Economics - Micro - Markets in Action

10:00 AM

Effects of price ceilings, minimum wages, taxes, subsidies, quotas, and trade in illegal goods.

Outside shocks can interrupt supply of goods or services in short run.

Short run = period in which suppliers cannot adjust capacity.

Price ceiling - upper limit on price

• If above eq, no effect; if below, there will be a shortage
• Leads to DWL
• Consumers may have to wait in line (a cost), suppliers may discriminate, take bribes, or reduce quality to a level commensurate with lower price
• Black Market - inefficient because:
• Contracts are not as enforceable
• Risk of prosecution increases prices demanded by supplier
• Quality control deteriorates

Minimum Wage - price floor - lower limit on wage

• If below eq, no effect; if above, there will be excess supply
• DWL on same side as before - Q transacted is lower than efficient quantity
• Consumers substitute away from the good
• Suppliers will devote resources but not be able to sell everything
• Wage floor (binding)
• Firms cannot employ all workers who want to work at that wage
• Firms substitute other productive resources for labor
• Leads to unemployment - even though workers are willing to work for less than minimum wage, they cannot
• Further, firms might decrease quality of nonmonetary compensation

Taxes and their effect on supply/demand/eq

• Tax increases eq price of an object and decreases its quantity demanded
• Tax on suppliers - suppliers reduce supply curve in and left
• Tax on buyers - demand goes in and left
• Vertical distance between old and new supply or demand is the tax
• Whether tax is on buyer or seller, actual incidence of the tax is same
• Tax revenue is rectangle - amount of tax times quantity
• Buyers and sellers share tax burden
• Incidence of tax is allocation of burden between buyers and sellers
• Statutory incedence - who is legally responsible for tax
• Actual incendence - who actually bears the cost of tax
• Statutory on buyer = downward shift in demand curve by the amount of the tax
• Buyer only sees price increase from Pe to Pt - rest of cost is borne by seller
• Seller is punished in form of reduced quantity
• In sum actual tax incidence is independent of whether tax is on consumers or suppliers

  Elasticity and taxes

• Demand
• Inelastic = consumers bear higher burden
• Elastic = consumers bear less burden
• Supply
• Inelastic = suppliers bear higher burden (consumers have the leverage)
• Elastic = suppliers bear less burden
• The party with the more elastic curve can respond better and avoid more of the burden
• More inelastic in either means less DWL
• Fewer trading opportunities are eliminated by the tax

Subsidies - payments by governments to producers

• Results in oversupply - DWL to the right of the efficient point
• MC now exceeds MB
• Supply shifts out (down) by amount of subsidy

Quotas - limits

• Supply and demand stay in place but production lowers - DWL to left
• Producers love quotas - price goes up and MC goes down

Illegal goods

• Supply and demand both decrease to reflect expected penalties
• Decrease in supply or demand increases as the value of the penalty increases
• Penalties higher for suppliers = prices go up
• Penalties higher for buyers = prices go down

End of reading

11:00 AM

1 hour