Market Model

1. Market Model Supply and Demand

2. Markets • Institutions that allow buyers and sellers to exchange • Demand • Supply • Examples • Posted-price • Haggling • Auctions Equilibrium Price/Quantity

3. Demand Curve • Demand: how much consumer are willing and able to buy at different prices Pepsi Auction

4. Market Equilibrium price S1 P1 At P1: Qd = Qs The market “clears” D1 quantity Q1 Note: Quantity Demanded vs Demand

5. Demand Shifters • Preferences • Population • Income • Normal goods • Inferior goods • Price of Related Goods • Substitutes • Complements • Expectations If income rises, demand rises If income rises, demand falls If Px rises, demand for Y rises If Px rises, demand for Y falls

6. Supply Shifters • Number of firms • Cost of inputs • Technology • Expectations

7. Market Disequilibrium price Surplus S1 Surplus PHi At PHi: Qd < Qs P1  Pressure on price to fall PLo Shortage D1 At PLo: Qd > Qs Shortage  Pressure on price to rise Qd quantity Qd Qs Q1 Qs

8. In the fall of 1903 Ohio Tech students for the first time had to pay to attend university football games; as a result, every game had many empty seats. This decline in attendance suggests that: • the demand for football games declined. • attending football games is an inferior good. • attending football games is a normal good. • the quantity demanded of football games fell.

9. A newspaper story recently reported that the price of new cars has increased, and the quantity of new cars sold has dropped. The price and quantity changes were probably caused by: • a decrease in buyers' incomes. • an increase in buyers' incomes. • an increase in production costs. • a decrease in production costs.

10. Consider the market for computers. Suppose that the price of plastic decreases and the income of consumers decreases. What may we conclude about the equilibrium price and quantity of computers? • price will fall and quantity is indeterminate. • quantity will rise and price is indeterminate. • quantity will rise and price will rise. • both price and quantity will be indeterminate.

11. Market Efficiency • Invisible Hand Theorem • Adam Smith: Wealth of Nations (1776) • Competitive, free markets will maximize social welfare “It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our necessities but of their advantages.”

12. Consumer Surplus • Net gain to consumers from buying at a single price • CS = Buyer Value - Price Price Buyer Values (or WTP) $50 Consumer Surplus Market price $25 Demand Total Expenditure quantity 1 5

13. Producer Surplus • Net gain to sellers from selling at a single price • PS = Price – Seller Cost Price Supply Market price $25 Producer Surplus Seller Costs $10 Total Cost 3 quantity

14. Which of the following is an example of consumer surplus? • Bo Yuan buys a hamburger for $2 and tells you she would not have paid a penny more. • Carrie believes the price she paid for her computer was too high. • Logan buys a paper tablet for $2 and finds the same good at another store for $1.50 • Cody would have paid $20 for a new compact disc but paid only $15.

15. Free Market Outcome: P*, Q* Maximizes social welfare: SW = CS + PS Social Welfare Price Supply CS Deadweight Loss P* PS Demand quantity Q*

16. Garden of Eden Tradeoff: Efficiency vs. Equity Adam and Eve in the Garden of Eden, by Titian (c. 1550)

17. Supply Demand

18. Session 4 Session 2 Session 1 Session 3

19. Government Intervention • Why does government intervene? • Market failures • Monopoly • Externalities • Public goods • Fairness • How does government intervene? • Price Controls • Quantity Controls • Regulations All generate some DWL

20. DWL Price Ceiling: Rent Control • Free Market: R1, Q1 • Gov’t imposes rent ceiling at R0 At R0: Qd > Qs  shortage • Non-Price Rationing • Black Market (Bribes) • Discrimination • Wait / Search • Lottery Rent S1 RF R1 R0 D1 QS Q1 QD Apartments Shortage

21. Other Examples of Price Ceilings • Gasoline (1970s) • Usury laws • Diagnostic Related Groups (DRGs)

22. Rapidly increasing health costs have been a major political concern since at least 1992. Suppose that to control rising health costs the government sets the maximum price for a normal doctor's visit at $20, but the current market price is $40. Then: • more people will try to visit the doctor, but the doctor will see fewer patients. • the same number of people will try to visit the doctor, and the doctor will see the same number of patients. • more people will be able to see the doctor, since the price is lower • fewer people will try to see the doctor, and the doctors will see fewer patients

23. Price Floor: Minimum Wage • Fair Labor Standards Act (1938) • 1938: $0.25 • 2008: $6.55 Federal minimum wage will rise to $ 7.25 this summer Ohio’s minimum wage went up to $7.30 this past January

24. States with minimum wage rates higher than the Federal rate States with minimum wage rates the same as the Federal rate States with minimum wage rates lower than the Federal rate States with no minimum wage law

25. minimum wage in 2008 dollars minimum wage in current dollars

26. Minimum Wage Relative to the Average Hourly Wage Rate 1965-2008

28. 2009 Poverty Guidelines (48 Contiguous States and DC) Source: http://aspe.hhs.gov/poverty/09poverty.shtml

29. Labor Market • Free Market: W1, Q1 • no unemployment: QD = QS (full-time income?) • Gov’t imposes min. wage at W2 • at W2: QD < QS • Unemployment occurs • How can employers offset impact? • Reduce hours of work • Reduce fringe benefits • Raise price • Reduce quality • Hire illegal aliens unemployment Wage S1 W2 = $7 W1= $6 DWL D1 QD Q1 QS Labor layoffs new entrants B W

31. Suppose that the equilibrium wage in the low-skilled labor market is $8.00. Further, suppose the federal government raises the minimum wage to $7.25 an hour from its present level of $6.55. The government’s action of increasing the minimum wage will result in: • a decrease in unemployment • an increase in unemployment • a shortage of low-skilled labor. • neither a shortage nor a surplus of labor in the low-skilled labor market.

32. Taxes • Sales Tax: percentage of sales • Excise Tax: fixed dollar amount per unit Sin Taxes?

33. Taxes • Sales Tax: percentage of sales • Excise Tax: fixed dollar amount per unit • Buyer Tax vs Seller Tax • Economic burden does not depend on legal burden Sin Taxes?

34. Excise Tax: Cigarettes • Free market: • P = $4.00 • Q = 27.4 b • Consumer Spending ≈ $110 b • Gov’t imposes tax = $1/pack • Supply shifts upward by $1 • Price rises (by less than $1) • Quantity falls • Economic burden of tax is split between buyers and sellers S2 price S1 buyer pays 4.40 Tax Revenue tax = $1 4.00 3.40 seller keeps D1 cigarettes 27.4 25.8 (Billions of packs)

39. Suppose the government imposes a $10 excise tax on the sale of sweaters by charging suppliers $10 for each sweater sold. Based on economic analysis, we would predict that: • The price of sweaters will increase by $10. • The price of sweaters will increase by more than $10. • Consumers of sweaters will bear the entire burden of the tax. • The price of sweaters will increase by less than $10. • (a) and (c) are true.

40. In the figure below, the amount of tax revenue is: • $2000 • $4000 • $6000 • $8000

41. Quotas International trade: agricultural goods, textiles Taxis, liquor licenses Prohibition What goods and services are illegal to trade? Why prohibit trade? Victimless crime? Immoral? Externalities? Quantity Controls Drugs Prostitution Body organs Babies Guns Exotic animals Gambling

42. Intrinsic Effects Health Damages Spousal/Family abuse DUI Lower worker productivity Black Market Effects Crime Property Murder Overdose Uncertain product quality Binge consumption Clogged prisons Corruption Reduced civil liberties Alcohol: 125m users-----85,000 annual deaths Tobacco: 70m users-----400,000 annual deaths Marijuana: 15m users-----0 annual deaths Cocaine: 2m users---- Heroin: 0.2m users---- 17,000 annual deaths War on Drugs Tradeoff: Intrinsic Effects v. Black Market Effects

43. Marijuana Market • Prohibition: P1, Q1 • Legalization: P2, Q2 • Consumption will rise (how much?) S1 price S2 $200 = P1 P2 Tradeoff: > More intrinsic costs > Less black market effects D1 Q1 Q2 Marijuana • What happens in the market for substitutes? • What happens in the market for complements?

44. When a government imposes penalties on both sellers and buyers of an illegal good, • the price of the good falls as does the quantity purchased. • the price of the good falls, but the quantity purchased may increase or decrease. • the price of the good rises, but the quantity purchased may increase or decrease. • the quantity purchased of the good decreases, but the price may rise or fall.

47. "If the DEA intercepts 100 tons of cocaine, the supply of cocaine will fall. This will cause the price to rise, which will increase the supply back to its original position." True, false, or uncertain. Explain.

48. Which of the following influences does NOT shift the supply curve? • an increase in consumer income • a decrease in the price firms expect to receive in the future • a rise in the wages paid workers • development of new technology

49. Market equilibrium is a situation in which: • consumers obtain the highest quantity at the lowest prices • producers obtain the highest price for a given quantity sold • quantity supplied equals quantity demanded at a single price • the market yields a substantial surplus of goods produced

50. The number of people seeking to obtain tickets to an OSU football game is nearly always larger than the number of available tickets (and seats) to the game. This is evidence that the price of the ticket is • above the equilibrium level • below the equilibrium level • too high for many to afford • at the equilibrium level because the number of tickets bought always equals the number of tickets for sale.