econ 1000 m2l3 c.l. mattoli 1 (c) red hill capital corp., delaware, usa 2008

Econ 1000 M2L3

C.L. Mattoli

1(C) Red Hill Capital Corp.,

Delaware, USA 2008

This week

Mod 2, part2: Markets in Action Chapter 4, Layton


Delaware, USA 2008

What you should already know You should understand how to think about

lost opportunity and opportunity cost. You should understand that, in a world of

limited time, people, natural resources, and productive capital equipment, that there is a limit on the amount of goods and services that can be produced at any one time.


Delaware, USA 2008

What you should already know You should be able to imagine that the

maximum capacity production of a mix of goods and services is described by the production possibilities frontier (PPF)

That any point to the left of the frontier is inefficient, and


Delaware, USA 2008

What you should already know Points to the right of the PPF are

unattainable by the economy, on its own, but a point to the right might be attained through trade with another economy.

You should understand how opportunity costs relate to moving from one point to another along the PPF.


Delaware, USA 2008

What you should already know You should understand the behavioral

underpinnings of the laws of supply and demand, which relate quantities supplied and demanded to price.

The laws state that the quantities supplied and demanded will vary with price.


Delaware, USA 2008

What you should already know The quantities supplied and demanded

are the dependant variables that depend on price.

Supply and demand curves, by themselves, don’t mean that much: they are only schedules of intentions for buying and selling quantities, if prices were at various levels.


Delaware, USA 2008

What you should already know It is only interesting when we put

supply and demand together and let them interact to result in an equilibrium price at which all quantities will be cleared in the market.

Graphically, in economics, the quantity is normally displayed on the horizontal axis and price is on the vertical axis.


Delaware, USA 2008

What you should already know That is contrary to the normal

convention in math. You may say “who cares?”, but there is a

reason that I bring this up: slope is always calculated as the change in the dependent variable per change in independent variable.


Delaware, USA 2008

What you should already know Also, laws are laws and cannot be broken or we

need a new laws. You should understand how non-price factors

can transform supply and demand curves into new curves.

You should be able to imagine how surplus and shortages will lead to behavior of the players in the market place that will eventually result in a unique ideal equilibrium market price and quantity that will exactly be cleared in the market.

Then, you will be ready to proceed through this next part of our analysis


Delaware, USA 2008

Learning objectivesModule 2 – Market analysis 2.2On successful completion of this part of the

module, you should be able to: Use the concepts of demand, supply, and

market equilibrium Use the market model to predict the

direction of change in prices and quantities caused by changes in the market-place, and by policy changes

Explain the concept of market failure and discuss causes of such failure


Delaware, USA 2008

What you should be able to do in the end Explain and illustrate the effects of a

change in demand on equilibrium price and quantity

Explain and illustrate the effects of a change in supply on equilibrium price and quantity

Explain and illustrate the effect of the policy of setting a price floor in a market

Explain and illustrate the effect of the policy of setting a price ceiling in a market.


Delaware, USA 2008

Overview

We studied concepts of opportunity cost and marginal analysis.

We looked at basic behaviorally based laws of supply, demand and market equilibrium.

In this part of the module, we apply these ways of thinking to the further studies of general markets.


Delaware, USA 2008

Overview

We examine how and why market equilibriums might change.

We also examine some failures of markets and look at various ways that governments intervene in markets and what happens when they do.


Delaware, USA 2008

Changes in Market Equilibrium


Delaware, USA 2008

Equilibrium changes Market Equilibriums can be constantly

changing. Equilibrium comes about because

behaviors cause an eventual exact balance of supply and demand at a certain price that will exactly clear a market.

Things in the market might change. If peoples’ perception changes or they get

more information, they can change their minds.


Delaware, USA 2008

Equilibrium changes Non-price factors can make changes of

whole supply and demand lines. Of course, if one of the lines changes,

supply or demand, there will be a new intersection point with the old other line, demand or supply.

If supply changes and demand remains the same, there will be a shift of equilibrium along the demand line.


Delaware, USA 2008

Equilibrium changes If demand changes and supply remains

the same, a new point will be reached on the supply line.

Changes in supply will cause a new equilibrium point on the old demand line.

Changes in demand will lead to a new intersection point on the old supply line. An example of a dynamic market in which prices change all day long are the stock markets and the commodities markets.


Delaware, USA 2008

Equilibrium changes There, as new buyers and sellers and new

information come into the markets throughout a day equilibrium prices constantly change.

We shall discuss reasons for such changes and can show the situations, graphically, for changes in one curve or the other, in order to further understand the processes at work.


Delaware, USA 2008

Changes in demand

Only non-price determinants will shift a demand curve.

Simple changes can come from more buyers entering a market.

Advertising, word-of-mouth, or information can change demand.


Delaware, USA 2008

Changes in demandExample: demand rises Consider demand at a hair cutting salon. If

everyone tells their friends that one of the boys there gives the most beautiful haircuts of anyone in town, the demand curve will shift to the right, and more haircuts will be demanded at each possible haircut price.

In the mean time, supply remains the same. The boy only works so many hours a day, and he can only cut so many heads of hair.


Delaware, USA 2008

Changes in demandExample: demand rises (contd.) This will mean that there is a shortage in the

market. As a result, the price of his haircuts will be

bid up and he will eventually work more hours because he is willing to work more and give more haircuts at a higher price on his new supply schedule.

We illustrate the situation in a slide, below.


Delaware, USA 2008

Changes in demandExample: demand falls Next, consider what might happen to

the demand for large SUV automobiles, if the price of gasoline triples and it is expected to remain there or higher.

Automobiles and gasoline are complementary goods, and the result of such a rise in petrol prices would likely be a decrease in the whole demand schedule for SUV’s.


Delaware, USA 2008

Changes in demand

That will leave a surplus in the market. As a result, the price and quantity

supplied will eventually be arrived at a lower price and quantity point along the automobile makers’ supply curve.

We show the 2 situations in the next slide.


Delaware, USA 2008

Effects of demand shifts on equilibrium Diagrams and causal chains

D1 D2 D2 D1P P

Q Q

S S

Increase indemand

Increase inEquilibrium price

Increase inQuantitysupplied

Decrease indemand

Decrease inQuantitysupplied

Decrease inEquilibrium price

When Haircut demand rises When SUV demand falls


Delaware, USA 2008

Extended causal chains We expand the cause and effect chains as

Increase indemand


Increase inQuantitysupplied

Decrease indemand

Decrease inQuantitysupplied

SuppliersWill begin toDiscount

Shortagewill obtain

Demanderswill begin to bribe suppliers

SurplusWill exist

Decrease inequilibriumPrice


Delaware, USA 2008

Changes in supply

Now, lets look at what happened, if we keep a constant demand curve and change supply.

The supply curve can be transformed into a new curve by various non-price factors of the supply equation.

The market will adjust, and a final new equilibrium will be reached at the new intersection point of the new supply and demand curves.


Delaware, USA 2008

Changes in supplyExample: technology expands supply Suppose that a new process was developed that

allows palm oil producers to squeeze 10% more oil of palm leaves.

Then, with only that technological change, the whole supply curve would shift to the right, and more palm oil will be offered at every price in a new supply curve.

In turn, since the industry is now able to supply larger quantities at every price there will be a temporary glut of palm oil on the market at the current equilibrium price.


Delaware, USA 2008

Changes in supply A surplus will exist because at the balancing

point of old demand with old supply, the market was just clearing the former amount of palm oil offered at an equilibrium price, and, now, suddenly there is more available than can be cleared at that price.

The signals to suppliers, seeing the glut, will lead them to begin to drop the price.

They will also be willing to offer less in the marketplace as they charge less: they will move down their new supply curve.


Delaware, USA 2008

Changes in supply

The stopping point on the way down will be the intersection point of the new supply and the old demand curves.

At that point, supply will be ahead of old supply but behind the glut supply level, and the price will be that which clears the market.

A new equilibrium will obtain.


Delaware, USA 2008

Changes in supply Supply can also decrease, as we have seen with

oil production over the last thirty years. Markets for food stocks can also display decreases in supply, as, for example, when there is a frost in early be spring, and the orange crop suffers.

Again, we can analyze the affect on market equilibrium, and examine the processes at work in the marketplace that will take us there.

Although we assume that the demand curve remains unchanged, there could be situations in which both supply and demand change.


Delaware, USA 2008

Changes in supply Example: supply recedes: Suppose that police crack down on street vendors

selling illegal copies of DVD’s on the streets of Guangzhou.

As a result, supply will decrease, and there will be a shortage of illegal copies of DVD’s on the streets of Guangzhou.

Some people will begin to bid up DVD prices to make sure that their neighborhood black market DVD dealers save DVD’s especially for them.


Delaware, USA 2008

Changes in supply

We will move up the old illegal DVD demand curve until we reach a price at which illegal DVD’s are exactly cleared in the marketplace.

A new equilibrium price and quantity will eventually obtain at the intersection of the old demand curve and the new supply curve.

The price will be above the old price and the quantity cleared will be down.


Delaware, USA 2008

Supply Changes Causal chain and graphs. Note there is a mistake in the arrow for price in the graph in the book on

page 92 for decrease in supply

S2S1 S1S2

P P

Q Q

D D

Increase insupply

Decrease inEquilibrium price

Increase inQuantity demanded

Decrease insupply


Decrease inquantitydemand


Delaware, USA 2008

Extended causal chains We expand the cause and effect chains as

Decrease insupply


Decrease inQuantitydemanded

Increase insupply

Increase inQuantitydemanded

SuppliersWill begin toDiscount

Shortagewill obtain

Demanderswill begin to bribe suppliers

SurplusWill exist

Decrease inequilibriumPrice


Delaware, USA 2008

Changes in both There’s no reason that supply and demand cannot

both change. To truly analyze an exact new equilibrium point

for that situation, we would need more precise supply and demand schedules than the general graphical representations that we have relied on when only one, supply or demand, was changed.

There are 4 possible scenarios with both changing. Both could increase, both could decrease, or one could go one way and the other, the other.


Delaware, USA 2008

Changes in both

If both curves change, the outcome for price and clearing quaintly after the changes may be more or less than before the changes, depending on the size and direction of each change.

Using the logic that we have developed for the cases of one changing, we could follow the forces that will come to bear on reaching a new equilibrium price and a new quantity that will clear in the market.

We show a few possibilities in the next slide.


Delaware, USA 2008

Changes in both We show some of the possible combinations of

dual changes in supply and demand, although there are additional possibilities.

Even the outcomes shown could be different for the types of changes displayed

S2S1 S1S2

P P

Q Q

D1 D2D2 D1


Delaware, USA 2008

Laws are laws: Trying to Violate the Laws


Delaware, USA 2008

Government Dickering in Markets Governments all around the world try to affect

some of the markets in their economies. Their objectives are either to set minimum or

maximum prices in certain markets. Thus, they seek to either prevent some prices from

rising to equilibrium or to keep others above equilibrium

For example, a favorite market in which governments like to set price floors (minimums) is wages.

A market in which they like to set price ceilings (maximums) is the market for rental housing.


Delaware, USA 2008

Ceilings A price ceiling is a legally established

maximum price that a seller can charge for a good or service

Rent controls are common in many U.S. cities. In other countries, government housing is subsidized to make rental prices lower.

The rationale for rent controls or subsidies is to provide a necessity to people that would be unaffordable many people at the true equilibrium price.


Delaware, USA 2008

Ceilings

So, will the market for rental units simply conform to the situation that the government dictated, or will market forces still be at work?

We shall see why many economists believe such controls are counter-productive and, in fact, lead to other more subtle costs.


Delaware, USA 2008

Ceilings Assume that market supply and demand curves

are as shown in the figure, below, and equilibrium would be at a point with rental price of $600 per month and a cleared quantity 6 million units per month.

Supply and demand theory will predict that, if a ceiling of $400 per month is artificially placed on market price, there will be 4 million units supplied, while demand is for 8 million units per month.

The result is that a shortage of 4 million units per month will persist in the market (see next slide)


Delaware, USA 2008

Ceilings Graphic effect of rental ceiling on market.

S

P

Q

D

$400

600

$600

400 800

$200

200

$800

1000

HousingShortage

Millions of units per month

$1000Ren

tal price p

er m

on

th

Price CeilingOn rents

Quantity demandedExceeds quantitySupplied at price

Shortage ofUnits obtains

Causal Chain

Ceiling


Delaware, USA 2008

Ceilings: costs and bad behaviors Of course, rigging a market and not allowing market

forces to prevail will result in some adverse affects.

Tenants:

1. Tenants will spend more time looking for housing or spend more time on waiting lists to get housing. This is opportunity cost to the tenant.

2. The artificially low rent might evolve a black market, an illegal hidden market, by tenants. They might sublet their units at a higher price to someone else and make an illegal profit for themselves.


Delaware, USA 2008

Ceilings: costs and bad behaviorsLandlords Because of substandard rents landlords might

skimp on maintenance and leave units in bad or even dangerous repair.

Landlords might also resort to discrimination and preferential treatment of renters in the market by giving preference to family and friends, even though they come onto lists behind others.

In the end, ceilings lead to inefficient and undesirable behavior


Delaware, USA 2008

47

Price Ceiling & Revenues

P

Q

S0

P0

Q0

D0

P1

Q1

Revenue (= PxQ) at Equilibrium

Revenue with ceiling

(C) Red Hill Capital Corp., Delaware, USA 2008

Ceiling: Economical alternatives Economists might suggest an alternative of subsidizing

rental payments, directly, for low income people. Then, low income people will be able to afford rentals at

the market price. More importantly, market forces will be allowed to

determine rental prices and availability, and the market will clear with no shortage, surplus, inefficiency, or misbehavior.

Although price ceilings were common throughout the world in the 20th century, they are steadily disappearing as governments allow markets to work on their own, while they seek better alternatives to increase their citizens’ general welfare


Delaware, USA 2008

Break time

Take 10 minute break Use time to come up and ask questions


Delaware, USA 2008

Floors A floor is a legally established minimum that a

seller may charge for a good or service. A common price that governments put floors on

is wages: minimum wages. Assume that we have the usual downward sloping

demand schedule for unskilled labor. At a higher wage, business will hire less unskilled workers; at a lower rate, they will hire more workers.

Concerning supply, workers will be willing to give up more free-time and work more hours in a year for higher wages and will want to work fewer hours for less wages.


Delaware, USA 2008

Floors: minimum wage If left to their own bargaining, the market would

establish an equilibrium price and a corresponding quantity of labor employed.

The intention is to help unskilled labor have a higher standard of living, but will a minimum wage really help?

First of all, the supply of willing workers will expand to the point on the supply curve corresponding to the minimum wage price.

On the other hand, demand will be up the demand curve to the point represented by the minimum wage.


Delaware, USA 2008

Floors: minimum wage Unfortunately, there will be less of a demand for

unskilled labor than there is supply, and unemployment will obtain.

Rather than pay such a high price for unskilled workers, companies will add skilled workers or replace labor with equipment.

Thus, as a result of enacting a minimum wage, the government unwittingly encourages business to use less unskilled labor, and there will be a higher rate of unemployment in the unskilled labor market.

Thus, the whole exercise is counterproductive.52


Minimum wage: economical alternative Many economists would suggest that rather than

fixing a minimum wage, the government, just as in the case with rent ceilings, would do better by subsidizing workers ’ wages by giving them welfare payments, directly.

Again, it appears that it is more efficient to allow the markets to work on their own and to find an alternative means of trying to help the less well-off members of the society.


Delaware, USA 2008

Minimum wage: counterarguments However, other economists argue that by

installing a minimum wage, employers will ultimately be forced to upgrade the skills and productivity of workers.

Still others argue that at least some of the less better off would be raised up in their standards of living and that the resulting unemployment of others is a fair price to pay for to pay for the majority.


Delaware, USA 2008

Graphical minimum wage Classical graphical minimum wage market.

S

P

Q

D

$4

400

$6

300 500

$2

200

$8

600

100,000’s annual unskilled labor hours

$10

Ho

urly w

ages u

nskilled

lab

or

Price FloorOn Wages

Quantity demandedFalls short of quantitySupplied at price

UnemploymentOf unskilled workers

Causal Chain

Floor

Unemployment


Delaware, USA 2008

Market Failures


Delaware, USA 2008

Why fail? We have learned how markets are supposed to

operate/ Normally, the price system is expected to

efficiently coordinate society's economic transactions, but there can be instances of failure of the market system.

Market failures mean that the price system fails to operate efficiently, and society loses benefits.

We shall look at 4 causes: lack of competition, externalities, public goods, and income inequality.


Delaware, USA 2008

Lack of competition The market theory assumes that there is intense

competition among both consumers and producers.

If producers collude to restrict output, artificially raising the price above its natural equilibrium, they will be able to reap extra profits.

Especially new markets or markets that are little understood may have a lack of competition.


Delaware, USA 2008

Lack of competition

That will mean that prices and quantities are not what they could be.

By subverting consumer sovereignty, business might reduce the well-being of society by wasting resources or by retarding technology and innovation.


Delaware, USA 2008

How can they do that? Anticompetitive behavior is illegal in many

countries, but it still exists in the world. Many countries even have government organizations to keep a watchful eye and protect society against such behavior.

There is the ACCC ( Australian Competition and Consumer Commission) in Australia, the Federal Trade Commission (FTC), in the U.S., and the European Union’s Competition Bureau, in Europe.


Delaware, USA 2008

How can they do that?

Cartels, groups of producers, band together to restrict output, and rig prices.

Two of the most common examples of cartels are the petroleum producer cartel, OPEC, and the diamond producers’ cartel. Both restrict output to keep prices at artificial levels.


Delaware, USA 2008

Rigging the market for supply We understand that the way markets

work is that supply curve intersects with the demand curve, and that intersection point will be the price at which the market will exactly clear the quantity offered for sale.

That process assumes consumer sovereignty.


Delaware, USA 2008

Rigging the market for supply Then, suppliers will offer what they are

comfortable with, considering their profits versus opportunities, and their offerings will be displayed in a supply schedule.

Consumers will compete for supplies by bidding up prices to the point at which their demand exactly clears the market of all supply.


Delaware, USA 2008

Rigging the market for supply However, if suppliers conspire to restrict their

output, they can offer supplies along a supply curve that does not represent their efficient decision-making or use of resources.

By moving their supply curve upward, they will be able to move the intersection point with the demand curve to a higher price per unit at less output than they could efficiently produce and they can make excess profits.

We show the potential situation in the next slide.


Delaware, USA 2008

Rigging supply: higher prices, less available In the figure we show the natural supply and demand

curves, along with a restricted collusive supply line. The result is a new intersection point on the demand line

with a higher price than the true free-market price and less available quantities

SfreeD SRestricted

Pfree

Qfree

P

QQresticted

Prestricted

Restricted supply market

65(C) Red Hill Capital Corp., Delaware, USA 2008

Case study: Commissions on stock trades in the U.S. Corporate Stocks are traded on stock exchanges and also

OTC. There are barriers to entry in both. For example, a

membership on the New York stock exchange (NYSE) will cost over $1 million, and to trade on the NASDAQ market means membership in the NASD. The cost to go through the process of filing and registering as a BD was around $50,000.

In the early 1980’s, commissions on buying stock were as much as $1 per share.


Delaware, USA 2008

Case study: Commissions on stock trades in the U.S. There was basically a lack of competition in

commission business because of the limited number of seats on the NYSE and the high cost of a seat. In the mid-1980’s, an apparent loop-hole in the rules of the SEC and the NYSE was exploited: If you were a registered broker-dealer (BD), you could gain access to the commissions charged for brokerage and clearing, about 1.5 cents.


Delaware, USA 2008

Case study: Commissions on stock trades in the U.S. In addition, you would also have advantageous

capital, margin, and short requirements, similar to NYSE members.

People began to take advantage of this template. With the growth of day trading salons and internet trading, some of those people built businesses around trading prices of 5 cents per share, and commissions have come down substantially over the past 20 years for all broker accounts.


Delaware, USA 2008

Externalities Markets can display failure because of side-

effects called externalities imposed on people other than the actual consumers and producers in a market.

Externalities, also called spillover effects or neighborhood effects, are costs or benefits to people, third parties, other than the actual market participants.

Thus, externalities can be either positive or negative.

Externalities can be consumption-derived or production-derived.


Delaware, USA 2008

Externalities: simple examples If the person next door to you in the dorm,

plays loud music late at night, it might interfere with either your sleep or your studying.

It is a negative consumption-based externality, based on your neighbor’s music consumption habits.

You drive through a community where all the houses are beautifully painted and have magnificent gardens.


Delaware, USA 2008

Externalities: simple examples You derive pleasure from the scenery, even

though you had to contribute nothings, and you enjoy the fruits of other people’s production efforts.

It is a positive production-based externality. Another example of a positive production

externality is spillover of technological developments from R&D of one firm to others. This is actually very important to growth of an economy.


Delaware, USA 2008

Externalities: some are of great concern Externalities are not a minor aspect of market

failure. They can have enormous impact on the quality of life.

Remember that people are self-interested. Sometimes self-interest can have a damaging affect on society, and sometimes it can have a positive affect.

We shall look at major examples of both: pollution as a negative and immunization against disease as a positive.


Delaware, USA 2008

Pollution: negative production externality Consider a steel industry that uses coal to

produce steel without pollution-control equipment to limit the amount of poisonous smoke and ash poured into the earth’s atmosphere.

The effect of the foul air is to reduce property values, increase the cost of health care, contribute to global warming, and generally erode the quality of life for third parties.


Delaware, USA 2008

Pollution: negative production externality Because of these detrimental external

affects, the equilibrium price in the market does not reflect the true cost of steel production to the society.

The equilibrium price of steel is too low because steel supply curves do not reflect those costs, and the output is too high. The output is above what should be socially desirable.


Delaware, USA 2008

Pollution: true costs If producers supply curves were, somehow, to include

all of the external costs, the supply curve would shift upward, and the equilibrium price would be higher than the existing market and suppliers would produce less output as shown, below.

SNPCD SPC

PNPC

QNPC

P

QQPC

PPC

Pollution costs and supply

75(C) Red Hill Capital Corp., Delaware, USA 2008

Pollution externalities: costs restrict supply You might notice that the result is the same result that

we found for an industry of collusive producers. In a collusive market, supply is restricted by

producers to increase price. In pollution, society forces costs onto the producer to

pay for the cost of the external losses to society that he causes.

By understanding the true costs of production that is produced by industries or companies that pollute the environment, society can begin to find remedies to assure that the final equilibrium prices and quantities reflect those costs.


Delaware, USA 2008

Pollution costs: remedies There are 2 basic approaches to adding the costs of

externalities to producers costs and changing the supply curve: taxes and regulation.

The government can charge a tax to producers. The tax is an added cost of production, which will be passed on to consumers of their product, and a new supply curve will intersect demand at a higher price and lower quantity. The taxes can be used to compensate the third parties affected by the damaging behavior of the company.

Pollution taxes might also encourage producers to install pollution control devices, on their own, in order to pay less tax.


Delaware, USA 2008

Pollution costs: remedies The other alternative is to make regulation

requiring companies to reduce pollution. In this remedy, producers are forced to purchase, install and maintain pollution control equipment. Then, pollution will be reduced, and the costs to society will be reduced or eliminated.

The extra cost of equipment will cause the cost of production to increase, and equilibrium will obtain at a higher price and lower output.


Delaware, USA 2008

Pollution costs: remedies However, the cost of complete elimination of

pollutants is prohibitive, so not all pollution will be eliminated through equipment. Moreover, producers can cheat on their polluting.

The tax method can eliminate all of the cost, but is still left with the uncertainty of the real long term costs of pollution.

Most countries prefer the tax approach because it can cover costs and it is easy to adjust.


Delaware, USA 2008

Immunization: case study In pollution, we found that the supply curve can

understate the costs to society of production. In immunization, the demand curve can understate benefits to society.

Modern medicine provides vaccines against many debilitating illnesses. People usually have their children immunized when they are very young.

People other than those paying for immunization, free-riders, because since many people pay for inoculation the disease becomes less common.


Delaware, USA 2008

Immunization: case study Thus, the demand curve does not truly reflect all

of the external benefits, and adjustment must be made to account for them.

Because demand does not reflect all benefits, producers will produce less at lower prices, and there is inefficient allocation of resources to the diseases immunization effort.

Now the government can use two methods to change the demand curve: subsidies or regulation.

We show the situation graphically, in the next slide.


Delaware, USA 2008

Immunization: unpaid benefits Demand does not reflect reality because free-riders do not

pay for but receive the benefits of immunization. Thus, equilibrium price and quantity are too low.

DIB SDNIB

PNIB

QNIB

P

QQIB

PIB

Immunization benefits and demand

82


Immunization: redistributing unpaid benefits Refunding subsidies are one means of

paying for benefits. This approach involves a payment by the

government to people who have their children immunized.

In this manner, dollar benefits are gained only by those who pay for immunization.


Delaware, USA 2008

Immunization: redistributing unpaid benefits Others still benefit but the cost of the

benefit is also shifted to those who do not pay for it directly.

The monetary payment might induce parents to have children immunized.

Only when they are immunized can a parent be truly confident of no disease and extra costs for medical care.

Demand may shift.


Delaware, USA 2008

Immunization: redistributing unpaid benefits What would happen, if immunization was

completely subsidized? Would everyone simply choose to inoculate their children, and the problem completely solved?

The answer to that has been seen in Australia’s decline in immunization even though it is completely subsidized by the government.

That leads us to consider an alternative for capturing, quantifying, and costing out the benefit of immunization: regulation.


Delaware, USA 2008

Immunization: redistributing unpaid benefits Another means of ensuring that all pay for the

benefit of immunization is to regulate and require that all children, by a certain age, must be immunized against certain major diseases.

In the U.S., for example, children are, on the one hand not allowed to enroll in school, if they have not been immunized against certain diseases, like polio or measles. On the other hand, children of school age are legally required to go to school.


Delaware, USA 2008

Immunization: redistributing unpaid benefits

In any event, although it may not be completely enforceable, laws requiring immunization will shift the demand curve right, and a proper efficient equilibrium will occur at a higher price and output, thus encouraging the health industry to continue to pursue immunization research and delivery


Delaware, USA 2008

Public Goods


Delaware, USA 2008

Public Goods There are certain goods and services that are

valuable to the welfare of the society but that would not be made available and purchased in sufficient quantities without government intervention.

Public goods are things like national defense, interstate roadways, and police protection,

Public goods are goods and services that, once produced, have 2 special characteristics:

1. The benefit is collectively consumed.2. There is no way to prevent free-riders from

taking advantage of the benefit,89


Immigration control: an example Suppose that, instead of the national coast guard

patrolling the coast of Australia, a private firm offered to guard against the entry of illegal aliens, and that the service was offered to individuals.

Then, all individuals, in the society, could decide whether or not they want to pay for the coast guarding service.

The result will be that some, if not all, members of the society will attempt to free-ride, while reaping the benefits that others pay for, and the market will either under-produce or not produce.


Delaware, USA 2008

Providing public goods Because these markets are likely to fail,

otherwise, governments tax their citizens and provide public goods and services for them.

The government does not have to undertake production, itself. It can contract out the production to the private sector.

It can force payment and eliminate the free-rider problem.


Delaware, USA 2008

Income inequality


Delaware, USA 2008

Inefficiency versus inequality In the previous market failure situations that we

described, the markets are inefficient because they allocate too many or too few productive resources to producing particular goods or services.

Even when markets are operating efficiently, they may result in a very uneven distribution of income among the members of a society.

Professional basketball players, CEO’s and doctors get huge incomes, while the unskilled and disabled get small or no wages.


Delaware, USA 2008

So what? Some politicians and economists argue

that something should be done about this inequality.

Others point out that income inequality provides incentive to gain skills and get a higher income.

Many governments, nonetheless, do feel a need to do something to cure some of the inequality.


Delaware, USA 2008

So what? They provide welfare payments to the

poor or disabled. They have progressive income tax systems in which higher amounts of income are taxed at higher percentage rates, like those in Australia.

Others argue that high earners should be taxed less to provide incentive for them to work hard and continue accumulate wealth


Delaware, USA 2008

Ask Yourself1. How can you find producer’s total revenue

from the supply-demand equilibrium graph?

2. Name several reasons/situations that the government might get involved in markets.

3. What do you expect will happen if a price ceiling is lifted in a market? A price floor?

(C) Red Hill Capital Corp., Delaware, USA 2008 96

Exam Prep ProblemsA shift in either the demand or supply curve for a

particular good will cause a change in the equilibrium price and quantity of that good. If the price of the good increased:

(a) describe the changes in those factors that would be likely to cause an increase in price;

(b) illustrate the effect of these changes on the price and quantity equilibrium; and

(c) explain and show how the price elasticity of demand will affect the sellers’ revenue should there be an increase in the price of this good.(Next week’s lecture)


Delaware, USA 2008

Problems due in tutorial

Chapter 4 Problems 1-10 Multiple choice 1-12


Delaware, USA 2008

Next week

Next week we discuss the concept of elasticity, which will require some mathematical understanding.

We shall cover chapter 5.


Delaware, USA 2008

END


Delaware, USA 2008

econ 1000 m2l3 c.l. mattoli 1 (c) red hill capital corp., delaware, usa 2008

Documents

c red hill capital

productive capital equipment

laws of supply

equilibrium price

demand curves

new laws

laws state

knowthe quantities