Chapter 4 Market Equilibrium and Elasticity Price Controls

Chapter 4 Market Equilibrium and Elasticity

Price Controls n Legal restrictions on how high or low a market price may go n Price Ceiling: – limiting price (on consumer goods to protect consumers welfare) – maximum price a seller can charge n Price Floor: – support price (on production factors, e. g. labor) – minimum price a buyer is required to pay

Example: Price Ceiling

The Effects of a Price Ceiling

Example: Rent Controls Figure 3. 8, P. 70

Example: Assumed Price Controls in the Pizza Market Figure 3. 9

Problems with Price Ceilings n Shortages n Inefficiencies – misallocation to consumers – wasted resources – low quality n black markets.

Example: Price Floor

The Effects of a Price Floor

Problems with Price Floors n Surplus n Inefficiencies – misallocation of sales among sellers – Wasted resources – Inefficiently high quality n Illegal activity

Price Controls cause Inefficiency n Consumer surplus n Producer surplus n Total surplus n Deadweight loss

Recall: Demand--the definition n The quantity of a good or service consumers’ are willing and able to buy at various prices n The maximum price the consumer is willing and able to pay for the next unit of the good or service.

Two Different Prices The maximum price the consumers are willing to pay for Vs. The market price the consumers actually paid for

Consumer Surplus n Individual consumer surplus – the net gain to an individual buyer from the purchase of a good. – equal to the difference between the buyer’s willingness to pay and the price paid.

Consumer Surplus The total consumer surplus generated by purchases of a good at a given price is equal to the area below the demand curve but above that price.

A Fall in the Market Price Increases Consumer Surplus

Recall: Supply--the definition n The quantity of a good or service producers are willing and able to sell at various prices n The minimum price the producer is willing and able to accept for providing the next unit of the good or service

Two Different Prices The minimum price the producers are willing to accept Vs. The market price the producers actually get

Producer Surplus and the Supply Curve n Individual producer surplus the net gain to a seller from selling a good equal to the difference between the price received and the seller’s cost (the minimum price the producer is willing to accept) n Total producer surplus the sum of the individual producer surpluses of all the sellers of a good

Producer Surplus The total producer surplus from sales of a good at a given price is the area above the supply curve but below that price.

A Rise in Price Increases Producer Surplus

Putting it together: Total Surplus n the total net gain to consumers and producers from trading in the market n the sum of the producer surplus and the consumer surplus

Pf Pc Total Surplus

Determination of Price and Quantities n D & S together determines n P determines Qd and Qs P – Increase in D What happens to – Decrease in D Equilibrium price – Increase in S And – Decrease in S Equilibrium quantity? – Increase in D and S – Decrease in D and S – Increase in D and decrease in S – Decrease in D and increase in S

Recall: factors affecting D n price of related goods – complements vs. substitutes n income: normal vs. inferior n preference n expectations (prices, income, …) n population n others

Recall: factors affecting S n prices of inputs – goods used to produce other goods n price of related goods – goods that use the same resources n technology n expectations n others

The Effect on the Market n for Tennis Balls of a Decline in Court-Rental Fees (change in price of a related good complements ) Figure 3. 11

Figure 3. 13 The Effect of a Federal Pay Raise n on the Rent for Conveniently Located Apartments in Washington, DC (change in income)

The Effect on the Market n for Overnight Letter Delivery of a Decline in the Price of Internet Access (change in price of a related good - substitute) Figure 3. 12

Rules Governing the Effects of Demand Shifts Figure 3. 17 A & B

Exercise 3. 4, P. 75 n How will a decline in airfare affect – Intercity bus fare – Price of hotel rooms in resort communities n Why?

The Effect on the Market n for New Houses of a Decline in Carpenters’ Wage Rates (change in price of an input) Figure 3. 15

The Effect of Technical Change on the Figure 3. 16 Market n for Term. Paper Revisions (change in technology)

The Effect on the Skateboard Market Figure 3. 14 n The Effect on the Skateboard Market of an Increase in the Price of Fiberglass (change in price of an input)

Rules Governing the Effects of Figure 3. 17 C & D Supply Shifts (continued)

The Effects of Simultaneous Shifts Figure 3. 18 in Supply and Demand 1. Researchers prove that the oils in which tortilla chips are fried are harmful to human health 2. The price of corn harvesting equipment falls

The Effects of Extra Border Patrols on the Market for Illicit Drugs Figure 4. 1

Equilibrium and Shifts of the Demand Curve

Equilibrium and Shifts of the Supply Curve

Simultaneous Shifts of the Demand Supply Curves