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MARKETS IN ACTION

MARKETS IN ACTION. Principles of Microeconomic Theory, ECO 284 John Eastwood CBA 213 523-7353 e-mail address: John.Eastwood@nau.edu. Learning Objectives. Explain how price ceilings create shortages and inefficiency Explain how price floors create surpluses and inefficiency

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MARKETS IN ACTION

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  1. MARKETS IN ACTION • Principles of Microeconomic Theory, ECO 284 • John Eastwood • CBA 213 • 523-7353 • e-mail address: John.Eastwood@nau.edu

  2. Learning Objectives • Explain how price ceilings create shortages and inefficiency • Explain how price floors create surpluses and inefficiency • Explain the effects of the sales tax • Define the total and excess burden of a tax.

  3. Learning Objectives (cont.) • Explain how markets for illegal goods work • Explain why farm prices and revenues fluctuate • Explain how speculation limits price fluctuations

  4. Learning Objectives • Explain how price ceilings create shortages and inefficiency • Explain how price floors create surpluses and inefficiency • Explain the effects of the sales tax • Define the total and excess burden of a tax.

  5. Housing Marketsand Rent Ceilings • San Francisco Earthquake — 1906 • How does the market deal with a dramatic reduction in the supply of housing?

  6. The San Francisco Housing Market in 1906 24 20 Rent (dollars per unit per month) 16 D 12 0 44 72 100 150 Quantity (thousands of units per month)

  7. The San Francisco Housing Market in 1906 24 SS 20 Rent (dollars per unit per month) 16 D 12 0 44 72 100 150 Quantity (thousands of units per month)

  8. The San Francisco Housing Market in 1906 24 SS 20 Rent (dollars per unit per month) LS 16 D 12 0 44 72 100 150 Quantity (thousands of units per month)

  9. The San Francisco Housing Market in 1906 SSa 24 SS 20 Rent (dollars per unit per month) LS 16 D 12 0 44 72 100 150 Quantity (thousands of units per month)

  10. The San Francisco Housing Market in 1906 SSa 24 SS 20 Rent (dollars per unit per month) LS 16 D 12 0 44 72 100 150 Quantity (thousands of units per month)

  11. The San Francisco Housing Market in 1906 SSa 24 SS 20 Rent (dollars per unit per month) LS 16 D 12 0 44 72 100 150 Quantity (thousands of units per month)

  12. The San Francisco Housing Market in 1906 SSa 24 SS 20 Rent (dollars per unit per month) LS 16 D 12 0 44 72 100 150 Quantity (thousands of units per month)

  13. The San Francisco Housing Market in 1906 SSa 24 SS 20 Rent (dollars per unit per month) LS 16 D 12 0 44 72 100 150 Quantity (thousands of units per month)

  14. The San Francisco Housing Market in 1906 24 SS 20 Rent (dollars per unit per month) LS 16 D 12 0 44 72 100 150 Quantity (thousands of units per month)

  15. A Regulated Housing Market • Price ceilings are regulations that make it illegal to charge a price higher than a specified level. • Rent ceilings are price ceilings applied to housing markets. How does a rent ceiling affect the housing market?

  16. A Regulated Housing Market • Rent ceilings set above equilibrium have no effect. • Rent ceilings set below equilibrium prevents price from regulating the quantities supplied and demanded.

  17. A Rent Ceiling SSa 24 20 Rent (dollars per unit per month) Rent ceiling 16 D 12 0 44 72 100 150 Quantity (thousands of units per month)

  18. A Rent Ceiling SSa 24 SS 20 Rent (dollars per unit per month) Rent ceiling 16 Housing shortage D 12 0 44 72 100 150 Quantity (thousands of units per month)

  19. A Regulated Housing Market • The ceiling results in two developments • Search activity • Black markets

  20. A Regulated Housing Market • Search activity is the time spent looking for someone to do business. • Search activity increases when there is a shortage • an opportunity cost

  21. A Regulated Housing Market • Black markets are illegal markets in which the price exceeds the legally imposed price ceiling.

  22. Inefficiency of Rent Ceilings 30 S 24 24 20 Rent (dollars per unit per month) Rent ceiling 16 D 12 0 44 72 100 150 Quantity (thousands of units per month)

  23. Inefficiency of Rent Ceilings 30 S 24 20 Rent (dollars per unit per month) Rent ceiling 16 D 12 0 44 72 100 150 Quantity (thousands of units per month)

  24. Inefficiency of Rent Ceilings 30 S 24 20 Rent (dollars per unit per month) Rent ceiling 16 D 12 Producer surplus 0 44 72 100 150 Quantity (thousands of units per month)

  25. Inefficiency of Rent Ceilings 30 S 24 Deadweight loss 20 Rent (dollars per unit per month) Rent ceiling 16 D 12 Producer surplus 0 44 72 100 150 Quantity (thousands of units per month)

  26. Inefficiency of Rent Ceilings 30 Consumer surplus S 24 Deadweight loss 20 Rent (dollars per unit per month) Rent ceiling 16 D 12 Producer surplus 0 44 72 100 150 Quantity (thousands of units per month)

  27. Learning Objectives • Explain how price ceilings create shortages and inefficiency • Explain how price floors create surpluses and inefficiency • Explain the effects of the sales tax • Define the total and excess burden of a tax.

  28. The Labor Market and the Minimum Wage • Wage rates adjust to make the quantity demanded of labor equal to the quantity supplied • Technology has reduced the demand for low-skilled labor

  29. The Labor Market and the Minimum Wage • Short-run • There is a given number of people with a given skill. • Wages must be increased in order to increase the number of hours worked.

  30. The Labor Market and the Minimum Wage • Long-run • People can acquire new skills and find new types of jobs • If wage rates are too high or low, people will enter or leave this labor market. • If people can freely enter and leave the labor market, the long-run supply of labor is perfectly elastic. • The longer the period of adjustment, the greater the elasticity of supply of labor.

  31. A Market for Low-Skilled Labor SS 6 Wage Rate (dollars per hour) LS 5 4 D 3 20 21 22 23 Quantity (millions of hours per year)

  32. A Market for Low-Skilled Labor SS 6 Wage Rate (dollars per hour) LS 5 4 D 3 DA 20 21 22 23 Quantity (millions of hours per year)

  33. A Market for Low-Skilled Labor SS 6 Wage Rate (dollars per hour) LS 5 4 D 3 DA 20 21 22 23 Quantity (millions of hours per year)

  34. A Market for Low-Skilled Labor SSA SS 6 Wage Rate (dollars per hour) LS 5 4 D 3 DA 20 21 22 23 Quantity (millions of hours per year)

  35. A Market for Low-Skilled Labor SSA SS 6 Wage Rate (dollars per hour) LS 5 4 D 3 DA 20 21 22 23 Quantity (millions of hours per year)

  36. The Minimum Wage • A minimum wage law is a regulation that makes the hiring of labor below a specified wage illegal. • If the minimum wage is set below equilibrium it will have no effect. • If the minimum wage is set above equilibrium, it prevents price from regulating quantity supplied and demanded.

  37. Minimum Wage and Unemployment SS 6 Wage Rate (dollars per hour) 5 4 3 DA 20 21 22 23 Quantity (millions of hours per year)

  38. Minimum Wage and Unemployment SS 6 Unemployment Wage Rate (dollars per hour) 5 a b Minimum wage 4 3 DA 20 21 22 23 Quantity (millions of hours per year)

  39. Learning Objectives • Explain how price ceilings create shortages and inefficiency • Explain how price floors create surpluses and inefficiency • Explain the effects of the sales tax • Define the total and excess burden of a tax.

  40. Elasticity and the Burden of a Tax • The economic incidence of taxation falls on the persons who suffer reduced purchasing power because of the tax. • The legal incidence falls on the persons who are required by law to pay the tax to the government.

  41. Burden “Shifting” • If a tax is passed on to the consumer in the form of higher prices, we say that the tax is forward-shifted. • A tax is said to be backward-shifted if resource suppliers receive lower factor payments (e.g., workers get lower take home wages, or entrepreneurs earn lower profits.).

  42. Vocabulary • An ad valorem tax is a percentage of price. • A specific tax is a fixed amount per unit sold, e.g., the excise tax we pay on gasoline.

  43. Taxes • Who Pays the Sales Tax? • Suppose a $10 sales tax is imposed on CD players • There are two prices • Including the tax — buyers respond to this • what they pay -- P gross • Excluding the tax — sellers respond to this • what they receive -- P net

  44. The Sales Tax S 110 Price (dollars per player) 105 100 95 DA 3 4 5 6 Quantity (thousands of CD players per week)

  45. The Sales Tax S + tax S 110 $10 tax Price (dollars per player) 105 100 95 DA 3 4 5 6 Quantity (thousands of CD players per week)

  46. The Sales Tax S + tax S 110 $10 tax Price (dollars per player) 105 Tax revenue 100 95 DA 3 4 5 6 Quantity (thousands of CD players per week)

  47. Elasticity and Slope ed and slope are inversely related.

  48. Comparing Elasticities @ (Q,P) • If D and S have the same slope, and • if D and S cross at a point (Q,P), • then their elasticities must be equal!

  49. Equal Elasticities, Equal Burdens • Slope of the demand curve = -5/1 • Slope of the demand curve = 5/1 • Original equilibrium = (5,100)

  50. Tax Incidence andElasticity of Demand • Two Extremes • Perfectly inelastic demand--buyer pays • Example: Insulin, Salt • Perfectly elastic demand--seller pays • Example: Pink marker pens, Imported paper clips

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