Government Policies & Efficiency Econ 1 Chapters 7,6

Periods of Analysis Long-Run: All inputs are variable (prospective) Short-Run: Some inputs fixed, some variable Market Period: All inputs Fixed  Output Fixed ( vertical supply)

Market Analysis The Market for Rental apartments Analyze an increase in demand Analyze price effects in the market period Analyze supply and price effects in the long-run

$ Rent Units/ Month Supply D0D0 $ 800 D1D1D1D $ 1000 LR new Supply $ 880 New LR Equilibrium

$ Rent Units/ Month Supply D0D0 $ 800 D1D1D1D Price Ceiling Short

Implications Price Ceiling below Equilibrium Increased Transaction Costs to Buyers & Sellers Increase in Non-Market rationing: Discrimination Decrease in Quality Decrease in Supply

Price Floor above Equilibrium How does the labor Market work? What happens when you place the Minimum Wage above Equilibrium wage ?

$ Wage Qty/T Demand Supply of Labor Wage E QEQE Min. Wage QdQd QsQs Surplus Surplus

The Minimum Wage: A Price Floor $Wage QTY / T D S PePe Qd Qs D Qe Minimum Wage

Implications of Price Floor above Equilibrium Increase in transaction costs Increase in non-market rationing (discrimination) Increase in quality (not demand driven) Increase in supply Wealth transfer: from unemployed to employed

ECON 1 Market Efficiency Chapter 7

$ P x $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ Qty x /T Supply Demand DxDx Market Interaction Pe Qe Exchange Value

Allocation Efficiency: Price allocates the goods to highest valued users ABC Market $ P Q/T D D D QaQb Qc Qe Pe Marginal Value A = Marginal Value B = Marginal Value C = Market Price Demand Supply Market Demand determines Price. Each buyer responds to price by buying till Marginal Value equals price. No reallocation can generate greater value.

Production Efficiency: Price coordinates the efficient use or resources Firm 2Firm 1Firm 3 Market $ P Q/T Demand S1S1 S2S2 Qe Q1Q2Q3 Pe Market Price = Marginal Cost Firm 1 = Marginal Cost Firm 2 = Marginal Cost Firm 3 Supply S3S3 Market Supply is the sum of the industry output at alternative prices. Each firm produces up to the quantity where Price = Marginal Cost. No reallocation of resources will produce at a lower opportunity cost.

$ P x $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ Qty x /T Supply Demand DxDx Market is Efficient since at Qe the Marginal Value = Marginal cost Pe Qe Marginal Value Marginal Cost

MVx Qty x / T $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ MV x = D x Demand = Marginal Value Exchange Value Pe Qe Consumer Surplus Value (MV – Price)

$ P x $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ Qty x /T The height reflects the marginal cost of producing an additional unit. Supply Reflects Marginal Cost Pe Qe Producer Surplus Value Price – Marginal Cost

$ P x $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ Qty x /T Supply Demand DxDx SxSx Market: Gains from Trade Pe Qe C.S V. P.S.V.

$ P x $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ Qty x /T Supply Demand DxDx SxSx Market Efficiency: Reduced Output Pe Qe Efficiency Loss

$ P x $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ Qty x /T Supply Demand DxDx SxSx Market Efficiency: Increased Output Pe Qe Efficiency Loss

Market Outcome is Efficient Marginal Value (MV) of last unit produced = Marginal Cost of production (MC) Producing less  Efficiency loss Producing more  Efficiency Loss