markets in action. tm 7-2 copyright © 1998 addison wesley longman, inc. learning objectives explain...

Markets in Action Markets in Action

TM 7-2Copyright © 1998 Addison Wesley Longman, Inc.

Learning Objectives

• Explain how housing markets work and how price ceilings create housing shortages and inefficiency

• Explain how labor markets work and how minimum wage laws create unemployment and inefficiency

• Explain the effects of the sales tax


Learning Objectives (cont.)

• Explain how markets for illegal goods work

• Explain why farm prices and revenues fluctuate

• Explain how speculation limits price fluctuations


Learning Objectives

• Explain how price ceilings create shortages and inefficiency

• Explain how price floors create surpluses and inefficiency




Housing Marketsand Rent Ceilings

San Francisco Earthquake — 1906

How does the market deal with a dramatic reduction in the supply of housing?

The destruction of buildings decreases the supply of housing and shifts the short-run supply curve leftward.

With sufficient time for new apartments and houses to be constructed, supply increases.


LS

Quantity (thousands of units per month)

Ren

t (do

llars

per

uni

t per

mon

th)

0 44 72 100 150

12

16

20

24

D

SS

The San Francisco Housing Market in 1906

SSa

After EarthquakeLong run Adjustment


A Regulated Housing Market

Price ceilings are regulations that make it illegal to charge a price higher than a specified level.

Rent ceilings are price ceilings applied to housing markets.

How does a rent ceiling affect the housing market?



Rent ceilings set above equilibrium have no effect.

Rent ceilings set below equilibrium prevents price from regulating the quantities supplied and demanded.


A Rent Ceiling


Ren

t (do

llars

per

uni

t per

mon

th)

0 44 72 100 150

12

16

20

24

D

SSa

Housingshortage

Maximum blackmarket rent

Rentceiling



The ceiling results in two developments:

Search activity

Black markets



Search activity is the time spent looking for someone to do business.

It increases when there is a shortage.



Black markets are illegal markets in which the price exceeds the legally imposed price ceiling.



Ren

t (do

llars

per

uni

t per

mon

th)

0 44 72 100 150

12

16

20

24

D

Rentceiling

30S

Producersurplus

Deadweightloss

Consumersurplus

Inefficiency of Rent Ceilings


Learning Objectives






The Labor Market and the Minimum Wage

Wage rates adjust to make the quantity demanded of labor equal to the quantity supplied

Technology has reduced the demand for low-skilled labor



Short-run

There is a given number of people with a given skill.

Wages must be increased in order to increase the number of hours worked.



Long-run

People can acquire new skills and find new types of jobs:

• If wage rates are too high or low, people will enter or leave this labor market.

• If people can freely enter and leave the labor market, the long-run supply of labor is perfectly elastic.



Long-run

People can acquire new skills and find new types of jobs (cont.):

The longer the period of adjustment, the greater the elasticity of supply of labor.


A Market for Low-Skilled Labor

Quantity (millions of hours per year)

Wag

e R

ate

(dol

lars

per

hou

r)

20 21 22 23

3

4

5

6 SS

D

LS

DA

After inventionLong-run adjustment


The Minimum Wage

A minimum wage law is a regulation that makes the hiring of labor below a specified wage illegal.

If the minimum wage is set below equilibrium it will have no effect.

If the minimum wage is set above equilibrium, it prevents price from regulating quantity supplied and demanded.


Minimum Wage and Unemployment

Quantity (millions of hours per year)

Wag

e R

ate

(dol

lars

per

hou

r)

20 21 22 23

3

4

5

6 SS

DA

Minimumwage

a b

Unemployment


Minimum wageUSA: Fair Labor Standards Act of 1938

The Federal Minimum $7.25 per hour as of July 24, 2009

Some states like: Georgia ($5.15), Wyoming ($5.15), Arkansas ($6.25) lower wage and others have higher rate: DC ($8.25), California ($8), Alaska ($7.75), Arizona ($7.75), Illinois ($8.25), Massachusetts ($8)

• The State law excludes from coverage any employment that is subject to the Federal Fair Labor Standards Act when the Federal rate is greater than the State rate.


Minimum wage

• UK: there are different levels of NMW, depending on your age and whether you are an apprentice. The current rates are:

• £5.93 - the main rate for workers aged 21 and over ; £4.92 - the 18-20 rate; £3.64 - the 16-17 rate for workers above school leaving age but under 18; £2.50 - the apprentice rate, for apprentices under 19 or 19 or over and in the first year of their apprenticeship


Minimum wage

• In the 8 out of 27 member states currently have national minimum wages. Many countries, such as Sweden, Finland, Germany, Italy and Cyprus have no minimum wage laws but rely on employer groups and trade unions to set minimum earnings through collective bargaining.

• France € 8.86 (2010); Ireland € 7.65 (2011)

• Japan $7.75 - $9.90 (regional basis)

• Bulgaria 240 lv/monthly


Learning Objectives



• Explain the effects of the sales tax (or VAT|



Taxes

Who Pays the Sales Tax (VAT)?

Suppose a $10 sales tax (VAT) is imposed on DVD players

There are two prices

Including the tax — buyers respond to this.• What they pay.

Excluding the tax — sellers respond to this.• What they receive.


Taxrevenue

S + tax

The Sales Tax

Quantity (thousands of DVD players per week)

Pri

ce (

dolla

rs p

er p

laye

r)

3 4 5 6

95

100

105

110 S

DA

$10 tax


Tax Division andElasticity of Demand

Two Extremes

Perfectly inelastic demand--buyer paysExample: Insulin

Perfectly elastic demand--seller paysExample: Pink marker pens


Sales Tax (VAT) and the Elasticity of Demand

Quantity (thousands of doses per day)

Pri

ce (

dolla

rs p

er d

ose)

2.00

2.20

100

D

S

S + taxBuyer paysentire tax

Perfectly inelasticdemand


Sales Tax (VAT) and the Elasticity of Demand

Quantity (thousands of marker pens per week) 1 4

0.90

1.00

SS + tax

Sellerpaysentiretax

Pri

ce (

cent

s pe

r pe

n)

Perfectly elasticdemand


Tax Division andElasticity of Demand

The division of the tax depends upon elasticity.

The more inelastic the demand, the more the buyer pays.

The more elastic the demand, the more the seller pays.


Tax Division andElasticity of Supply

Two Extremes:

Perfectly inelastic supply -- seller pays.Example: water from a mineral spring.

Perfectly elastic supply -- buyer pays.Example: sand used to make silicon used by computer chip makers.


Sales Tax (VAT) and theElasticity of Supply

Quantity (thousands of bottles per week)

Pri

ce (

dolla

rs p

er b

ottle

)

45

50

100

S

D

Seller paysentire tax

Perfectly inelasticsupply


Sales Tax (VAT) and theElasticity of Supply

Quantity (thousands of pounds per week)

Pri

ce (

cent

s pe

r po

und)

10

11

3 5

S

D

S + taxbuyer paysentire tax

Perfectly ElasticSupply


Tax Division andElasticity of Supply

The division of the tax depends upon elasticity.

The more inelastic the supply, the more the seller pays.

The more elastic the supply, the more the buyer pays.


Sales Taxes (VAT) in Practice

Items with low elasticity of demand (alcohol, tobacco, & gasoline) are good sources of tax revenue for the government.

Why?

Poor source: 1991 Luxury Tax


Taxes and Efficiency

Inefficiency

Due to the difference in price paid by the buyer and received by the seller the marginal benefit does not equal the marginal cost.

The more inelastic demand or supply, the smaller the decrease in quantity and deadweight loss.


Taxes and Efficiency

Quantity (thousands of DVD players per week)

Pri

ce (

dolla

rs p

er p

laye

r)

0 1 2 3 4 5 6 7 8 9 10

75

100

130

DD

S

105

95

Tax Revenue

Consumersurplus

Producersurplus

S + tax

Deadweightloss


Learning Objectives






Markets for Illegal Goods

When a good is illegal, the cost of trading in the good increases.

Penalties and policing increase the cost.

Decreasing supply and/or demand


D - CBL

S + CBL

A Market for an Illegal Good

Quantity

Pri

ce

Qc

Pc

D

c

Sa

b

Cost per unitof breakingthe law...

…to buyer

…to seller

d

Q p


Markets for Illegal Goods

Enforcement

Price effects depend upon who receives the most severe penalty -- the buyer or seller.

Today, penalties on sellers are larger.

This causes the equilibrium quantity to decrease and price increases compared to an unregulated market.


Stabilizing Farm Revenues

Farm output fluctuates considerably due to fluctuations in the weather.

How do changes in farm output affect farm prices and farm revenues?

How can farm revenues be stabilized?


$20billion

$30 billion

$60 billion

0 5 10 15 20 25

2

4

6

8

Quantity (billions of bushels (35.24L) per year)

Pri

ce (

dolla

r pe

r bu

shel

)MS0

D

Poor harvest

MS1

Harvest, Farm Prices,and Farm Revenues



Farm Revenues during a bad harvest

Total farm revenue actually increases due to inelastic demand.

Some farmers, whose entire crop is destroyed, lose.

Others, whose crop is unaffected, earn enormous profits.


$40 billion

$40 billion

$10billion

0 5 10 15 20 25

2

4

6

8

Quantity (billions of bushels per year)

Pri

ce (

dolla

r pe

r bu

shel

)

MS0

D

MS2

Bumper Harvest(record high)

Harvest, Farm Prices,and Farm Revenues



Farm Revenues during a bumper harvest

Total farm revenue actually decreases due to inelastic demand.



Two institutions designed to stabilize farm revenue

Speculative markets in inventories

Farm price stabilization policy


0 5 10 15 20 25

2

4

6

8

Quantity (billions of bushels)

S

D

Pri

ce (

dolla

r pe

r bu

shel

)Q1

Inventory

Inventory Speculation

How Inventories Limit Price ChangesQ2

5 billion toinventory

Productiondecreases

Productionincreases

5 billion frominventory


Farm Revenue

Speculative markets in inventories do not stabilize farm revenue

When price is stabilized, revenue fluctuates as production fluctuates.

Bumper crops bring larger revenues than poor harvest do.


Farm Revenue

Farm Price Stabilization Policy

• Set production limits

• Set price floors

• Hold inventories


Farm RevenueFarm Price Stabilization Policy

Production limits

Quotas restrict the quantity produced. Can result in higher farm prices.

Price floors Set above equilibrium create surpluses.

Hold inventoriesThe government must hold inventory to maintain the equilibrium price.

markets in action. tm 7-2 copyright © 1998 addison wesley longman, inc. learning objectives explain...

Documents

addison wesley longman

housing markets

labor markets

adjustment slide

action slide

supply of housing

minimum wage wage rates

low skilled labor slide