Supply, Demand, and Government Policies

1. 6 Supply, Demand, andGovernment Policies

2. 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

3. Market Failure • Unregulated (“free”) markets are usually a good way to organize economic activity • But not always – an example of market failure • As CEO of Turing, Shkreli hiked the price of the drug Daraprim from $13.50 a pill to $750 overnight. • "We raised the price from $1,700 per bottle to $75,000 ... So 5,000 paying bottles at the new price is $375,000,000 • Market power – patent -> monopoly

4. 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 P1 P2 P1 S2 Supply, S1 S1 Demand Demand QS Q1 Q1 QD 0 0 Quantity of Gasoline Quantity of Gasoline

5. 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

6. 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

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

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

9. Consequences of Binding Price Supports Compared to a “free” market (unregulated) • Consumers buy less milk • Lost Consumer Surplus • 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

10. 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

11. 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

12. 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. 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

13. Cost of Price Supports • In 2013, the U.S. Department of Agriculture spent $107 million buying sugar to increase prices to producers • Other Agricultural Price Support Programs • Wheat • Corn • Milk and milk products

14. Cost of Price Supports The U.S. government has been protecting farmers against unpredictable hardships such as bad weather since the 1930s, when drought and the Great Depression devastated the nation's agriculture industry. Today, agricultural subsidies and insurance cost the U.S. taxpayers about $20 billion annually, according to the U.S.

15. Agricultural Price Supports in the 3rd World Agricultural price supports often stimulate larger production, tax consumers, and impede international trade. They often transfer income from lower-income consumers to wealthier owners of farmland. Price supports do little to help farmers with below-average incomes because benefits are distributed in proportion to sales. A more efficient and equitable way to help low-income farmers would be to transfer income to them directly. Agricultural Price Supports by Robert L. Thompson

16. Agricultural Price Support Programs in the US The Economist labeled the recently enacted 2008 farm bill “A Harvest of Disgrace” (May 24, 2008). The five-year $307 billion bill, through a complicated system of government programs, lavishes cash on upper-income farm households. The major beneficiaries of U.S. agricultural programs, commercial farmers, will have an average income of some $230,000 in 2008, according to the U.S. Department of Agriculture (USDA). The main restriction on these subsidies is a means test that applies to couples making more than $1.5 million per year. A host of “emergency programs” was enacted as part of President Franklin Roosevelt’s New Deal during the Great Depression of the 1930s. Despite huge changes over time in the particulars, the programs affecting the growing and marketing of farm crops remain largely intact.

17. Agricultural Price Supports – An Economic Analysis https://en.wikipedia.org/wiki/Price_support

18. 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.

19. 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