© 2010 Pearson Education CanadaChapter Chapter 5 What Gives When Prices Don’t? © 2010 Pearson Education Canada

Chapter What Gives When Prices Don’t? Government Choices, Markets, Efficiency & Equity

© 2010 Pearson Education CanadaChapter LEARNING OBJECTIVES 5.1Explain how government-fixed prices cause quantities to adjust and market coordination to fail 5.2Describe price ceilings and explain the unintended consequences of rent controls 5.3Describe price floors and explain the unintended consequences of minimum wage laws continued…

© 2010 Pearson Education CanadaChapter Explain the trade-offs in government policies between efficient and equitable outcomes 5.5Illustrate how positive economic thinking identifies the smartest choices for achieving a normative goal

© 2010 Pearson Education CanadaChapter MINDING YOUR P’S & Q’S DO PRICES OR QUANTITIES ADJUST? When government fixes prices, quantities adjust. Smart choices of consumers and businesses are not coordinated. Either consumers or businesses will be frustrated.

© 2010 Pearson Education CanadaChapter DO PRICES OR QUANTITIES ADJUST? When price is fixed below market-clearing – shortages develop (quantity demanded > quantity supplied) – consumers are frustrated – quantity sold = quantity supplied only When price is fixed above market-clearing – surpluses develop – (quantity supplied > quantity demanded) – businesses are frustrated – quantity sold = quantity demanded only continued…

© 2010 Pearson Education CanadaChapter Governments can fix prices, but can’t force businesses (or consumers) to produce (or buy) at the fixed price – businesses can reduce output or move resources elsewhere – consumers can reduce purchases or buy something else

© 2010 Pearson Education CanadaChapter Figure 5.1 Market Demand & Supply for Gasoline Price Quantity Demanded Quantity Supplied $ $ $ $

© 2010 Pearson Education CanadaChapter DO RENT CONTROLS HELP THE HOMELESS? PRICE CEILINGS Rent controls fix rents below market-clearing levels, quantity adjustment takes the form of apartment shortages. Unintended consequences are reduced quantity of housing supplied and subsidized, well-off tenants.

© 2010 Pearson Education CanadaChapter PRICE CEILINGS Rent controls are a price ceiling — maximum price set by government, making it illegal to charge higher price Rent controls sometimes justified by Robin Hood principle — take from the rich (landlords) and give to the poor (tenants) Rent controls have unintended consequences – create housing shortages, giving landlords power over tenants – subsidize well-off tenants continued…

© 2010 Pearson Education CanadaChapter Alternative policies to help the homeless that do not sacrifice market flexibility are – government income subsidies – government-supplied housing All policies have opportunity costs

© 2010 Pearson Education CanadaChapter DO MINIMUM WAGES HELP THE WORKING POOR? PRICE FLOORS Minimum wage laws fix wages above market-clearing levels, quantity adjustment takes the form of a surplus of workers. Benefit is higher wages to the employed, but unintended consequence is fewer are employed.

© 2010 Pearson Education CanadaChapter PRICE FLOORS Minimum wage laws are a price floor — minimum price set by government, making it illegal to pay a lower price – Living wage —$10 per hour, enough to allow urban individual to live above the poverty line For minimum wage above market-clearing wage, quantity of labour supplied greater than quantity of labour demanded by businesses, creating unemployment continued…

© 2010 Pearson Education CanadaChapter Unemployment from higher minimum wage depends on elasticity of business demand for unskilled labour – when demand inelastic and businesses have few substitutes, small response in decreased quantity demanded – when demand elastic and businesses can easily substitute machines for people, large response in decreased quantity demanded continued…

© 2010 Pearson Education CanadaChapter – minimum wages help the working poor if gains of workers who keep jobs with higher incomes are greater than losses of workers who lose their jobs and income Alternative policies to help the working poor – training programs for higher-paying jobs – wage supplements All policies have opportunity costs

© 2010 Pearson Education CanadaChapter WHEN MARKETS WORK WELL, ARE THEY FAIR? EFFICIENCY/EQUITY TRADE-OFFS Outcomes of well-functioning markets, while efficient, are not always equitable. Government may smartly choose policies that create more equitable outcomes, even though trade-off is less efficiency.

© 2010 Pearson Education CanadaChapter EFFICIENCY/EQUITY TRADE-OFFS To say that well-functioning markets produce products/ services we value most means outputs go to those most willing and able to pay – efficient market outcome may not be fair or equitable. – efficient market outcome coordinates smart choices of businesses and consumers so outputs produced at lowest cost (prices just cover all opportunity costs of production) and consumers buy products/services providing most bang per buck (marginal benefit greater than price) continued…

© 2010 Pearson Education CanadaChapter Consumers who do not buy at market-clearing prices are – unwilling — marginal benefit less than price (even though could afford to buy) – unable to afford to buy — even though willing (marginal benefit greater than price) continued…

© 2010 Pearson Education CanadaChapter Allowing markets to operate without government interaction is a choice that has an opportunity cost There is a tradeoff between efficiency and equity – Canadian-style government healthcare is more equitable, but less efficient – U.S.-style private market healthcare more efficient, but less fair or equitable

© 2010 Pearson Education CanadaChapter CAN OPINIONS BE RIGHT OR WRONG? POSITIVE VS. NORMATIVE CLAIMS Once you choose to support a political position or social goal based on your values, positive economic thinking helps identify the smartest choices to efficiently achieve that goal.

© 2010 Pearson Education CanadaChapter POSITIVE VERSUS NORMATIVE CLAIMS Positive (or empirical) statements — about what is: can be evaluated as true or false by checking facts Normative statements — about what you believe should be; involve value judgments – cannot be evaluated as true or false by checking the facts For any policy, always weigh benefits against opportunity costs

© 2010 Pearson Education CanadaChapter Chapter 5 Refresh Slides

© 2010 Pearson Education CanadaChapter DO PRICES OR QUANTITIES ADJUST? 1.If government makes it illegal for businesses to lower their prices, and there is a surplus of products/services in the market, explain how consumers and businesses will react. 2.Tim Hortons charges the same price for coffee no matter what time of day it is. At your local Tim’s, there are times of the day you walk right up to the counter and order, and other times when you have to wait in line for 15 minutes. Explain how quantities supplied and quantities demanded are being coordinated. continued…

© 2010 Pearson Education CanadaChapter You own a flower shop and usually sell roses for $25 a dozen. In the month before Valentine’s Day, your suppliers charge you a higher price for roses. A politician who has many romantics in his riding gets Parliament to pass a private member’s bill making it illegal to charge more than $25 for a dozen roses. Other flower prices are not fixed. What will be your smart business choice for Valentine’s Day?

© 2010 Pearson Education CanadaChapter PRICE CEILINGS 1.What are rent controls? 2.Explain the unintended consequences of rent controls for the choices of tenants and of landlords. 3.Activists argue that education, like housing, is an essential service that should be affordable for all citizens. A tuition freeze (to keep college affordable) is another form of a price ceiling. What are the unintended consequences for students? What other policies might better provide a supply of affordable education?

© 2010 Pearson Education CanadaChapter PRICE FLOORS 1.Explain what a “living wage” is and how it works as a price floor. 2.Explain how a rise in the minimum wage will affect job losses when the demand for labour is inelastic, and when the demand for labour is elastic? continued…

© 2010 Pearson Education CanadaChapter If you were a social activist arguing for a rise in the minimum wage to a “living wage,” what data would support your argument that this policy will help the working poor? If you ran a business (employing unskilled labour), what data would you need to counter the argument?

© 2010 Pearson Education CanadaChapter EFFICIENCY/EQUITY TRADE-OFFS 1.Describe what an “efficient market outcome” means for businesses and for consumers. 2.What are the trade-offs between efficiency and equity in comparing a private market for health care services with government provision of health care services? 3.If you had to choose between a health care system run by the market or run by government, which would you prefer? How might your choice be influenced by your income?

© 2010 Pearson Education CanadaChapter POSITIVE VERSUS NORMATIVE CLAIMS 1.Explain the difference between a positive statement and a normative statement. 2.Is the statement “Government taxes on tobacco will reduce smoking” positive or normative? If you answered “positive,” rewrite the statement so that it becomes normative. If you answered “normative,” rewrite the statement so that it becomes positive. continued…

© 2010 Pearson Education CanadaChapter Arguments often end with someone saying “Everyone is entitled to an opinion.” Does that mean that all opinions are equally valid? (The positive/normative distinction can help answer this question.)