1. Unit 1: Basic Economic Concepts

2. Price Controls
Who likes the idea of having a price ceiling on gas so prices will never go over $2 per gallon?

3. Price Ceiling To be “binding”, a price ceiling must
Maximum legal price a seller can charge for a product.
Goal: Make affordable by keeping price from reaching Eq.
To be “binding”,
a price ceiling must
be below equilibrium $8 6 4 2 1
Price
Gasoline S
Does this policy help consumers?
Result: BLACK MARKETS
Rent control is a common type of price ceiling that large municipalities, such as New York City, often impose to make housing more affordable for low-income tenants. Over the short run, the supply for apartments is inelastic, since the quantity of buildings already supplied is constant, and those that are being constructed will continue to be constructed because of sunk costs.
Over the long-run however, rent control decreases the availability of apartments, since suppliers do not wish to spend money to build more apartments when they cannot charge a profitable rent. Landlords not only do not build any more apartments, but they also do not maintain the ones that they have, not only to save costs, but also because they do not have to worry about market demand, since there is excessive demand for rent-controlled apartments. Hence, excess demand and limited supply leads to a large shortage.
Price Ceiling
Shortage
(Qd>Qs) D Q 3
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4. To have an effect, a price floor must be above equilibrium
Minimum legal price a seller can sell a product.
Goal: Keep price high by keeping price from falling to Eq.
To have an effect,
a price floor must be
above equilibrium P
Corn S $ 4 3 2 1
Surplus
(Qd<Qs)
Price Floor
Does this policy help corn producers?
Minimum wage laws require employers to pay all employees at least the minimum wage. First enacted during the Great Depression in 1938, under the Fair Labor Standards Act, the purpose was to ensure workers a minimum standard of living. Currently, the minimum wage is $7.25 an hour in the United States. Other countries, such as France and Britain, have much higher minimum wages.
While the minimum wage increases the income of many workers who have jobs that are traditionally low-paying, it increases unemployment, since the demand for labor, as is the demand for other things, is inversely related to price. So while the employed are earning higher wages, the unemployed are earning nothing. Teenagers and minorities are particularly affected. People who have specialized skills with a large market demand are unaffected by the minimum wage laws because they are already earning higher pay. D Q 4
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5. 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 and quantity 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
Answers: D C
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6. Elasticity shows how sensitive quantity is to a change in price.
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7. Inelastic Demand
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8. Inelastic Demand
INelastic Demand= Quantity is INsensitive to a change in price.
If price increases, quantity demanded will fall a little
If price decreases, quantity demanded increases a little.
In other words, people will continue to buy it.
20% 5%
A INELASTIC demand curve is steep! (looks like an “I”)
Examples:
Gasoline
Milk
Diapers
Chewing Gum
Medical Care
Toilet paper
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9. General Characteristics of INelastic Goods:
Inelastic Demand
General Characteristics of INelastic Goods:
Few Substitutes
Necessities
Small portion of income
Required now, rather than later
Elasticity coefficient less than 1
20% 5%
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10. Elastic Demand
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11. Elastic Demand An ELASTIC demand curve is flat!
Elastic Demand = Quantity is sensitive to a change in price.
If price increases, quantity demanded will fall a lot
If price decreases, quantity demanded increases a lot.
In other words, the amount people buy is sensitive to price.
An ELASTIC demand curve is flat!
Examples:
Soda
Boats
Beef
Real Estate
Pizza
Gold
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12. General Characteristics of Elastic Goods:
Elastic Demand
General Characteristics of Elastic Goods:
Many Substitutes
Luxuries
Large portion of income
Plenty of time to decide
Elasticity coefficient greater than 1
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13. Elastic or Inelastic? What about the demand for insulin for diabetics?
Beef-
Gasoline-
Real Estate-
Medical Care-
Electricity-
Gold-
Elastic- 1.27
INelastic - .20
Elastic- 1.60
INelastic - .31
INelastic - .13
Elastic - 2.6
What if % change in quantity demanded equals % change in price?
Perfectly INELASTIC
(Coefficient = 0)
Unit Elastic (Coefficient =1)
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14. Price Elasticity of Supply
Elasticity of supply shows how sensitive producers are to a change in price.
Elasticity of supply is based on time limitations.
Producers need time to produce more.
INelastic = Insensitive to a change in price (Steep curve)
Most goods have INelastic supply in the short-run
Elastic = Sensitive to a change in price (Flat curve)
Most goods have elastic supply in the long-run
Perfectly Inelastic Supply= Q doesn’t change Set quantity supplied (Vertical line)
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