1. Controls on prices a. Price ceiling: price is not allowed to rise above this level. i.

If the price that balances supply and demand is below the ceiling, it is not binding 1. The price ceiling therefore has no effect on the price or quantity sold ii. If the equilibrium price is above the price ceiling, it is a binding constraint on the market 1. Results in a shortage 2. When the shortage develops, some mechanism for rationing will naturally develop a. Long lines b. Sellers could ration according to their own personal biases i. Selling only to friends, relatives, or members of their own racial or ethnic group 3. Not all buyers benefit from price ceilings iii. When the government imposes a binding price ceiling on a competitive market, a shortage of the good arises, and sellers must ration the scarce goods among the large number of potential buyers. iv. The rationing mechanisms that develop under price ceilings are rarely desirable 1. In contrast, the rationing mechanism in a free, competitive market is both efficient and impersonal a. Free markets ration goods with prices b. Price floor: Government imposes a legal minimum on the price i. If the equilibrium is above the floor, the price floor is not binding 1. If it is below the equilibrium price, then it is a binding constraint on the market 2. When the market price hits the floor, it can fall no further a. The market price= the price floor b. The quantity supplied exceeds the quantity demanded i. Binding price floor causes a surplus 3. With a binding price floor a. Some sellers are unable to sell all they want at the market price b. The sellers who appeal to the personal biases of the buyers, perhaps due to racial or familial ties, are better able to sell their goods than those who do not

c. Rent subsidies do not reduce the quantity of housing supplied and therefore. Taxes . the quantity of labor supplied exceeds the quantity demanded. Earned income tax credit. When policymakers set prices by legal decree. Impact on teenage labor i. i. but it also discourages landlords from maintaining their buildings and makes housing hard to find c. encourages teenagers to drop out of school. Minimum wage depends on the skill and experience of the worker. and sellers can sell all they want at the equilibrium price 2. Workers determine the supply of labor ii. Firms determine the demand b. The economy has many labor markets for different types of workers i. The minimum wage a. Wage subsidies raise the living standards of the working poor without discouraging firms from hiring them 1. Minimum wage is more often binding for teens than for other members of the labor force e. In addition to altering the quantity of labor demanded. The labor market is subject to the forces of supply and demand i. Ex. and prevents some unskilled workers from getting the on the job training they need 3. the minimum wage alters the quantity supplied i. Minimum wage raises the income of those workers who have jobs but lowers the incomes of workers who cannot find jobs c. Rent and wage subsides cost the government money which requires higher taxes 4. a government program that supplements the incomes of low wage workers iii. For these workers. Raises in minimum wage increases the number of teenagers who choose to look for jobs f. they obscure the signals that normally guide the allocation of society’s resources b. If the minimum wage is above the equilibrium level. 1. Rent control may keep rents low. do not lead to housing shortages ii. the minimum wage is not binding d. Subsidy: government paying a fraction of the price i. Evaluating price controls a. Least skilled and least experienced members of the labor force ii. the price serves as the rationing mechanism. The result is unemployment ii. Workers with high skills are not affected because their equilibrium wages are well above the minimum a. By contrast: in a free market. High minimum wage causes unemployment.

Lawmakers can decide whether a tax comes from the buyer’s pocket or from the seller’s. The wedge between the buyers’ price and the sellers’ price is the same. a. and half is deducted from workers’ paychecks c.50 higher than it actually is 1. The tax on ice cream reduces the size of the market i. The supply curve is not affected because for any given price. The price received by sellers does not fall much. The difference in the two panels is the relative elasticity of supply and demand. buyers demand a smaller quantity at every price i. 8. Places a wedge between the wedge that firms pay and the wage that workers receive d. Asdifjaodfjaidjfaildj Taxes on buyers a. so sellers only carry a small burden iii. Tax incidence refers to how the burden of a tax is distributed among the various people who make up the economy Taxes on sellers a. As a result of the tax. b. Taxes levied on sellers and taxes levied on buyers are equivalent ii. Sellers are responsive to changes in price(curve relatively flat) and buyers are not very responsive (curve relatively steep) ii. iii. 6. they demand a quantity of the icecream as if the market price were $.5. The price paid by buyers rises substantially. Impact of tax affects the demand i. but the effective price rises. In a market with a very elastic supply and relatively inelastic demand i. Implications i. Thus the tax shifts the demand curve downward from D1 to D2 by the exact size of the tax c. The wedge shifts the relative positions of the supply and demand curves Payroll tax a. Demand curve shifts to the left ii. d. A tax on the wages that firms pay their workers b. Sellers get a lower price and buyers pay a lower market price to sellers than they did previously. 7. regardless of whether the tax is levied on buyers or sellers. indicating that buyers bear most of the burden of the tax . Half of the tax is paid out of firms’ revenues. sellers have the same incentive to provide their product to the market b. Because buyers look at their total cost including the tax. but they cannot legislate the true burden of a tax Elasticity and tax incidence a.

Who pays the luxury tax? a. the supply of labor is much less elastic than the demand i. the economy is governed by 2 kinds of laws i. the elasticity measures the willingness of buyers or sellers to leave the market when conditions become unfavorable. with the elastic demand and inelastic supply. the burden of the tax falls largely on the suppliers c. A small elasticity of demand means that buyers do not have good alternatives to consuming this particular good. Buyers are very responsive (curve is flatter) iii. h. A small elasticity of supply means that sellers do not have good alternatives to producing this particular good. the side of the market with fewer good alternatives is less willing to leave the market and must. demand is quite elastic 2. workers rather than firms bear most of the burden of the payroll tax. bear more of the burden of the tax. 9. a millionaire can easily not buy a yacht 1.c. supply is relatively inelastic iii. f. and workers who build yachts are not eager to change careers in response to changing market condition 1. A tax burden falls more heavily on the side of the market that is less elastic e. In a market with a relatively inelastic supply and very elastic demand: i. When the good is taxed. yacht factories are not easily converted to alternative uses. g. the laws of supply and demand and the laws enacted by governments CHAPTER 7 ECON NOTES Welfare economics the study of how the allocation of resources affects economic well-being CONSUMER SURPLUS . the goal of the tax was to raise revenue from those would could most easily afford to pay b. Sellers bear most of tax. The price paid by buyers does not rise much but the price received by sellers falls substantially 1. could easily spend her money on something else ii. d. Sellers are not very responsive to changes in the price (curve is steeper) ii. therefore. yacht market i.

willingness to pay each buyer’s maximum is called his willingness to pay and it measures how much that buyer values a good a. c. in essence. a smooth curve b. the total area below the demand curve and above the price is the sum of the consumer surplus of all buyers in the market for a good or service. What consumer surplus measures . as measured by their willingness to pay for it. Thus. In a market with many buyers. he would refuse to buy the album at the price greater than his willingness to pay. the resulting steps from each buyer dropping out are so small that they form. At a price equal to his willingness to pay. c. the price given by the demand curve shows the willingness to pay of the marginal buyer i.1. The buyer who would leave the market first if the price were any higher e. Consumer surplus is closely related to the demand curve for a product d. The difference between this willingness to pay and the market price is each buyer's consumer surplus. This is true because the height of the demand curve measures the value buyers place on the good. Measures the benefit buyers receive from participating in a market b. he would be equally happy buying it or keeping his money 2. How a lower price raises consumer surplus a. each buyer would be eager to buy an item at a price less than his willingness to pay b. we can also use it to measure consumer surplus f. the buyer would be indifferent about buying the good i. New buyers enter the market bc they are willing to buy the good at a lower price 4. Total consumer surplus can be calculated by adding up all the individual consumer surplus’ in the market c. Because the demand curve reflects buyers willingness to pay. At any quantity. Consumer surplus is the amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it a. The area below the demand curve and above the price measures the consumer surplus in a market. 3. a. An increase in consumer surplus is composed to 2 parts i. b. If the price is exactly the same as the value he places on the item. The CS from those buyers who were already buying Q1 of a good at the higher price of P1 because they are now better off bc they pay a lower price 1. An increase in consumer surplus of existing buyers is the reduction in the amount they pay ii.

Producer surplus is the amount a seller is paid minus the cost of production i. The height of the supply curve is related to the sellers’ costs c. it includes the painter’s out of pocket expenses (materials. basically the value of everything he or she must give up to produce a good iii. and would refuse to sell his services at a price less than his costs d. the painter would be indifferent about selling his services i. policymakers might choose not to care about consumer surplus because they do not respect the preferences that drive buyer behavior d. A worker is willing to take the job if the price he would receive exceeds his cost of doing the work b. Cost and the willingness to sell a. he would be equally happy getting the job or using his time and energy for another purpose. the price given by the supply curve shows the cost of the marginal seller i. Measures the benefit sellers receive from participating in a market ii. At any quantity. Producer surplus is closely related to the supply curve b. A measure of producer well being in dollar terms 2. paying employees) as well as the value that the painter places on his own time ii. Consumer surplus is a good measure of economic wellbeing if policymakers want to respect the preferences of buyers c. and the difference between the price and the cost of production is each seller's producer surplus. It is a measure of consumer well being in dollar terms PRODUCER SURPLUS 1. .a. gas. The height of the supply curve measures sellers' costs. In some circumstances. It measures the benefit that buyers receive from a good as the buyers themselves perceive it b. The height of the lowest point on the supply curve is the cost for a seller who would leave the market first if the price were any lower. a measure of his willingness to sell his services c. Using the supply curve to measure producer surplus a. cost should be interpreted as the painters’ opportunity cost i. each painter would be eager to sell his services at a price greater than his costs. Consumers are the best judges of how much benefit they receive from the goods they buy e. at a price exactly equal to his cost. i. the area below the price and above the supply curve measures the producer surplus in a market. d. e.

Some sellers will leave the market after a price fall because their costs now exceed their pay b. Some new sellers enter the market because they are willing to produce the good at the higher price. moving production from a high-cost producer to a low-cost producer will lower the total cost to sellers and raise total surplus ii. Total surplus= value to buyers. Similarly. moving consumption of the good from a buyer with a low valuation to a buyer with a high valuation will raise total surplus . we say that the allocation exhibits efficiency h. The planner wants to maximize the economic well being of everyone in society. The benevolent social planner is an all knowing.amount paid by buyers e. Consumer surplus= value to buyers. then some of the potential gains from trade among buyers and sellers are not being realized i. an allocation is inefficient if a good is not being consumed by the buyers who value it most highly 1. A= 1/2 (h)(a+b) 3. In this case. c.ii. How a higher price raises producer surplus a. When a price raises from P1 to P2… i. the total area is the sum of the producer surplus of all sellers iii. resulting in an increase in the quantity supplied from Q1 to Q2 4. The benevolent social planner a. One possible measure is the sum of consumer and producer surplus total surplus d. The planner must first decide to how to measure the economic well being of society i. Thus. If an allocation of resources maximizes total surplus. 1. an allocation is inefficient if a good is not being produced by the sellers with lowest cost 1.cost to sellers g. PS is represented as a trapezoid 1. well intentioned dictator b. The sellers who remain and accept the lower price then make less revenue MARKET EFFICIENCY Consumer surplus and producer surplus are the basic tools that economists use to study the welfare of buyers and sellers in a market. all powerful. Producer surplus= amount received by sellers. Those sellers who were already selling Q1 of the good at the lower price of P1 are better off because they now get more for what they sell ii. How a lower price reduces PS a. In this case. For example.cost to sellers f. If an allocation is not efficient.

The outcome in a market matters only to the buyers and sellers in that market i. At any quantity below the equilibrium level such as Q1. decreasing the quantity raises total surplus. As a result. . Whether the various buyers and sellers in the market have a similar level of economic well being 2. Observations about market outcomes i. as measured by their willingness to pay ii. d. The equilibrium outcome is an efficient allocation of resources b. Important assumptions a. at any quantity beyond the equilibrium level.The social planner might also care about equality i. Evaluating the market equilibrium a. Markets are perfectly competitive i. The invisible hand takes all the information about buyers and sellers into account and guides everyone in the market to the best outcome as judged by the standard of economic efficiency CONCLUSION: MARKET EFFICIENCY AND MARKET FAILURE a. the decisions of buyers and sellers sometimes affect people who are not participants in the market at all i. Free markets allocate the demand for goods to the sellers who can produce them at the least cost iii. such as Q2. Centrally planned economies never work very well c. Can cause markets to be inefficient because it keeps the price and quantity away from the equilibrium of supply and demand b. Similarly. the social planner would choose the quantity where the supply and demand curves intersect. ii. In this case. and this continues to be true until quantity falls to the equilibrium level a. To maximize total surplus. In the world. the value to the marginal buyer exceeds the cost to the marginal seller. The total area between the supply and demand curves up to the point of equilibrium represents the total surplus in the market b. the value to the marginal buyer is less than the cost to the marginal seller. A single buyer or seller may be able to control market prices 1. increasing the quantity produced and consumed raises total surplus. This continues to be true until the quantity reaches the equilibrium level. Free markets produce the quantity of goods that maximizes the sum of consumer and producer surplus c. Market power a. Free markets allocate the supply of goods to the buyers who value them most highly. i. i. a.

Rent control a. Ex pollution 2. But removing rent control also clearly makes things worse for incumbent renters 1.b. Removing rent control increases landlords’ producer surplus and renters’ consumer surplus b. The side effects known as externalities cause welfare in a market to depend on more than just the value to buyers and the cost to the sellers .

Sign up to vote on this title
UsefulNot useful