Ch 3 Government Control of Prices

1
Ch 3 Government Control of Prices

• The free enterprise system is
• absolutely too important to be left to
• the competitive forces of the marketplace.
• A U.S. Senator

2
Ch 3 Govt. Price Controls

• In market systems, prices result from interaction
  of market forces.
• In mixed systems, market forces are not always
  allowed to operate unhindered.
• Some prices are under legal control of government.

Minimum prices are set to benefit sellers of
goods. Maximum prices are set to benefit buyers
of goods.
3
Ch 3 Govt. Price Controls

• Are these controls effective?
• Do they achieve the intended results?
• Do they improve the market, maximize well being?

4
Ch 3 Govt. Price Controls
Price Ceilings

• Maximum prices allowed by law
• Must be below equilibrium to be effective.
• Two main purposes
• Keep inflation in check
• Keep prices of certain goods and services within
  reach of lower income people.

5
Ch 3 Govt. Price Controls
Price Ceilings
P
S
PE
D
0
Q
QE
6
Ch 3 Govt. Price Controls
Price Ceilings
P
S
PE
Maximum price
PC
D
Shortage, QDgtQS
0
Q
QE
QS
QD
7
Ch 3 Govt. Price Controls
Price Floors

• Minimum prices allowed by law
• Must be above equilibrium to be effective.
• Main purpose
• Increase incomes of sellers of the good or
  service.

8
Ch 3 Govt. Price Controls
Price Floors
P
S
PF
PE
D
0
Q
QE
QD
QS
9
Ch 3 Govt. Price Controls
Price Floors
P
S
Surplus, QDltQS
PF
Minimum price
PE
D
0
Q
QE
QD
QS
10
Ch 3 Govt. Price Controls
Price Ceilings Rent Control

• Households choose how many dollars to allocate to
  housing based on incomes, other expenses.
• Some larger cities placed ceilings on rent to
  ensure availability of affordable housing for
  lower incomes.
• Household mobility - If rents increase,
  households move to smaller places, get roommates,
  etc.
• Produces market shortage of housing.

QE
11
Ch 3 Govt. Price Controls
Effects of Rent Control

• Housing Shortage
• Not all households that want housing at that
  price can find it.
• Housing mobility cannot take place. People dont
  leave home, share when they dont have to, dont
  downsize or upsize when they need to.
• People live further from employment than they
  would otherwise.
• Costs Not Kept Down for Everyone
• Under table payments commonly made for
  available apartments.
• Black Market
• Profit Incentives Removed, Supply Does Not
  Increase
• Other ventures become more profitable than real
  estate.
• Example Paris almost no new rental housing
  built between 1914 and 1950.
• Supply decreases in long run as landlords give up
  and change use of property.

12
Ch 3 Govt. Price Controls
Effects of Rent Control (cont.)

• Housing Quality Deteriorates
• Lower quality for same price same quality at
  higher price.
• Landlords cannot afford maintenance.
• Resource Misallocation
• Households value housing at higher price.
• Want MORE resources allocated to housing, not
  less.

13
Ch 3 Govt. Price Controls

• This is the market for minimum wage labor.
• Demand for labor is a derived demand (Demand is
  dependent on demand for the product being
  produced).
• Employers will hire up to the point where MCMB
  (where wage contribution to output)
• Supply curve represents workers available for
  jobs at various wages.

Price Floors Minimum Wage
P (WAGE)
S
PF
PE
D
0
Q
QE
QD
QS
14
Ch 3 Govt. Price Controls
Effects of Minimum Wage (Some win, some lose)

• Increased Unemployment in Minimum Wage Jobs
• Price floor results in surplus of minimum wage
  labor.
• Qty of labor demanded by employers is less than
  quantity of labor supplied by workers at higher
  wages.
• When required to pay ALL minimum wage workers a
  higher per person wage, employers will not be
  able to employ as many workers.
• Workers impacted most young minority males.
• Higher Incomes for Minimum Wage Workers Still
  Employed
• Though more workers are unemployed, those that
  remain employed earn higher wages.
• Does Not Impact Poverty Rates
• So few of those working for minimum wage are head
  of households, it does not tend to pull families
  out of poverty.

15
Ch 4 Pollution Problems

• The use of solar energy has not been opened up
  because the oil industry does not own the
  sun. Ralph Nader

16
Ch 4 Pollution Problems
Opie, you havent finished your milk. We cant
put it back in the cow, you know. Aunt
Bee
17
Ch 4 Pollution Problems

• Pollution clean-up and prevention is one of the
  most hotly debated topics in politics, social
  sciences, natural sciences, AND economics.
• How much is too much? Should ALL pollution be
  prevented? How do we know where to stop?

18
Ch 4 Pollution Problems
What is Pollution?

• Services of the Environment
• Air, water and land for survival
• Habitat, or environment
• Resources for production processes by households
  and firms.
• Three Ways Environment is Affected by Use
• Exhaustible resources are diminished (coal, oil).
• Replaceable resources are used (trees, animals).
• Waste from production and consumption is
  disposed.

19
Ch 4 Pollution Problems
What is Pollution?

• Pollution comes primarily from waste disposal
• Recycling
• Transformation of waste, either naturally or
  mechanically, into raw materials that can be
  used again.
• Pollution
• Waste that is either
• not completely recycled
• not recycled fast enough, or
• not recycled at all.
• Pollution takes place when the capacity of
  environmental services is diminished.

20
Ch 4 Pollution Problems
Economics of Pollution

• Why is pollution a problem?
• Property rights are nonexistent or not enforced.
• Nobody owns air, rivers, sides of highways.
• If owned, owner is not always around to monitor.
• Environments services are shared by population

21
Ch 4 Pollution Problems
Externalities
Externality A cost or benefit imposed on a
consumer or a firm by actions taken by others.
The cost or benefit is thus generated externally
to the consumer or firm. Externalities occur
when a third party to the market (someone not
directly in the market) is affected by the
production or consumption of the good or
service. An externally imposed benefit is a
positive externality. An externally imposed
cost is a negative externality.
22
Ch 4 Pollution Problems
Externalities

• Examples of Externalities
• Positive
• A well-maintained property next door that raises
  the market value of your own property.
• A pleasant cologne or scent worn by the person
  seated next to you.
• Improved driving habits that reduce accident
  risks.
• A scientific advance.
• Negative
• Air and water pollution
• Loud parties next door that keep you awake.
• Traffic congestion.
• Second-hand cigarette smoke suffered by a
  non-smoker.
• Increased health insurance premiums due to
  alcohol or tobacco consumption.

23
Ch 4 Pollution Problems
Markets and Resource Allocation
Demand

• Demand curve represents marginal private benefit
  (MPB) achieved by consumer.
• If consumer is the only party to achieve benefits
  from transactions in this market, marginal
  private benefit marginal social benefit. (MPB
  MSB)
• If third parties outside of the market benefit
  from transactions, even though they arent
  consuming or producing the good or service, MPB lt
  MSB.
• If MPB lt MSB, there are positive (or benefit)
  externalities in consumption in this market.

P
D MPB
Q
24
Ch 4 Pollution Problems
Markets and Resource Allocation

• EXAMPLE
• MARKET FOR VACCINATIONS
• There are benefits to parties other than the
  direct consumers (if you get your shots, I
  benefit, even though I dont get my shots).
• This demand curve does not measure all of the
  benefits that result from transactions taking
  place in this market.
• Positive externalities in consumption, so
  MPBltMSB. Difference is the externality.
• Since market doesnt know about all benefits,
  resources will be underallocated in this market
  (not enough vaccinations will be provided by
  private market).

Demand
P
D MPB
Q
25
Ch 4 Pollution Problems
Markets and Resource Allocation

• Supply curve represents marginal private cost
  (MPC) paid by producers.
• If producer is the only party to pay costs from
  transactions in this market, marginal private
  cost marginal social cost. (MPC MSC)
• If third parties outside of the market also pay
  costs from transactions taking place in this
  market, even though they arent consuming or
  producing the good or service, MPC lt MSC.
• If MPC lt MSC, there are negative (or cost)
  externalities in production in this market.

Supply
P
S MPC
Q
26
Ch 4 Pollution Problems
Markets and Resource Allocation

• EXAMPLE
• MARKET FOR PAPER
• There are costs to parties other than the
  producers (the process of producing paper creates
  dirty air and water, affecting neighbors of
  plant).
• Negative (cost) externalities in production, so
  MPCltMSC. Difference is the externality.
• This supply curve does not measure all of the
  costs associated with transactions taking place
  in this market.
• Since market doesnt know about all costs,
  resources will be overallocated in this market
  (too much paper will be produced by this factory).

Supply
P
S MPC
Q
27
Ch 4 Pollution Problems
Markets and Resource Allocation

• EXAMPLE
• MARKET FOR PAPER
• These demand and supply curve are measuring only
  the private benefits and private costs associated
  with this market.
• Consumption and production take place at
  equilibrium point A.
• However, there are costs being borne by third
  parties in this market (pollution created in air
  and water of neighborhood around factory). These
  are negative externalities of production.

Demand and Supply
P
S MPC
A
PE
DMPB
Q
QE
28
Ch 4 Pollution Problems
Markets and Resource Allocation

• EXAMPLE
• MARKET FOR PAPER
• New supply curve represents
• MPC externalitiesMSC.
• Equilibrium in this market SHOULD be at point B.
• Increase in equilibrium price, decrease in
  equilibrium quantity.
• Until externalities are internalized and
  reflected in the market, there is an
  overallocation of resources in this market (too
  much paper being produced).

Demand and Supply
MSC
P
S MPC
B
A
PE
DMPB
Q
QE
29
Ch 4 Pollution Problems
Externalities
When externalities exist, equilibrium does not
yield desired resource allocation. Social
well-being is not maximized. (Externalities are
also called social spill-overs) This is Market
Failure ! Government needs to intervene and
correct for market failure by internalizing the
externalities, to ensure proper allocation of
resources
30
Ch 4 Pollution Problems
Economics of Pollution

• What are appropriate levels of control?
• Cost-Benefit Analysis
• Control pollution up to where MSC MSB.

MSC
Cost of Abatement
MSB
Pollution Control
31
Ch 4 Pollution Problems
Pollution Control Policies

• Direct Controls
• Ban production
• Regulate production
• Indirect Controls
• Taxation
• Cost-benefit analysis shows a tax rate that would
  get optimal results (MSCMSB)
• Pollution Rights Market
• Firms allowed to buy and sell government issued
  licenses granting right to create certain amount
  of pollution.
• EXAMPLE
• Pollution right costs 1000. If Firm A can cut
  pollution for less than 1000, they do so, then
  sell right to pollute to Firm B, who cannot cut
  pollution as cheaply.