© 2010 pearson education canadachapter 5 - 1 chapter 5 what gives when prices don’t? © 2010...

© 2010 Pearson Education CanadaChapter 5 - 1

Chapter 5

What Gives When Prices Don’t?

© 2010 Pearson Education Canada


What Gives When Prices

Don’t?

Government Choices,

Markets, Efficiency &

Equity


LEARNING OBJECTIVES

5.1 Explain how government-fixed prices cause

quantities to adjust and market coordination

to fail

5.2 Describe price ceilings and explain the

unintended consequences of rent controls

5.3 Describe price floors and explain the

unintended consequences of minimum

wage laws

continued…


5.4 Explain the trade-offs in government

policies between efficient and equitable

outcomes

5.5 Illustrate how positive economic

thinking identifies the smartest choices for

achieving

a normative goal


MINDING YOUR P’S & Q’SDO PRICES OR QUANTITIES ADJUST?

When government fixes prices, quantities adjust.

Smart choices of consumers and businesses

are not coordinated. Either consumers or businesses will be frustrated.


DO PRICES OR QUANTITIES ADJUST?

• When price is fixed below market-clearing

– shortages develop (quantity demanded > quantity supplied)

– consumers are frustrated

– quantity sold = quantity supplied only

• When price is fixed above market-clearing

– surpluses develop

– (quantity supplied > quantity demanded)

– businesses are frustrated

– quantity sold = quantity demanded onlycontinued…


• Governments can fix prices,

but can’t force businesses (or consumers)

to produce (or buy) at the fixed price

– businesses can reduce output or move resources elsewhere

– consumers can reduce purchases or buy something else


Figure 5.1 Market Demand & Supply for Gasoline

Price Quantity

Demanded

Quantity

Supplied

$ 0.80 95 35

$ 1.00 85 55

$ 1.20 75 75

$ 1.40 65 95


DO RENT CONTROLS HELP THE HOMELESS? PRICE CEILINGS

Rent controls fix rents below market-clearing levels, quantity adjustment takes the form of

apartment shortages. Unintended consequences are reduced quantity of housing

supplied and subsidized, well-off tenants.


PRICE CEILINGS

• Rent controls are a price ceiling — maximum price set by government, making it illegal to charge higher price

• Rent controls sometimes justified by Robin Hood principle — take from the rich (landlords) and give to the poor (tenants)

• Rent controls have unintended consequences– create housing shortages,

giving landlords power over tenants– subsidize well-off tenants

continued…


• Alternative policies to help the homeless

that do not sacrifice market flexibility are

– government income subsidies

– government-supplied housing

• All policies have opportunity costs


DO MINIMUM WAGES HELP THE WORKING POOR? PRICE FLOORS

Minimum wage laws fix wages above market-clearing levels, quantity adjustment takes the form of a surplus of workers. Benefit is higher

wages to the employed, but unintended consequence is fewer are employed.


PRICE FLOORS

• Minimum wage laws are a price floor —

minimum price set by government,

making it illegal to pay a lower price

– Living wage —$10 per hour, enough to allow urban individual to live above the poverty line

• For minimum wage above market-clearing

wage, quantity of labour supplied greater

than quantity of labour demanded by

businesses, creating unemployment

continued…


• Unemployment from higher minimum wage

depends on elasticity of business demand for

unskilled labour

– when demand inelastic and businesses have few substitutes, small response in decreased quantity demanded

– when demand elastic and businesses can easily substitute machines for people, large response in decreased quantity demanded

continued…


– minimum wages help the working poor if gains of workers who keep jobs with higher incomes are greater than losses of workers who lose their jobs and income

• Alternative policies to help the working poor

– training programs for higher-paying jobs

– wage supplements

• All policies have opportunity costs


WHEN MARKETS WORK WELL, ARE THEY FAIR?

EFFICIENCY/EQUITY TRADE-OFFS

Outcomes of well-functioning markets, while efficient, are not always equitable. Government may smartly choose policies

that create more equitable outcomes, even though trade-off is less efficiency.



• To say that well-functioning markets produce products/ services we value most means outputs go to those most willing and able to pay– efficient market outcome may not be fair

or equitable.

– efficient market outcomecoordinates smart choices of businesses and consumers so outputs produced at lowest cost (prices just cover all opportunity costs of production) and consumers buy products/services providing most bang per buck (marginal benefit greater than price)

continued…


• Consumers who do not buy at market-

clearing prices are

– unwilling —marginal benefit less than price (even though could afford to buy)

– unable to afford to buy —even though willing (marginal benefit greater than price)

continued…


• Allowing markets to operate without

government interaction is a choice that has an

opportunity cost

• There is a tradeoff between efficiency and

equity

– Canadian-style government healthcare is more equitable, but less efficient

– U.S.-style private market healthcare more efficient, but less fair or equitable


CAN OPINIONS BE RIGHT OR WRONG?POSITIVE VS. NORMATIVE CLAIMS

Once you choose to support a political position

or social goal based on your values, positive economic thinking helps identify the smartest choices to efficiently achieve

that goal.


POSITIVE VERSUS NORMATIVE CLAIMS

• Positive (or empirical) statements —

about what is:

can be evaluated as true or false by checking

facts

• Normative statements —

about what you believe should be;

involve value judgments

– cannot be evaluated as true or false by checking the facts

• For any policy,

always weigh benefits against opportunity costs


Chapter 5Refresh Slides


DO PRICES OR QUANTITIES ADJUST?

1. If government makes it illegal for businesses to lower their prices, and there is a surplus of products/services in the market, explain how consumers and businesses will react.

2. Tim Hortons charges the same price for coffee no matter what time of day it is. At your local Tim’s, there are times of the day you walk right up to the counter and order, and other times when you have to wait in line for 15 minutes. Explain how quantities supplied and quantities demanded are being coordinated.

continued…


3. You own a flower shop and usually sell roses

for $25 a dozen. In the month before

Valentine’s Day, your suppliers charge you a

higher price

for roses. A politician who has many romantics

in his riding gets Parliament to pass a private

member’s bill making it illegal to charge more

than $25 for a dozen roses. Other flower prices

are not fixed. What will be your smart business

choice for Valentine’s Day?


PRICE CEILINGS

1. What are rent controls?

2. Explain the unintended consequences of rent controls for the choices of tenants and of landlords.

3. Activists argue that education, like housing, is an essential service that should be affordable for all citizens. A tuition freeze (to keep college affordable) is another form of a price ceiling. What are the unintended consequences for students? What other policies might better provide a supply of affordable education?


PRICE FLOORS

1. Explain what a “living wage” is and how it

works as a price floor.

2. Explain how a rise in the minimum wage

will affect job losses when the demand for

labour

is inelastic, and when the demand for

labour

is elastic?

continued…


3. If you were a social activist arguing for a

rise in the minimum wage to a “living

wage,” what data would support your

argument that this policy will help the

working poor? If you ran a business

(employing unskilled labour), what data

would you need to counter the argument?



1. Describe what an “efficient market outcome” means for businesses and for consumers.

2. What are the trade-offs between efficiency and equity in comparing a private market for health care services with government provision of health care services?

3. If you had to choose between a health care system run by the market or run by government, which would you prefer? How might your choice be influenced by your income?


POSITIVE VERSUS NORMATIVE CLAIMS

1. Explain the difference between a positive

statement and a normative statement.

2. Is the statement “Government taxes on

tobacco will reduce smoking” positive or

normative?

If you answered “positive,” rewrite the

statement so that it becomes normative.

If you answered “normative,” rewrite the

statement so that it becomes positive.

continued…


3. Arguments often end with someone saying

“Everyone is entitled to an opinion.”

Does that mean that all opinions are

equally valid? (The positive/normative

distinction

can help answer this question.)

© 2010 pearson education canadachapter 5 - 1 chapter 5 what gives when prices don’t? © 2010...

Documents

pearson education canada

gasoline price quantity

frustrated quantity

quantity adjustment

continued slide

fixed price businesses

price ceilings rent

higher price rent controls