand? Why would we want to?
Price fixing is an attempt by the government to control the equilibrium price of a good or service in order to achieve a goal. The goal may be to keep the price of a staple good, such as bread, below the equilibrium price so that more people can afford it. On the other hand, the goal may be to keep the price of a good, such as milk, above the equilibrium price so that the producer is assured a certain income.
Two types of price controls:
Price ceilings: legally established maximum price a seller can charge. Cannot be exceeded. Think of price as a helium balloon that cannot rise to its equilibrium height above sea level because it hits the ceiling.
In order to change the market equilibrium, should the price ceiling be set above or below the equilibrium price?
BELOW the equilibrium point.
What does our previous discussion of market equilibrium tell us will happen to quantity demanded and quantity supplied when a price ceiling is imposed that prevents the market from reaching equilibrium?
Quantity demanded will exceed quantity supplied and a shortage will occur.
If it becomes illegal for price to rise to resolve the shortage, what other mechanisms are available?
Possible impacts on consumers:
Possible impacts on sellers:
Textbook discussed rent control and gasoline during the 1970's as examples of price ceilings. What are some other examples?
Usury laws....
Price floor: legally established minimum price a seller can be paid.
In order to be effective, the price floor must be set at a price ABOVE the equilibrium point. Why?
Think of a floor in a tall building as keeping someone from falling to ground level. Similarly a price floor keeps price from falling to its equilibrium level.
When price is artificially set above the equilibrium point, quantity supplied is greater than quantity demanded and a surplus will occur.
Textbook discussed the minimum wage and agricultural price supports as price floors. Others?
Economic theory tells us that price fixing is inefficient because it causes either shortages or surpluses. Why would our government continue to support some price fixing programs? Do the advantages outweigh the disadvantages?
Market Failure
Market failure: situation in which the price system creates a problem for society or fails to achieve society's goals.
Four examples of market failure are lack of competition, externalities, public goods, and income inequality.
LACK OF COMPETITION
Competition is seen as one of the key elements to successful market operations. When competition is limited, supply may be restricted in order to achieve artificially high prices and profits.
EXTERNALITIES
Define a positive externality. If positive externalities are good things, then what's the problem?
Positive externalities are unpaid-for benefits enjoyed by "3rd parties" that are generated as a side effect of a private transaction.
What are some examples of positive externalities?
What, exactly, is the market failure associated with positive externalities?
Draw the diagram. Two demand curves: One based on private benefits alone, and the other larger demand based on social benefits (private benefits + external benefits).
What government intervention might enhance the efficiency of this market? Examples? What might be some problems?
Define a negative externality to be uncompensated costs borne by "3rd parties" that are generated as a side effect of a private transaction.
What are some side examples of negative externalities?
What, exactly, is the market failure associated with negative externalities?
Draw the diagram. Two supply curves: One larger curve based on private costs alone, the other based on social costs (private costs + external costs).
What government intervention might enhance the efficiency of this market?
PUBLIC GOODS
Public Goods: Pure public goods have the following characteristics:
(a) It is difficult to exclude people from accessing the goods.
(b) Use of the good by one person does not subtract from what is available to others.
Both of these characteristics distinguish pure public goods from private goods and services traded in markets.
What are some examples of pure public goods?
Why won't markets provide an adequate quantity of pure public goods?
Discuss the free rider problem. Examples?
What mechanism(s) assures that the government will provide an appropriate quantity of public goods?
INCOME INEQUALITY
The examples of market failures described above may lead to an unequal distribution of income called income inequality.
People disagree as to the degree of income inequality that is acceptable in a society.
Government sometimes intervenes in order to attempt to create a more equitable distribution of wealth. What are some ways that government intervenes?