1 / 14

Supply, Demand, and Government Policies

6. Supply, Demand, and Government Policies. Lines at the gas pump Price Ceiling – Not Binding then Binding. 1973, OPEC raised the price of crude oil Reduced the supply of gasoline Long lines at gas stations What was responsible for the long gas lines? OPEC: created shortage of gasoline

east
Download Presentation

Supply, Demand, and Government Policies

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. 6 Supply, Demand, andGovernment Policies

  2. Lines at the gas pumpPrice Ceiling – Not Binding then Binding • 1973, OPEC raised the price of crude oil • Reduced the supply of gasoline • Long lines at gas stations • What was responsible for the long gas lines? • OPEC: created shortage of gasoline • U.S. government regulations: price ceiling on gasoline • Before OPEC raised the price of crude oil – pre-1973 • Equilibrium price - below price ceiling: no effect • When the price of crude oil rose • Reduced the supply of gasoline • Equilibrium price – above price ceiling: shortage

  3. 2 The market for gasoline with a price ceiling Price of Gasoline Price of Gasoline • The price ceiling on gasoline • is not binding (b) The price ceiling on gasoline is binding 3…the price ceiling becomes binding… 2…but when supply falls… 1. Initially, the price ceiling is not binding … 4. …resulting in a shortage Price ceiling Price ceiling P2 P1 P1 S2 Supply, S1 S1 Demand Demand QS Q1 Q1 QD 0 0 Quantity of Gasoline Quantity of Gasoline Panel (a) shows the gasoline market when the price ceiling is not binding because the equilibrium price, P1, is below the ceiling. Panel (b) shows the gasoline market after an increase in the price of crude oil (an input into making gasoline) shifts the supply curve to the left from S1 to S2. In an unregulated market, the price would have risen from P1 to P2. The price ceiling, however, prevents this from happening. At the binding price ceiling, consumers are willing to buy QD, but producers of gasoline are willing to sell only QS. The difference between quantity demanded and quantity supplied, QD – QS, measures the gasoline shortage.

  4. 4 A market with a price floor Price of Ice Cream Cone Price of Ice Cream Cone (a) A price floor that is not binding (b) A price floor that is binding Surplus Price floor Price floor Equilibrium price Equilibrium price $3 $4 2 3 Quantity demanded Quantity supplied Equilibrium quantity Supply Supply 120 100 80 Demand Demand 0 0 In panel (a), the government imposes a price floor of $2. Because this is below the equilibrium price of $3, the price floor has no effect. The market price adjusts to balance supply and demand. At the equilibrium, quantity supplied and quantity demanded both equal 100 cones. In panel (b), the government imposes a price floor of $4, which is above the equilibrium price of $3. Therefore, the market price equals $4. Because 120 cones are supplied at this price and only 80 are demanded, there is a surplus of 40 cones. Quantity of Ice-Cream Cones Quantity of Ice-Cream Cones

  5. Minimum wage Can create a surplus of labor Agricultural price supports Every year, farmers produce and sell a certain product at a certain price that is determined by the market. If the market price is lower than that price at which the farmers want to sell, the farmers are in a deficit. Therefore, in order to assist American farmers, our government gives price supports for some crops and dairy products. So in a case where the market price is lower that the target price for farmers, farmers receive a "deficiency payment", or price support, from the government in order to make up for the difference. Has created a surplus of cheese and milk products Some released to low-income/poverty households Can exacerbate the effect by increasing supply Examples of Price Floors

  6. 5 How the minimum wage affects the labor market Labor surplus (unemployment) Wage Wage (a) A free labor market (b) A Labor Market with a Binding Minimum Wage Equilibrium wage Minimum wage Labor demand Labor demand Equilibrium employment Quantity demanded Quantity supplied Labor supply Labor supply 0 0 Quantity of Labor Quantity of Labor Panel (a) shows a labor market in which the wage adjusts to balance labor supply and labor demand. Panel (b) shows the impact of a binding minimum wage. Because the minimum wage is a price floor, it causes a surplus: The quantity of labor supplied exceeds the quantity demanded. The result is unemployment.

  7. The minimum wage • Impact of the minimum wage • Workers with high skills and much experience • Not affected: Equilibrium wages - above the minimum • Minimum wage - not binding • Teenage labor – least skilled and least experienced • Low equilibrium wages • Willing to accept a lower wage in exchange for on-the-job training • Minimum wage – binding

  8. Controls on Prices • Evaluating price controls • Markets are usually a good way to organize economic activity • Economists usually oppose price ceilings and price floors • Prices – coordinate economic activity

  9. Agricultural Price Supports • Price Support • Market price is set by Government at > equilibrium price (binding) • Price is “supported” as Gov buys up the surplus • Thus price will not drop due market forces (surplus)

  10. Impacts of a Price Support Inefficient Production MC(C) > MV(D) Transfer CS-PS Transfer Due to Increased Production Increased PS

  11. Consequences of Binding Price Supports Compared to a “free” market (unregulated) • Consumers buy less milk at a higher price • Lost Consumer Surplus – compared to lower price • Producers • Gain lost consumer surplus (transfer to Producers) • Increased milk production (> old equilibirum) • Get even more producer surplus • Produced inefficiently • Value (marginal benefits) of additional milk to consumers < increased (marginal) costs of resources used to produce it • And then there are the taxes to pay for it

  12. What Do We Do With the Surplus • Surplus milk bought by the Government • Give it to Low Income • Decreases Private Sector Demand (Nbuyers) • Increases amount of surplus milk to be bought • Make cheese from it • No effect on Milk market price • Strategic Cheese Reserve at Hanford • Transfer to 3rd World countries • Powdered Milk • Disrupts their dairy industry

  13. What Could Go Wrong? The Complete Stupidity Of The Looming Dairy Cliff: Milk To ... www.forbes.com/.../the-complete-stupidity-of-the-looming-dairy-... Forbes Dec 31, 2012 - That will compel the Department of Agriculture to roughly double the price supports for dairy and other farm products thanks to a mystical  Dairy Price Supports: Still Milking the Public www.cato.org/.../dairy-price-supports-still-milking-public Cato Institute Why $7-Per-Gallon Milk Looms Once Again : The Salt : NPR www.npr.org/sections/.../why-7-per-gallon-milk-looms-once-againNPR

  14. Cato Institute http://www.cato.org/pubs/tbb/tbb_0707_47.pdf The federal government has subsidized and regulated the dairy industry since the 1930s. A system of “marketing order” regulations was enacted in 1937. A dairy price support program was added in 1949. An income support program for dairy farmers was added in 2002. As part of this year’s farm bill, Congress may reauthorize dairy programs, but they are among the most illogical of all farm programs.1 The government spends billions of dollars reducing food costs through programs such as food stamps, yet dairy programs increase milk prices. An Economist’s Perspective

More Related