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Markets in Action

Markets in Action. 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.

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Markets in Action

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  1. Markets in Action

  2. 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

  3. Learning Objectives (cont.) • Explain how markets for illegal goods work • Explain why farm prices and revenues fluctuate • Explain how speculation limits price fluctuations

  4. Learning Objectives • Explain how price ceilings create shortages and inefficiency • Explain how price floors create surpluses and inefficiency • Explain the effects of the sales tax • Explain how markets for illegal goods work

  5. 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.

  6. SSa LS The San Francisco Housing Market in 1906 24 SS Rent (dollars per unit per month) 20 After Earthquake Long run Adjustment 16 D 12 0 44 72 100 150 Quantity (thousands of units per month)

  7. 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?

  8. A Regulated Housing Market Rent ceilings set above equilibrium have no effect. Rent ceilings set below equilibrium prevents price from regulating the quantities supplied and demanded.

  9. Maximum black market rent Rent ceiling Housing shortage A Rent Ceiling SSa 24 Rent (dollars per unit per month) 20 16 D 12 0 44 72 100 150 Quantity (thousands of units per month)

  10. A Regulated Housing Market The ceiling results in two developments: Search activity Black markets

  11. A Regulated Housing Market Search activity is the time spent looking for someone to do business. It increases when there is a shortage.

  12. A Regulated Housing Market Black markets are illegal markets in which the price exceeds the legally imposed price ceiling.

  13. Consumer surplus Deadweight loss Producer surplus Inefficiency of Rent Ceilings 30 S 24 Rent (dollars per unit per month) 20 Rent ceiling 16 D 12 0 44 72 100 150 Quantity (thousands of units per month)

  14. Learning Objectives • Explain how price ceilings create shortages and inefficiency • Explain how price floors create surpluses and inefficiency • Explain the effects of the sales tax • Explain how markets for illegal goods work

  15. 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

  16. The Labor Market and the Minimum Wage 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.

  17. The Labor Market and the Minimum Wage 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.

  18. The Labor Market and the Minimum Wage 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.

  19. DA A Market for Low-Skilled Labor SS 6 Wage Rate (dollars per hour) LS 5 After invention Long-run adjustment 4 D 3 20 21 22 23 Quantity (millions of hours per year)

  20. 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.

  21. Unemployment a b Minimum wage Minimum Wage and Unemployment SS 6 Wage Rate (dollars per hour) 5 4 3 DA 20 21 22 23 Quantity (millions of hours per year)

  22. Minimum wage USA: 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.

  23. 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

  24. 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

  25. Learning Objectives • Explain how price ceilings create shortages and inefficiency • Explain how price floors create surpluses and inefficiency • Explain the effects of the sales tax (or VAT| • Explain how markets for illegal goods work

  26. 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.

  27. S + tax $10 tax Tax revenue The Sales Tax S 110 Price (dollars per player) 105 100 95 DA 3 4 5 6 Quantity (thousands of DVD players per week)

  28. Tax Division andElasticity of Demand Two Extremes Perfectly inelastic demand--buyer pays Example: Insulin Perfectly elastic demand--seller pays Example: Pink marker pens

  29. Buyer pays entire tax Sales Tax (VAT) and the Elasticity of Demand S + tax S Price (dollars per dose) 2.20 Perfectly inelastic demand 2.00 D 100 Quantity (thousands of doses per day)

  30. S + tax Seller pays entire tax Sales Tax (VAT) and the Elasticity of Demand S Price (cents per pen) 1.00 Perfectly elastic demand 0.90 1 4 Quantity (thousands of marker pens per week)

  31. 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.

  32. 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.

  33. Seller pays entire tax Sales Tax (VAT) and theElasticity of Supply S Perfectly inelastic supply Price (dollars per bottle) 50 45 D 100 Quantity (thousands of bottles per week)

  34. S + tax buyer pays entire tax Sales Tax (VAT) and theElasticity of Supply Perfectly Elastic Supply Price (cents per pound) 11 10 S D 3 5 Quantity (thousands of pounds per week)

  35. 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.

  36. 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

  37. 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.

  38. Consumer surplus Deadweight loss Tax Revenue Producer surplus Taxes and Efficiency 130 S + tax S Price (dollars per player) 105 100 95 75 D D 0 1 2 3 4 5 6 7 8 9 10 Quantity (thousands of DVD players per week)

  39. Learning Objectives • Explain how price ceilings create shortages and inefficiency • Explain how price floors create surpluses and inefficiency • Explain the effects of the sales tax • Explain how markets for illegal goods work

  40. 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

  41. S + CBL a d b D - CBL A Market for an Illegal Good Cost per unit of breaking the law... …to seller …to buyer Price S Pc c D Q p Qc Quantity

  42. 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.

  43. Learning Objectives (cont.) • Explain why farm prices and revenues fluctuate • Explain how speculation limits price fluctuations

  44. 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?

  45. $30 billion $20 billion $60 billion Harvest, Farm Prices,and Farm Revenues MS0 MS1 8 Poor harvest Price (dollar per bushel) 6 4 2 D 0 5 10 15 20 25 Quantity (billions of bushels (35.24L) per year)

  46. Stabilizing 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.

  47. $40 billion $10 billion $40 billion Harvest, Farm Prices,and Farm Revenues MS2 MS0 8 Price (dollar per bushel) 6 Bumper Harvest (record high) 4 2 D 0 5 10 15 20 25 Quantity (billions of bushels per year)

  48. Stabilizing Farm Revenues Farm Revenues during a bumper harvest Total farm revenue actually decreases due to inelastic demand.

  49. Learning Objectives (cont.) • Explain why farm prices and revenues fluctuate • Explain how speculation limits price fluctuations

  50. Stabilizing Farm Revenues Two institutions designed to stabilize farm revenue Speculative markets in inventories Farm price stabilization policy

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