Have hw on your desk for me to check! Warm Up Should the government control the price of goods and services? (for example, should they place a $2 price limit on a cup of coffee?) Have hw on your desk for me to check!

Current Events http://www.nydailynews.com/life-style/real-estate/photos-life-hong- kong-tiniest-apartment-article-1.1273112

Government Involvement Module 8 & 9 3

If you could live in any city, where would you live and why? Warm Up If you could live in any city, where would you live and why?

So Far We Have Been Discussing Voluntary Exchanges But What if the Government Got Involved to Remove The Voluntary Component? 6

So Why are there Price Ceilings (aka Maximum Legal Prices) Political Pressure Persistent Shortage of a Good or Service Continuing Black Market (illegal) Activity ------------------------------------------------------------ Examples of Price Ceilings include 1. WWII Wage Controls 2. Oil Shortages in the 1970s 3. NYC Rent Controlled Apartments

Potential Problems with a Price Ceiling: Inefficient Allocation to Consumers (those willing to pay cannot have the good) Wasted Resources (opportunity cost) Inefficiently Low Quality Black Markets

So Why are there Price Controls (aka Minimum or Floor Prices) Political Pressure Lack of Economic Understanding Benefit Some ------------------------------------------------------------ Examples of Price Controls include 1. Agriculture (Farm Products) 2. Minimum Wage 3. Air Travel (until the 1980s)

Potential Problems of a Price Floor: Inefficiently Low Quantity=reduces Q of goods bought and sold; raises the price of a good to consumers, it reduces the quantity of that good demanded; because sellers can’t sell more units of a good than buyers are willing to buy Inefficient Allocation of Sales Among Sellers (blocking out sellers)

An episode from the Belgian movie Rosetta, a realistic fictional story, illustrates the problem of inefficient allocation of selling opportunities quite well. Like many European countries, Belgium has a high minimum wage, and jobs for young people are scarce. At one point Rosetta, a young woman who is very eager to work, loses her job at a fast-food stand because the owner of the stand replaces her with his son—a very reluctant worker. Rosetta would be willing to work for less money, and with the money he would save, the owner could give his son an allowance and let him do something else. But to hire Rosetta for less than the minimum wage would be illegal.

Wasted Resources Inefficiently High Quality (sellers offer high-quality goods at a high price, even though buyers would prefer a lower quality at a lower price.) Illegal Activity

KEY TO PRICE CONTROLS AND CEILINGS IF the assumption is that markets are operating efficiently before any government intervention then such interventions will cause problems IF markets were operating inefficiently then such interventions might not cause problems and could move the market closer to efficiency. = they can be inefficient or irrelevant depending on the market

Practice Questions 1. Which of the following will occur if a legal price floor is placed on a good below its free market equilibrium? Surpluses will develop Shortages will develop Underground markets will develop The equilibrium price will remain the same The quantity sold will increase 2. Which of the following statements about price control is true? A. A price ceiling causes a shortage if the ceiling price is above the equilibrium price B. A price floor causes a surplus if the price floor is below the equilibrium price C. Price ceilings and price floors result in a misallocation of resources D. Price floors above equilibrium cause a shortage 19 19

Surpluses will develop Shortages will develop 1. Which of the following will occur if a legal price floor is placed on a good below its free market equilibrium? Surpluses will develop Shortages will develop Underground markets will develop The equilibrium price will remain the same {Correct} The quantity sold will increase 2. Which of the following statements about price control is true? A. A price ceiling causes a shortage if the ceiling price is above the equilibrium price B. A price floor causes a surplus if the price floor is below the equilibrium price C. Price ceilings and price floors result in a misallocation of resources {Correct} D. Price floors above equilibrium cause a shortage 20 20

Read the article and describe the problems with rent control Read the article and describe the problems with rent control. Make an argument using graphs AND your notes to convince the Mayor of New York City to either keep or get rid of rent control. Bill de Blasio

Have your homework on your desk!!! Warm Up: What are the problems and benefits of floors and ceilings? Have your homework on your desk!!!

Review: Price control= one way in which the government intervenes Price ceiling= legal maximum price that lies below Pe. Price floor= legal minimum price that lies above Pe. Inefficient==missed opportunities http://www.youtube.com/watch?v=Ct1Moeaa-W8

Controlling Quantities A quantity control, or quota, is an upper limit on the quantity of some good that can be bought or sold. A license gives its owner the right to supply a good.

-upper limit of a quantity of a good that can be bought or sold The court has ordered the centre and the state governments to implement within three months an 18-year-old law that mandates 3% reservation in government jobs for disabled people. Quotas: -upper limit of a quantity of a good that can be bought or sold People with a license can buy/sell within the quota limits

Effect of a Quota on the Market for Taxi Rides 27

Import Quotas A quota is a limit on the number of imports. The government sets the maximum amount that can come in the country. Purpose: To protect domestic producers from a cheaper world price. To prevent domestic unemployment

The Costs of Quantity Controls Inefficiency: in the form of mutually beneficial transactions that don’t occur Anytime the demand price at a given quantity is not equal to the supply price at that quantity, there will be missed opportunities. Incentives for illegal activities: Suppliers know that additional units could be supplied and buyers could be found. This kind of overproduction would violate the quota.

Controlling Quantities The demand price of a given quantity is the price at which consumers will demand that quantity. The supply price of a given quantity is the price at which producers will supply that quantity.

The Market for Taxi Rides in the Absence of Government Controls Fare (per ride) Quantity of rides Fare (millions per year) (per ride) S Quantity demanded Quantity supplied $7.00 6.50 $7.00 6 14 6.00 $ 6.50 7 13 5.50 E $ 6.00 8 12 5.00 $ 5.50 9 11 4.50 $ 5.00 10 10 $ 4.50 11 9 Figure Caption: Figure 9.1: The Market for Taxi Rides in the Absence of Government Controls Without government intervention, the market reaches equilibrium with 10 million rides taken per year at a fare of $5 per ride. 4.00 $ 4.00 12 8 3.50 $ 3.50 13 7 3.00 D $ 3.00 14 6 6 7 8 9 10 11 12 13 14 Quantity of rides (millions per year)

Effect of a Quota on the Market for Taxi Rides Fare (per ride) Quantity of rides (millions per year) Fare S $7.00 Deadweight loss (per ride) Quantity demanded Quantity supplied 6.50 A 6.00 $7.00 6 14 The “wedge” 5.50 6.50 $ 7 13 E 5.00 6.00 $ 8 12 4.50 5.50 $ 9 11 4.00 5.00 $ 10 10 Figure Caption: Figure 9.2: Effect of a Quota on the Market for Taxi Rides The table shows the demand price and the supply price corresponding to each quantity: the price at which that quantity would be demanded and supplied, respectively. The city government imposes a quota of 8 million rides by selling licenses for only 8 million rides, represented by the black vertical line. The price paid by consumers rises to $6 per ride, the demand price of 8 million rides, shown by point A. The supply price of 8 million rides is only $4 per ride, shown by point B. The difference between these two prices is the quota rent per ride, the earnings that accrue to the owner of a license. The quota rent drives a wedge between the demand price and the supply price. And since the quota discourages mutually beneficial transactions, it creates a deadweight loss equal to the shaded triangle. B 3.50 4.50 $ 11 9 3.00 4.00 $ 12 8 D 3.50 $ 13 7 Quota 3.00 $ 14 6 6 7 8 9 10 11 12 13 14 Quantity of rides (millions per year)

The Anatomy of Quantity Controls A quantity control, or quota, drives a wedge between the demand price and the supply price of a good. The price paid by buyers ends up being higher than that received by sellers. The difference between the demand and supply price at the quota limit is the quota rent.

The Costs of Quantity Controls Deadweight loss because some mutually beneficial transactions don’t occur. A deadweight loss occurs when a market is not perfectly competitive—the price is greater and the quantity is lower than in a perfectly competitive market structure.

The Clams of New Jersey In the 1980s, excessive fishing threatened to wipe out New Jersey’s clam beds. To save the resource, the U.S. government introduced a clam quota. This set an overall limit on the number of bushels of clams to be caught and allocated licenses to owners of fishing boats based on their historical catches.

Quantity controls, or quotas, limit the quantity of a good that can be bought or sold. The quantity allowed for sale is the quota limit. Economists say that a quota drives a wedge between the demand price and the supply price. Quantity controls lead to deadweight loss.

There are many side effects to Quantity Controls or Quotas on Prices: 1. Missed Opportunities (inefficiencies) 2. Lost Gains from the Missed Opportunities (aka Dead Weight Loss) 3. Encourage Evasion (aka law breaking) As example: Lets consider NYC Taxicabs

http://www.youtube.com/watch?v=2zisxWMu34k What is the NBER?

What you will learn in this Module: The meaning of price controls, one way government intervenes in markets How price controls can create problems and make a market inefficient Why economists are often deeply skeptical of attempts to intervene in markets Who benefits and who loses from price controls, and why they are used despite their well-known problems

Why Governments Control Prices Unpopular market prices Political pressure Sometimes the efficient outcome in the market is judged as unfair to some groups, usually those that are disadvantaged (poor) and struggling to begin with.   How will we deal with this? A price control is a legal restriction on how high or low a market price may go. Price controls are enacted by governments in response to political pressures from buyers and sellers.

Price Ceilings Legal maximum price Examples Resource prices during WWII Oil Prices in1970s California electricity New York City apartments http://www.youtube.com/ watch?v=R0h8kfA4i_A A price ceiling is a maximum price sellers are allowed to charge for a good.   Who would want such a thing? Consumers. Note: Ask the students what goods/services they consider to be unfairly expensive. You will often get responses like “gasoline” or “college tuition”. You might use one of these examples to show students the impacts of a price ceiling on the market for this good. If Pe is considered “too high”, then a price ceiling must be set below the equilibrium price. A price ceiling set above the equilibrium price has no effect. Or you could go through an example of a common good that is very unlikely to be the target of a price control.

Modeling a Price Ceiling Shortage at Pc = Qd - Qs   If the Pc=$2, Qd =5.75 and Qs = 4 so there is a shortage of almost 2 tacos. Is this so bad? Aren’t consumers helped by this lower price? Yes, if you are among the lucky 4 who get tacos!

How a Price Ceiling Causes Inefficiency Inefficient Allocation to Consumers Wasted Resources Inefficiently Low Quality Black Markets http://www.youtube.com/wat ch?v=ZrNKHCCVfB8 People who want the good badly and are willing to pay a high price don’t get it, and those who care relatively little about the good and are only willing to pay a low price do get it.   Suppose Stan was our sixth potential consumer. He would not have paid $5 for a taco before the price control, but maybe now he is one of the lucky ones that gets a taco at $3. Julia was our second potential customer who would have paid $8 for a taco, but can’t find one now. One way to define inefficiency: A market or an economy is inefficient if there are missed opportunities: Some people could be made better off without making other people worse off. This is inefficient, because Stan can sell a taco to Julia for $7 and both win. This is exactly the reallocation that improves someone without harming another. People spend money and expend effort in order to deal with the shortages caused by the price ceiling. Time spent looking for scarce tacos has an opportunity cost. You could be working, having some leisure, etc. These missed opportunities create more inefficiency to the price control. Sellers offer low-quality goods at Pc, even though buyers would prefer a higher quality at a higher price. Taco suppliers may cut corners on food safety because that costs money. Maybe we get more tacos that make us sick A black market is a market in which goods or services are bought and sold illegally—either because it is illegal to sell them at all or because the prices charged are legally prohibited by a price ceiling.

So Why Are There Price Ceilings? Benefit some Uncertainty Lack of understanding Price ceilings are enacted because 1. They do benefit some consumers. Consumers may have the political clout to persuade government that the equilibrium price is taking advantage of them. This is a normative argument. 2. When they have been in effect for a long time, buyers may not have a realistic idea of what would happen without them. 3. Government officials often do not understand supply and demand analysis.

Price Floors Legal minimum price Examples Agricultural products Minimum wage Trucking Air travel A price floor is a legal minimum price buyers are required to pay for a good.   The minimum wage is a legal floor on the wage rate, which is the market price of labor. If Pe is considered “too low”, a price floor is set above the equilibrium price. A price floor set below the equilibrium price has no effect.

Modeling a Price Floor . Surplus at Pf   Price floors lead to excess supply; the quantity supplied is greater than quantity demanded.

How a Price Floor Causes Inefficiency Inefficiently Low Quantity Inefficient Allocation of Sales Among Sellers Wasted Resources Inefficiently High Quality Illegal Activity 1. Surplus at Pf   Price floors lead to excess supply; the quantity supplied is greater than quantity demanded. 2. Inefficiently low quantity: Since a price floor raises the price of a good to consumers, quantity demanded falls, so the quantity bought and sold falls, creating a loss to society. 3. Inefficient allocation of sales among sellers: Those who would be willing to sell the good at the lowest price are not always those who actually manage to sell it. Suppose Susan isn’t a very efficient taco vendor and couldn’t sell tacos at a price of $5, but can at $7. She is lucky enough to get one of the few buyers. Juan is very efficient and could sell at $4, but is unlucky and doesn’t get a buyer at $7. The price floor has just enabled a less efficient seller to make a sale, and might force an efficient seller out of the market. 4. Wasted resources. Government price floors set about the equilibrium price cause surpluses which the government may be required to buy and destroy. Minimum wages result in fewer jobs available and so would-be workers waste time searching for a job. What do we do with the surplus tacos? Maybe they go to waste, even if the government purchases them. 5. Goods of inefficiently high quality: Sellers offer high-quality goods at a high price, even though buyers would prefer a lower quality at a lower price. The high price may induce taco suppliers to provide extravagantly expensive ingredients that would be unprofitable at the lower market price. Taco consumers would probably just rather have a low-priced taco without the fancy bells and whistles. If they were really wanting expensive ingredients, their preferences would have been reflected in a stronger demand curve to begin with and the market price would have been $6 or higher. 6. Illegal activity. Bribery of sellers or government officials. Examples of working for less than minimum wage (off the books) because there is a surplus of labor willing to work. Minimum wage laws are an example of price floors. Relatively high minimum wages in Europe lead to higher levels of unemployment and black markets in labor. In contrast, the minimum wage in the United States is set closer to the equilibrium wage, and labor is relatively more productive in the United States.

So Why Are There Price Floors? Benefit some Disregard Lack of understanding Price floors are enacted because:   They do benefit some producers. Producers may have the political clout to persuade government that the equilibrium price is unfairly low. This is a normative argument. Price floors create a persistent surplus of the good. Inefficiencies arising from the persistent surplus come in the form of inefficiently low quantity, inefficient allocation of sales among sellers, wasted resources, and an inefficiently high level of quality offered by suppliers. There is also the temptation to engage in illegal activity, particularly bribery and corruption of government officials.

Try these questions from the AP board Try these questions from the AP board. Most are micro questions but good to do and try just the same. http://apcentral.collegeboard.com/apc/public/repository/MicroEcon- Deadweight-Loss-2011.pdf

Review: Go Mr. Clifford http://www.youtube.com/watch?v=ZfMUS-FnaHE http://www.youtube.com/watch?v=e0MbpaBkUPk

http://www.foxnews.com/opinion/2013/10/16/obamas-victory-on-debt-ceiling-comes-at-terrible-price/