Chapter 5 Flashcards
What do voluntary market transactions require?
A willing buyer and a willing seller
What determines the amount actually exchanged when quantity demanded is less than quantity supplied?
Demand
What determines the amount actually exchanged when quantity demanded exceeds quantity supplied?
Supply
What determines the quantity exchanged at disequilibrium?
The lesser quantity demanded and quantity supplied
What is a price floor?
A price floor is the minimum permissible price that can be charged for a particular good or service (example on slides 6-7)
What does a binding price floor lead to?
It leads to excess supply
What are price ceilings?
It is the maximum price
What do free markets with flexible prices eliminate?
Excess demand by allowing prices to rise
When does another method of allocation need to be adopted?
When there is a binding price ceiling
What is first-come, first-served allocation result in?
It is results in buyers waiting in lines, disappointed to discover supplies are exhausted
What can first-come, first-served allocation lead to
It can lead to a hidden market (shadow market, black market)
What is a hidden market?
It is created when products are sold at prices that violate a legal price control
The idea is to make profit by buying at the controlled price and selling at the (illegal) hidden-market price
What are the goals of price ceilings?
- To restrict production
- To keep specific prices down
- To satisfy notions of equity in the consumption of a product that is temporarily in short supply
What happens when the price ceiling is high?
The rich people get the product
What happens when the price ceiling is low?
The first in line gets the product (those with low value for their time who can wait in line)
What are the effects of binding rent controls?
They lead to a shortage of rental housing because quantity demanded exceeds quantity supplied, alternative allocation schemes (ex air b&b), and hidden markets will also appear (ex illegal subletting)
What occurs in the long run when binding rent controls are in effect?
Price ceilings lead to a decrease in income for landlords so they are less incentivized to make more apartments to meet the demand so, in the long run, there will be a decrease in the supply of apartments as a consequence of the price ceiling
Who gains and who loses when binding rent controls are put in place?
Existing tenants in rent-controlled accommodations are the principal gainers from a policy of rent control
Landlords lose because they do not receive the rate of return they expected on their investments
Potential future tenants also suffer because the rental housing they will require will not exist in the future
What does the imposition of controlled prices generate?
It generates benefits for some individuals and costs for others
What does the market demand curve for any product show?
It shows how much of that product consumers want to purchase
If we turn it around by starting with any given quantity and ask about the price what does the demand curve show us?
It tells us the highest price that people are willing to pay for a given unit
What does the market demand curve show us for each unit of a product?
It shows us the value to consumers from consuming that unit
What does the market supply curve for any product show?
It shows how much producers want to sell at each possible price
If we turn the supply curve around and start with any given quantity and ask about the price, what does the supply curve show us?
It shows us the lowest price that producers are willing to accept for a given unit
What does the price on the market supply curve show for each unit of a product?
It shows the lowest acceptable price to firms for selling that unit. This is the lowest acceptable price reflects the additional cost to firms from producing that unit
Where is the total economic surplus shown on a graph with a demand curve and supply curve?
Below the demand curve and above the supply curve
Where is total economic surplus maximized?
At the free-market equilibrium quantity
What do binding price floors in competitive markets lead to?
It leads to a reduction in overall economic surplus and thus to market inefficiency
What is the deadweight loss? (slide 23)
It is the overall loss of economic surplus to society of the binding price floor
What do binding price ceilings in competitive markets lead to?
It leads to a reduction in overall economic surplus and thus to market inefficiency
Why does the government intervene in otherwise free
markets when the outcome is inefficient?
The answer in many situations is that the government
policy is motivated by the desire to help a specific
group of people.
The overall costs are deemed to be a worthwhile price
to pay to achieve the desired effect.
What kind of judgements are policy makers making?
They are making normative judgements
What is the job of the economist when informing the policy maker of what the right decision might be?
The job of the economist is to undertake positive analysis, emphasizing the actual effects of the policy rather than what might be desirable
What other factors must policy makers consider other than the concept of economic surplus?
Social responsibility, which is deemed to be more important to the conduct of society in markets prohibited by law
