Government Intervention and Disequilibrium _ Boundless Economics.pdf

  • RMU
  • ACC 2060
  • Elnino33
  • 26
  • 100% (1) 1 out of 1 people found this document helpful

This preview shows page 1 out of 26 pages.

Unformatted text preview: 18.10.2018 Government Intervention and Disequilibrium | Boundless Economics Boundless Economics Introducing Supply and Demand Government Intervention and Disequilibrium … 1/26 18.10.2018 Government Intervention and Disequilibrium | Boundless Economics Why Governments Intervene In Markets Governments intervene in markets when they ine ciently allocate resources. LEARNING OBJECTIVES Identify reasons why the government might choose to intervene in markets KEY TAKEAWAYS Key Points The government tries to combat market inequities through regulation, taxation, and subsidies. Governments may also intervene in markets to promote general economic fairness. Maximizing social welfare is one of the most common and best understood reasons for government intervention. Examples of this include breaking up monopolies and regulating negative externalities like pollution. Governments may sometimes intervene in markets to promote other goals, such as national unity and advancement. Key Terms ine cient market: An economy where social optimality is not acheived; an economy where resources are not optimally allocated … 2/26 18.10.2018 Government Intervention and Disequilibrium | Boundless Economics Governments intervene in markets to address ine ciency. In an optimally e cient market, resources are perfectly allocated to those that need them in the amounts they need. In ine cient markets that is not the case; some may have too much of a resource while others do not have enough. Ine ciency can take many di erent forms. The government tries to combat these inequities through regulation, taxation, and subsidies. Most governments have any combination of four di erent objectives when they intervene in the market. Maximizing Social Welfare In an unregulated ine cient market, cartels and other types of organizations can wield monopolistic power, raising entry costs and limiting the development of infrastructure. Without regulation, businesses can produce negative externalities without consequence. This all leads to diminished resources, sti ed innovation, and minimized trade and its corresponding bene ts. Government intervention through regulation can directly address these issues. Another example of intervention to promote social welfare involves public goods. Certain depletable goods, like public parks, aren’t owned by an individual. This means that no price is assigned to the use of that good and everyone can use it. As a result, it is very easy for these assets to be depleted. Governments intervene to ensure those resources are not depleted. Macro-Economic Factors Governments also intervene to minimize the damage caused by naturally occurring economic events. Recessions and in ation are part of the natural business cycle but can have a devastating e ect on citizens. In these cases, governments intervene through subsidies and manipulation of the money supply to minimize the harsh impact of economic forces on its constituents. Socio-Economic Factors … 3/26 18.10.2018 Government Intervention and Disequilibrium | Boundless Economics Governments may also intervene in markets to promote general economic fairness. Government often try, through taxation and welfare programs, to reallocate nancial resources from the wealthy to those that are most in need. Other examples of market intervention for socioeconomic reasons include employment laws to protect certain segments of the population and the regulation of the manufacture of certain products to ensure the health and well-being of consumers. Former President Bill Clinton signing welfare reform: Former President signing a welfare reform bill. Welfare programs are one way governments intervene in markets. Other Objectives Governments can sometimes intervene in markets to promote other goals, such as national unity and advancement. Most people agree that governments should provide a military for the protection of its citizens, and this can be seen as a type of intervention. Growing a large and impressive military not only increases a country’s security, but may also be a source of pride. Intervening in a way that promotes national unity and pride can be an extremely valuable goal for government o cials. Price Ceilings A price ceiling is a price control that limits how high a price can be … 4/26 18.10.2018 Government Intervention and Disequilibrium | Boundless Economics charged for a good or service. LEARNING OBJECTIVES De ne price ceilings KEY TAKEAWAYS Key Points For a price ceiling to be e ective, it must be less than the free-market equilibrium price. The purpose of a price ceiling is to protect consumers of a certain good or service. By establishing a maximum price, a government wants to ensure the good is a ordable for as many consumers as possible. Rent control is an example of a price ceiling. Key Terms free-market equilibrium price: The price established through competition such that the amount of goods or services sought by buyers is equal to the amount of goods or services produced by sellers Price ceiling: An arti cially set maximum price in a market. A price ceiling is a price control that limits the maximum price that can be charged for a product or service. Generally ceilings are set by governments, although groups that manage exchanges can set ceilings as well. The purpose of a price ceiling is to protect consumers of a certain good or service. By establishing a minimum price, a government … 5/26 18.10.2018 Government Intervention and Disequilibrium | Boundless Economics wants to ensure the good is a ordable for as many consumers as possible. US Poster for Price Ceilings: Governments often impose price ceilings in times of war to ensure goods are available to as many people as possible. An example of a price ceiling is rent control. These regulations require a more gradual increase in rent prices than what the market may demand. This regulation is meant to protect current tenants. Without rent control, there could be situations where the demand for housing in an area could cause rent prices to make a substantial jump. Unable to a ord the new, signi cantly higher rent, a majority of the neighborhood’s tenants may be forced to move out of the neighborhood. Rent controls limit the possibility of tenant displacement by minimizing the amount by which rent can be increased. By de nition, however, price ceilings disrupt the market. By setting a maximum price, any market in which the equilibrium price is above the price ceiling is ine cient. There will be excess demand because the price cannot increase enough to clear the excess. For a price ceiling to be e ective, it must be less than the free-market equilibrium price. This is the price established through competition such that the amount of goods or services sought by buyers is equal to the amount of goods or services produced by sellers. It is also the price that the market will naturally set for a given good or service. If the price ceiling is higher than what the market would already charge, the regulation would not be e ective. As a result, a government will do … 6/26 18.10.2018 Government Intervention and Disequilibrium | Boundless Economics signi cant research into the current market conditions for a good before setting a price ceiling. Price Ceiling Impact on Market Outcome A binding price ceiling will create a surplus of supply and will lead to a decrease in economic surplus. LEARNING OBJECTIVES Explain how price controls lead to economic ine ciency KEY TAKEAWAYS Key Points A price ceiling has an economic impact only if it is less than the free-market equilibrium price. An e ective price ceiling will lower the price of a good, which decreases the producer surplus. The e ective price ceiling will also decrease the price for consumers, but any bene t gained from that will be minimized by the decreased sales due to the drop in supply caused by the lower price. If a ceiling is to be imposed for a long period of time, a government may need to ration the good to ensure availability for the greatest number of consumers. Prolonged shortages caused by price ceilings can create black markets for that good. Key Terms Price ceiling: An arti cially set maximum price in a market. … 7/26 18.10.2018 Government Intervention and Disequilibrium | Boundless Economics black market: trade that is in violation of restrictions, rationing or price controls A price ceiling will only impact the market if the ceiling is set below the free-market equilibrium price. This is because a price ceiling above the equilibrium price will lead to the product being sold at the equilibrium price.If the ceiling is less than the economic price, the immediate result will be a supply shortage. As you can see from the chart below, a lower base price means less of a good will be produced. The quantity demanded will increase because more people will be willing to pay the lower price to get the good while producers will be willing to supply less, leading to a shortage. Price Supply curve Free market price at equilibrium Consumer surplus Deadweight loss Free market equilibrium Binding price ceiling Producer surplus excess demand Demand curve Free market equilibrium quantity Market quantity with price ceiling Quantity Price Ceiling Chart: If a price ceiling is set below the free-market equilibrium price (as shown where the supply and demand curves intersect), the result will be a shortage of the good in the market. The dead weight loss, represented in yellow, is the minimum dead weight loss in such a … 8/26 18.10.2018 Government Intervention and Disequilibrium | Boundless Economics scenario. If individuals who value the good most are not capable of purchasing it, there is a potential for a higher amount of dead weight loss. A price ceiling will also lead to a more ine cient market and a decreased total economic surplus. Economic surplus, or total welfare, is the sum of consumer and producer surplus. Consumer surplus is the monetary gain obtained by consumers because they are able to purchase a product for a price that is less than the highest that they are willing pay. Producer surplus is the amount that producers bene t by selling at a market price that is higher than the least they would be willing to sell for. An e ective price ceiling will lower the price of a good, which means that the the producer surplus will decrease. While the e ective price ceiling will also decrease the price for consumers, any bene t gained from that will be minimized by decreased sales caused by decreased available supply for sale from producers due to the decrease in price. This translates into a net decrease total economic surplus, otherwise known as deadweight loss. This loss is signi ed in the attached chart as the yellow triangle. Rationing If a ceiling is to be imposed for a long period of time, a government may need to ration the good to ensure availability for the greatest number of consumers. One way the government may ration the good is to issue ticket to consumers. A government will only allow as much of good to be out in the marketplace as there are available tickets. To obtain the good, the consumer must present the ticket and the money to the vendor when making the purchase. This is generally considered a fair way to minimize the impact of a shortage caused by a ceiling, but is generally reserved for times of war or severe economic distress. Black Market Prolonged shortages caused by price ceilings can create black markets for that good. A black market is an underground network of producers that will sell consumers as much of a controlled good as they want, but at a price higher than the price ceiling. Black markets are generally illegal. However these markets provide higher pro ts for producers and … 9/26 18.10.2018 Government Intervention and Disequilibrium | Boundless Economics more of a good for a consumers, so many are willing to take the risk of nes or imprisonment. Price Floors A binding price oor is a price control that limits how low a price can be charged for a product or service. LEARNING OBJECTIVES De ne price oors KEY TAKEAWAYS Key Points For a price oor to be a ect the market, it must be greater than the free-market equilibrium price. Price oors above the equilibrium price will induce a surplus. The federal minimum wage is an example of a price oor. Key Terms free-market equilibrium price: The price established through competition such that the amount of goods or services sought by buyers is equal to the amount of goods or services produced by sellers price oor: A mandated minimum price for a product in a market. … 10/26 18.10.2018 Government Intervention and Disequilibrium | Boundless Economics A price oor is a price control that limits how low a price can be charged for a product or service. Generally oors are set by governments, although groups that manage exchanges can set price oors as well. The purpose of a price oor is to protect producers of a certain good or service. By establishing a minimum price, a government seeks to promote the production of the good or service and ensure that the producers have su cient resources to go about their work. For a price oor to be e ective, it must be greater than the free-market equilibrium price. This is the price established through competition such that the amount of goods or services sought by buyers is equal to the amount of goods or services produced by sellers. It is also the price that the market will naturally set for a given good or service. If the price oor is lower than what the market would already charge, the regulation would serve no purpose. Since the price is set arti cially high, there will be a surplus: there will be a higher quantity supplied and a lower quantity demanded than in a free market. As a result, a government will generally do signi cant research into the current market conditions for a good or service before setting a price oor. Price Floor: If a price oor is set above the equilibrium price, consumers will demand less and producers will supply more. … 11/26 18.10.2018 Government Intervention and Disequilibrium | Boundless Economics An example of a price oor is the federal minimum wage. In this case the suppliers are employees and employers are the consumers. The federal government has established a price that all employers must pay their workers. Obviously employers can pay more than that amount, but they cannot pay less. The purpose of setting this oor is to ensure that all employees make enough money from their jobs to provide for their basic needs. U.S. Federal Minimum Wage $11 Nominal Dollars / 2013 Dollars $10 $9 $8 $7 $6 $5 $4 $3 $2 $1 1940 1950 1960 1970 1980 1990 2000 2010 History of the Federal Minimum Wage: History of the federal minimum wage in real and nominal dollars. The federal minimum wage is one example of a price oor. Price Floor Impact on Market Outcome Binding price oors typically cause excess supply and decreased total economic surplus. LEARNING OBJECTIVES Show how price oors contribute to market ine ciency KEY TAKEAWAYS … 12/26 18.10.2018 Government Intervention and Disequilibrium | Boundless Economics Key Points A price oor is economically consequential if it is greater than the free-market equilibrium price. Price oors lead to a surplus of the product. Supply surpluses created by price oors are generally added to producer’s inventory or are purchased by governments. Consumer surplus is the gain obtained by consumers because they can obtain a product for a lower price than they would be willing to pay. Producer surplus is the bene t producers get by selling at a price higher than the lowest price they would sell for. Key Terms free-market equilibrium price: The price established through competition such that the amount of goods or services sought by buyers is equal to the amount of goods or services produced by sellers price oor: A mandated minimum price for a product in a market. A price oor will only impact the market if it is greater than the freemarket equilibrium price. If the oor is greater than the economic price, the immediate result will be a supply surplus. As you can see from, a higher base price will lead to a higher quantity supplied. However, quantity demand will decrease because fewer people will be willing to pay the higher price. This will lead to a surplus of supply. … 13/26 18.10.2018 Government Intervention and Disequilibrium | Boundless Economics Surplus from Price Floor S Price Surplus F E D Quantity Surplus from a price oor: If a price oor is set above the free-market equilibrium price (as shown where the supply and demand curves intersect), the result will be a surplus of the good in the market. A price oor will also lead to a more ine cient market and a decreased total economic surplus. Economic surplus, or total welfare, is the sum of consumer and producer surplus. Consumer surplus is the monetary gain obtained by consumers because they are able to purchase a product for a price that is less than the highest that they are willing pay. Producer surplus is the amount that producers bene t by selling at a market price that is higher than the least they would be willing to sell for. An e ective price oor will raise the price of a good, which means that the the consumer surplus will decrease. While the e ective price oor will also increase the price for producers, any bene t gained from that will be minimized by decreased sales caused by decreased demand from consumers due to the increase in price. This translates into a net decrease total economic surplus, otherwise known as deadweight loss. Since well designed price oors create surpluses, the big issue is what to do with the excess supply. The rst option is to let inventories grow and have the private producers bear the cost of storing it. The other … 14/26 18.10.2018 Government Intervention and Disequilibrium | Boundless Economics option is for the government that set the price oor to purchase the excess supply and store it on its own. The government could then sell the surplus o at a loss in times of a food shortage. Introduction to Deadweight Loss Deadweight loss is the decrease in economic e ciency that occurs when a good or service is not priced at its pareto optimal level. LEARNING OBJECTIVES De ne deadweight loss KEY TAKEAWAYS Key Points Deadweight loss can be caused by monopolies, binding price controls, taxes, subsidies, and externalities. When deadweight loss occurs, it comes at the expense of consumer surplus and/or producer surplus. Deadweight loss can be visually represented on supply and demand graphs as a gure known as Harberger’s triangle. Key Terms Pareto optimal: Describing a situation in which the pro t of one party cannot be increased without reducing the pro t of another. deadweight loss: A loss of economic e ciency that can occur when an equilibrium is not Pareto optimal. … 15/26 18.10.2018 Government Intervention and Disequilibrium | Boundless Economics Deadweight loss is the decrease in economic e ciency that occurs when a good or service is not priced and produced at its pareto optimal level. When output is at its pareto optimal point, the price, production, and consumption of a good cannot be altered for one person’s bene t without making at least one other worse o . In a perfectly competitive market, products are priced at the pareto optimal point. When deadweight loss occurs, it comes at the expense of either the consumer economic surplus or the producer’s economic surplus. Consumer surplus is the gain that consumers receive when they are able to purchase a product for less than the price they are willing to pay; producer surplus is the bene t producers receive when the sell a product for more than they are willing to sell for. While price controls, subsidies and other forms of market intervention might increase consumer or producer surplus, economic theory states that any gain would be outweighed by the losses sustained by the other side. This net harm is what c...
View Full Document

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture