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...
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