1 Markets in Action ©2006 South-Western College Publishing

2 What causes a change in market equilibrium? A change in demand A change in supply

3 What can cause a shift in a demand curve? A change in: Number of buyers in the market Tastes and preferences Income Expectations of consumers Prices of related goods

4 What can cause a shift in a supply curve? A change in: Technology Number of sellers in the market Resource prices Taxes and subsidies Expectations of producers

Supply, Demand, and Government Policies uIn a free, unregulated market system, market forces establish equilibrium prices and exchange quantities. uWhile equilibrium conditions may be efficient, it may be true that not everyone is satisfied. uOne of the roles of economists is to use their theories to assist in the development of policies.

Markets are usually a good way to organize economic activity. uIn a market economy, households decide what to buy and who to work for. uFirms decide who to hire and what to produce.

Markets are usually a good way to organize economic activity. Adam Smith made the observation that households and firms interacting in markets act as if guided by an “invisible hand.”

Markets are usually a good way to organize economic activity. uBecause households and firms look at prices when deciding what to buy and sell, they unknowingly take into account the social costs of their actions. uAs a result, prices guide decision makers to reach outcomes that tend to maximize the welfare of society as a whole.

Governments can sometimes improve market outcomes. When the market does not provide a fair distribution the government can sometimes improve equity. When the market fails (the price does not adjust to the proper level) government can intervene to promote efficiency.

Governments can sometimes improve market outcomes. Equity means the benefits of those resources are distributed fairly among the members of society.

Price Controls... u Are usually enacted when policymakers believe the market price is unfair to buyers or sellers. u Result in government-created price ceilings and floors.

12 What is a price ceiling? A legally established maximum price a seller can charge

Rent Control uRent controls are ceilings placed on the rents that landlords may charge their tenants. uThe goal of rent control policy is to help the poor by making housing more affordable. uOne economist called rent control “the best way to destroy a city, other than bombing.”

14 Why may rent controls be counterproductive? Shortages Illegal markets Less maintenance Discrimination

15 Lines at the Gas Pump In 1973 OPEC raised the price of crude oil in world markets. Because crude oil is the major input used to make gasoline, the higher oil prices reduced the supply of gasoline. What was responsible for the long gas lines? Economists blame government regulations that limited the price oil companies could charge for gasoline.

16 What is a price floor? A legally established minimum price a seller can be paid

17 What are examples of price floors? Minimum wage law Agricultural price supports

18 The Minimum Wage An important example of a price floor is the minimum wage. Minimum wage laws dictate the lowest price possible for labor that any employer may pay.

19 Why do we have price ceilings and floors? Because of failures in the free market or to improve equity

Governments can sometimes improve market outcomes. Market failure occurs when the market fails to allocate resources efficiently. Prices do not adjust properly.

Governments can sometimes improve market outcomes. Market failure may be caused by an externality, which is the impact of one person or firm’s actions on the well-being of a bystander.

Governments can sometimes improve market outcomes. Market failure may also be caused by market power, which is the ability of a single person or firm to unduly influence market prices.

uAutomobile exhaust uCigarette smoking uBarking dogs (loud pets) uLoud stereos in an apartment building Examples of Negative Externalities

uImmunizations uRestored historic buildings uResearch into new technologies Examples of Positive Externalities

25 External costs Inefficient equilibrium

26 External benefits Inefficient equilibrium

27 What is another example of a positive externality? Public goods

“The best things in life are free...” When goods are available free of charge, the market forces that normally allocate resources in our economy are absent.

29 What is a public good? A good that, once produced, has two properties: (1) users collectively consume benefits (2) no one can be excluded

30 What are examples of public goods? National defense Public education Roads

31 The Free-Rider Problem A free-rider is a person who receives the benefit of a good but avoids paying for it.

32 Are Lighthouses Public Goods?

33 Cost-Benefit Analysis uIn order to decide whether to provide a public good or not, the total benefits of all those who use the good must be compared to the costs of providing and maintaining the public good. uCost benefit analysis estimates the total costs and benefits of a good to society as a whole.

34 Common Resources Common resources, like public goods, are not excludable. They are available free of charge to anyone who wishes to use them.

35 Tragedy of the Commons The Tragedy of the Commons is a story with a general lesson: When one person uses a common resource, he or she diminishes another person’s enjoyment of it. u Common resources tend to be used excessively when individuals are not charged for their usage. u This creates a negative externality.

Examples of Common Resources uClean air and water uOil pools uCongested roads uFish, whales, and other wildlife

37 Why Isn’t the Cow Extinct? Private Ownership and the Profit Motive!