Download presentation
Presentation is loading. Please wait.
1
Supply, Demand, and Government Policies
6 Supply, Demand, and Government Policies
2
Lines at the gas pump Price Ceiling – Not Binding then Binding
1973, OPEC raised the price of crude oil Reduced the supply of gasoline Long lines at gas stations What was responsible for the long gas lines? OPEC: created shortage of gasoline U.S. government regulations: price ceiling on gasoline Before OPEC raised the price of crude oil – pre-1973 Equilibrium price - below price ceiling: no effect When the price of crude oil rose Equilibrium price – above price ceiling: shortage
3
The market for gasoline with a price ceiling
2 The market for gasoline with a price ceiling The price ceiling on gasoline is not binding (b) The price ceiling on gasoline is binding Price of Gasoline Price of Gasoline 2…but when supply falls… S2 1. Initially, the price ceiling is not binding … Demand Demand Supply, S1 S1 P2 Price ceiling Price ceiling QS QD 3…the price ceiling becomes binding… 4. …resulting in a shortage P1 P1 Q1 Q1 Quantity of Gasoline Quantity of Gasoline Panel (a) shows the gasoline market when the price ceiling is not binding because the equilibrium price, P1, is below the ceiling. Panel (b) shows the gasoline market after an increase in the price of crude oil (an input into making gasoline) shifts the supply curve to the left from S1 to S2. In an unregulated market, the price would have risen from P1 to P2. The price ceiling, however, prevents this from happening. At the binding price ceiling, consumers are willing to buy QD, but producers of gasoline are willing to sell only QS. The difference between quantity demanded and quantity supplied, QD – QS, measures the gasoline shortage.
4
A market with a price floor
4 A market with a price floor (a) A price floor that is not binding (b) A price floor that is binding Price of Ice Cream Cone Price of Ice Cream Cone Surplus Supply Demand Supply Demand $4 Price floor 80 120 $3 3 Equilibrium price 100 Equilibrium price 2 Price floor Equilibrium quantity Quantity demanded Quantity supplied Quantity of Ice-Cream Cones Quantity of Ice-Cream Cones In panel (a), the government imposes a price floor of $2. Because this is below the equilibrium price of $3, the price floor has no effect. The market price adjusts to balance supply and demand. At the equilibrium, quantity supplied and quantity demanded both equal 100 cones. In panel (b), the government imposes a price floor of $4, which is above the equilibrium price of $3. Therefore, the market price equals $4. Because 120 cones are supplied at this price and only 80 are demanded, there is a surplus of 40 cones.
5
Examples of Price Floors
Minimum wage Can create a surplus of labor Agricultural price supports Every year, farmers produce and sell a certain product at a certain price that is determined by the market. If the market price is lower than that price at which the farmers want to sell, the farmers are in a deficit. Therefore, in order to assist American farmers, our government gives price supports for some crops and dairy products. So in a case where the market price is lower that the target price for farmers, farmers receive a "deficiency payment", or price support, from the government in order to make up for the difference. Has created a surplus of cheese and milk products Some released to low-income/poverty households Can exacerbate the effect by increasing supply
6
How the minimum wage affects the labor market
5 How the minimum wage affects the labor market (a) A free labor market (b) A Labor Market with a Binding Minimum Wage Wage Wage Labor supply Labor supply Labor surplus (unemployment) Labor demand Labor demand Minimum wage Quantity demanded Quantity supplied Equilibrium wage Equilibrium employment Quantity of Labor Quantity of Labor Panel (a) shows a labor market in which the wage adjusts to balance labor supply and labor demand. Panel (b) shows the impact of a binding minimum wage. Because the minimum wage is a price floor, it causes a surplus: The quantity of labor supplied exceeds the quantity demanded. The result is unemployment.
7
Impact of the minimum wage
Workers with high skills and much experience Not affected: Equilibrium wages - above the minimum Minimum wage - not binding Teenage labor – least skilled and least experienced Low equilibrium wages Willing to accept a lower wage in exchange for on-the-job training Minimum wage – binding
8
Controls on Prices Evaluating price controls
Markets are usually a good way to organize economic activity Economists usually oppose price ceilings and price floors Prices – coordinate economic activity
9
Agricultural Price Supports
Market price is set by Government at > equilibrium price (binding) Price is “supported” as Gov buys up the surplus Thus price will not drop due market forces (surplus)
10
Impacts of a Price Support
Inefficient Production MC(C) > MV(D) Transfer CS-PS Transfer Due to Increased Production Increased PS
11
Consequences of Binding Price Supports
Compared to a “free” market (unregulated) Consumers buy less milk at a higher price Lost Consumer Surplus – compared to lower price Producers Gain lost consumer surplus (transfer to Producers) Increased milk production (> old equilibirum) Get even more producer surplus Produced inefficiently Value (marginal benefits) of additional milk to consumers < increased (marginal) costs of resources used to produce it And then there are the taxes to pay for it
12
What Do We Do With the Surplus
Surplus milk bought by the Government Give it to Low Income Decreases Private Sector Demand (Nbuyers) Increases amount of surplus milk to be bought Make cheese from it No effect on Milk market price Strategic Cheese Reserve at Hanford Transfer to 3rd World countries Powdered Milk Disrupts their dairy industry
13
What Could Go Wrong? The Complete Stupidity Of The Looming Dairy Cliff: Milk To ... Forbes Dec 31, That will compel the Department of Agriculture to roughly double the price supports for dairy and other farm products thanks to a mystical Dairy Price Supports: Still Milking the Public Cato Institute Why $7-Per-Gallon Milk Looms Once Again : The Salt : NPR
14
An Economist’s Perspective
Cato Institute The federal government has subsidized and regulated the dairy industry since the 1930s. A system of “marketing order” regulations was enacted in A dairy price support program was added in An income support program for dairy farmers was added in 2002. As part of this year’s farm bill, Congress may reauthorize dairy programs, but they are among the most illogical of all farm programs.1 The government spends billions of dollars reducing food costs through programs such as food stamps, yet dairy programs increase milk prices.
Similar presentations
