Unit I: Basic Economic Concepts

What is Economics in General?

Economics is the science of scarcity. Scarcity is the condition in which our wants are greater than our limited resources. Since we are unable to have everything we desire, we must make choices on how we will use our resources. In economics we will study the choices of individuals, firms, and governments. Economics is the study of _________. choices

Examples:
You must choose between buying jeans or buying shoes. Businesses must choose how many people to hire Governments must choose how much to spend on welfare.

Economics Defined
Economics-Social science concerned with the efficient use of limited resources to achieve maximum satisfaction of economic wants. (Study of how individuals and societies deal with ________) scarcity

Micro vs. Macro

MICROeconomicsStudy of small economic units such as individuals, firms, and industries (competitive markets, labor markets, personal decision making, etc.)

MACROeconomicsStudy of the large economy as a whole or in its basic subdivisions (National Economic Growth, Government Spending, Inflation, Unemployment, etc.)

 Economists use the scientific method to make

generalizations and abstractions to develop theories. This is called theoretical economics. These theories are then applied to fix problems or meet economic goals. This is called policy economics.

How is Economics used?

Positive vs. Normative

Positive Statements- Based on facts. Avoids value judgements (what is). Normative Statements- Includes value judgements (what ought to be).

Thinking at the Margin

# Times Watching Movie

Benefit $30 $15 $5 $50

Cost $10 $10 $10 $30

1st 2nd 3rd Total

Would you see the movie three times? Notice that the total benefit is more than the total cost but you would NOT watch the movie the 3rd time.

Marginal Analysis
In economics the term marginal = additional Thinking on the margin, or MARGINAL ANALYSIS involves making decisions based on the additional benefit vs. the additional cost.
For Example:

You have been shopping at the mall for a half hour, the additional benefit of shopping for an additional half-hour might outweigh the additional cost (the opportunity cost). After three hours, the additional benefit from staying an additional half-hour would likely be less than the additional cost.

5 Key Economic Assumptions

1. Societys wants are unlimited, but ALL resources are limited (scarcity). 2. Due to scarcity, choices must be made. Every choice has a cost (a trade-off).

3. Everyones goal is to make choices that maximize their satisfaction. Everyone acts in their own selfinterest. 4. Everyone acts rationally by comparing the marginal costs and marginal benefits of every choice
5. Real-life situations can be explained and analyzed through simplified models and graphs.

Given the following assumptions, make a rational choice in your own self-interest (hold everything
else constant) 1. You want to visit your friend for the weekend 2. You work every weekday earning $100 per day 3. You have three flights to choose from: Thursday Night Flight = $300 Friday Early Morning Flight = $345 Friday Night Flight = $380

Which flight should you choose? Why?

9

Trade-offs
ALL decisions involve trade-offs.
Trade-offs are all the alternatives that we give up whenever we choose one course of action over others. (Examples: going to the movies)

The most desirable alternative given up as a result of a decision is known as opportunity cost.

What are trade-offs of deciding to go to college? What is the opportunity cost of going to college?
10

The Factors of Production

11

The Production Possibilities Curve (PPC)

Using Economic Models
Step 1: Explain concept in words Step 2: Use numbers as examples Step 3: Generate graphs from numbers Step 4: Make generalizations using graph
12

What is the Production Possibilities Curve?

A production possibilities graph (PPG) is a model that shows alternative ways that an economy can use its scarce resources This model graphically demonstrates scarcity, trade-offs, opportunity costs, and efficiency.

4 Key Assumptions Only two goods can be produced Full employment of resources Fixed Resources (Ceteris Paribus) Fixed Technology
13

Production Possibilities Table

Bikes Computers

a 14 0

b 12 2

c 9 4

d 5 6

e 0 8

f 0 10

Each point represents a specific combination of goods that can be produced given full employment of resources.
NOW GRAPH IT: Put bikes on y-axis and computers on x-axis
14

PRODUCTION POSSIBILITIES
How does the PPG graphically demonstrates scarcity, trade-offs, opportunity costs, and efficiency?
Impossible/Unattainable
14 12

(given current resources)

B
G

Bikes

10 8 6 4

C
Efficient

D
Inefficient/ Unemployment

E
0

10
15

Computers

Opportunity Cost
Example:
1. The opportunity cost of moving from a to b is 2 Bikes 2.The opportunity cost of moving from b to d is 7 Bikes 3.The opportunity cost of moving from d to b is 4 Computers 4.The opportunity cost of moving from f to c is 0 Computers

5.What can you say about point G? Unattainable

16

The Production Possibilities Curve (or Frontier)

17

PRODUCTION POSSIBILITIES
A B C D E

CALZONES PIZZA

4 0

3 1

2 2

1 3

0 4

List the Opportunity Cost of moving from a-b, b-c, c-d, and d-e. Constant Opportunity Cost- Resources are easily adaptable for producing either good. Result is a straight line PPC (not common)

18

PRODUCTION POSSIBILITIES
A B C D E

PIZZA ROBOTS

18 17 0 1

15 2

10 3

0 4

List the Opportunity Cost of moving from a-b, b-c, c-d, and d-e. Law of Increasing Opportunity Cost As you produce more of any good, the opportunity cost (forgone production of another good) will increase. Why? Resources are NOT easily adaptable to producing both goods. Result is a bowed out (Concave) PPC

PER UNIT Opportunity Cost

How much each marginal = Opportunity Cost unit costs Units Gained Example:
1. The PER UNIT opportunity cost of moving from a to b is 1 Bike 2.The PER UNIT opportunity cost of moving from b to c is 1.5 (3/2) Bikes 3.The PER UNIT opportunity cost of moving from c to d is 2 Bikes 4.The PER UNIT opportunity cost of moving from d to e is

2.5 (5/2) Bikes

NOTICE: Increasing Opportunity Costs

20

Shifting the Production Possibilities Curve

21

PRODUCTION POSSIBILITIES
4 Key Assumptions Revisited Only two goods can be produced Full employment of resources

Fixed Resources (4 Factors) Fixed Technology

What if there is a change?

3 Shifters of the PPC

1. Change in resource quantity or quality 2. Change in Technology 3. Change in Trade
22

PRODUCTION POSSIBILITIES
Q 14
13 12 11 10 9 8 7 6 5 4 3 2 1 1 2 3

What happens if there is an increase in population?

Robots

Q
23

Pizzas

PRODUCTION POSSIBILITIES
Q 14
A B 13 12 11 10 9 8 7 6 5 4 3 2 1 1 2

What happens if there is an increase in population? C

D

Robots

E 3 4 5 6 7 8

Q
24

Pizzas

PRODUCTION POSSIBILITIES
Q 14
13 12 11 10 9 8 7 6 5 4 3 2 1
1 2

Robots

Technology improvements in pizza ovens

Q
25

Pizzas

The Production Possibilities Curve and Efficiency

26

Two Types of Efficiency

Productive Efficiency Products are being produced in the least costly way. This is any point ON the Production Possibilities Curve Allocative Efficiency The products being produced are the ones most desired by society. This optimal point on the PPC depends on the desires of society.

27

Productive and Allocative Efficiency

Which points are productively efficient? Which are allocatively efficient?
14 12

Productively Efficient points are A through D

G

Bikes

10
8 6

E F

Allocative Efficient points depend on the wants of society

(What if this represents a country with no electricity?)
D

4
2 0

10
28

Computers

Capital Goods and Future Growth

Panama - FAVORS CONSUMER GOODS
Capital Goods CURRENT CURVE

Mexico - FAVORS CAPITAL GOODS

FUTURE CURVE Capital Goods

FUTURE CURVE

CURRENT CURVE Consumer goods

Consumer goods

Panama

Mexico
29

PPC Practice
Draw a PPC showing changes for each of the following:
Pizza and Robots (3) 1. New robot making technology 2. Decrease in the demand for pizza 3. Mad cow disease kills 85% of cows Consumer goods and Capital Goods (4) 4. BP Oil Spill in the Gulf 5. Faster computer hardware 6. Many workers unemployed 7. Significant increases in education
30

Question #1 New robot making technology

Q A shift only for Robots

Robots

Q Pizzas
31

Question #2
Decrease in the demand for pizza
Q

Robots

The curve doesnt shift! A change in demand doesnt shift the curve

Q Pizzas
32

Question #3 Mad cow disease kills 85% of cows

Q A shift inward only for Pizza

Robots

Q Pizzas
33

Question #4 BP Oil Spill in the Gulf

Capital Goods (Guns)
Q Decrease in resources decrease production possibilities for both

Q Consumer Goods (Butter)

34

Question #5 Faster computer hardware

Capital Goods (Guns)
Q

Quality of a resource improves shifting the curve outward

Q Consumer Goods (Butter)

35

Question #6 Many workers unemployed

Capital Goods (Guns)
Q

The curve doesnt shift! Unemployment is just a point inside the curve

Q Consumer Goods (Butter)

36

Question #7 Significant increases in education

Capital Goods (Guns)
Q The quality of labor is improved. Curve shifts outward.

Q Consumer Goods (Butter)

37

Scarcity Means There Is Not Enough For Everyone

Government must step in to help allocate (distribute) resources

38

Every society must answer three questions:

The Three Economic Questions

1. What goods and services should be produced? 2. How should these goods and services be produced? 3. Who consumes these goods and services?
The way these questions are answered determines the economic system

An economic system is the method used by a society to produce and distribute goods and services.

39

Economic Systems
1. Centrally-Planned (Command) Economy 2. Free Market Economy 3. Mixed Economy
40

Centrally-Planned Economies
(aka Communism)

41

Centrally Planned Economies

In a centrally planned economy (communism) the government 1. owns all the resources. 2. decides what to produce, how much to produce, and who will receive it. Examples:
Cuba, China, North Korea, former Soviet Union

Why do centrally planned economies face problems of poor-quality goods, shortages, and unhappy citizens?
NO PROFIT MEANS NO INCENTIVES!!
42

Advantages and Disadvantages

What is GOOD about Communism? 1. Low unemploymenteveryone has a job 2. Great Job Securitythe government doesnt go out of business 3. Equal incomes means no extremely poor people 4. Free Health Care What is BAD about Communism? 1. No incentive to work harder 2. No incentive to innovate or come up with good ideas 3. No Competition keeps quality of goods poor. 4. Corrupt leaders 5. Few individual freedoms
43

Free Market System

(aka Capitalism)

44

Characteristics of Free Market

1. Little government involvement in the economy. (Laissez Faire = Let it be) 2. Individuals OWN resources and answer the three economic questions.

3. The opportunity to make PROFIT gives people INCENTIVE to produce quality items efficiently.
4. Wide variety of goods available to consumers. 5. Competition and Self-Interest work together to regulate the economy (keep prices down and quality up).
Reword for Communism
45

Example of Free Market

Example of how the free market regulates itself: If consumers want computers and only one company is making them Other businesses have the INCENTIVE to start making computers to earn PROFIT. This leads to more COMPETITION. Which means lower prices, better quality, and more product variety. We produce the goods and services that society wants because resources follow profits. The End Result: Most efficient production of the goods that consumers want, produced at the lowest prices and the highest quality.

46

The Invisible Hand

The concept that societys goals will be met as individuals seek their own self-interest.
Example: Society wants fuel efficient cars Profit seeking producers will make more. Competition between firms results in low prices, high quality, and greater efficiency. The government doesnt need to get involved since the needs of society are automatically met. Competition and self-interest act as an invisible hand that regulates the free market.
47

The difference between North and South Korea at night.

North Korea's GDP is $40 Billion South Korea's GDP is $1.3 Trillion (32 times greater).

Connection to the PPC

Communism in the Long Run
Capital Goods

Free Markets in the Long Run

FUTURE CURVE Capital Goods

CURRENT CURVE
FUTURE CURVE

CURRENT CURVE Consumer goods

Consumer goods

Cuba

Puerto Rico
49

The Circular Flow Model

50

Supply and Demand

51

DEMAND

Resource Market

SUPPLY

Businesses

Individuals

SUPPLY

Product Market

52 DEMAND

DEMAND DEFINED
What is Demand?
Demand is the different quantities of goods that consumers are willing and able to buy at different prices.
(Ex: Bill Gates is able to purchase a Ferrari, but if he isnt willing he has NO demand for one)

What is the Law of Demand? The law of demand states There is an INVERSE relationship between price and quantity demanded
53

Why does the Law of Demand occur?

The law of demand is the result of three separate behavior patterns that overlap:
1.The Substitution effect 2.The Income effect 3.The Law of Diminishing Marginal Utility We will define and explain each
54

Why does the Law of Demand occur?

1. The Substitution Effect

If the price goes up for a product, consumer but less of that product and more of another substitute product (and vice versa)

2. The Income Effect

If the price goes down for a product, the purchasing power increases for consumers allowing them to purchase more. 55

Why does the Law of Demand occur?

3. Law of Diminishing Marginal Utility
Utility = Satisfaction We buy goods because we get utility from them The law of diminishing marginal utility states that as you consume more units of any good, the additional satisfaction from each additional unit will eventually start to decrease In other words, the more you buy of ANY GOOD the less satisfaction you get from each new unit. Discussion Questions: 1. What does this have to do with the Law of Demand? 56 2. How does this effect the pricing of businesses?

U-TIL- IT- Y

The Demand Curve

A demand curve is a graphical representation of a demand schedule. The demand curve is downward sloping showing the inverse relationship between price (on the y-axis) and quantity demanded (on the x-axis) When reading a demand curve, assume all outside factors, such as income, are held constant. (This is called ceteris paribus)

Lets draw a new demand curve for cereal

57

GRAPHING DEMAND
Demand Schedule
Price
Quantity Demanded

Price of Cereal
$5

$5 $4

10 20

$3
$2 $1

30
50 80
1

Demand o
10 20 30 40 50 60 70 80

Q
58

Quantity of Cereal

Where do you get the Market Demand?

Billy
Price Q Demd

Jean
Price Q Demd

Other Individuals
Price Q Demd

Market
Price Q Demd

$5 $4 $3 $2 $1
P

1 2 3 5 7

$5 $4 $3 $2 $1
P

0 1 2 3 5

$5 $4 $3 $2 $1
P

9 17 25 42 68
P

$5 $4 $3 $2 $1

10 20 30 50 80

$3

$3
D D

$3
D

$3
D

25

30

Shifts in Demand

CHANGES IN DEMAND Ceteris paribus-all other things held constant. When the ceteris paribus assumption is dropped, movement no longer occurs along the demand curve. Rather, the entire demand curve shifts. A shift means that at the same prices, more people are willing and able to purchase that good.

Changes in price DONT shift the curve!

This is a change in demand, not a change in quantity demanded

60

Change in Demand
Demand Schedule
Price
Quantity Demanded

Price of Cereal
$5
What if cereal makes you smarter?

$5 $4

10 20

$3
$2 $1

30
50 80
1

Demand o
10 20 30 40 50 60 70 80

Q
61

Quantity of Cereal

Change in Demand
Demand Schedule
Price
Quantity Demanded

Price of Cereal
$5

Increase in Demand Prices didnt change but people want MORE cereal

$5 $4 $3 $2

10 30 20 40

30 50 50 70
1

D2 Demand o
10 20 30 40 50 60 70 80

$1

80 100

Q
62

Quantity of Cereal

Change in Demand
Demand Schedule
Price
Quantity Demanded

Price of Cereal
$5
What if cereal causes baldness?

$5 $4

10 20

$3
$2 $1

30
50 80
1

Demand
10 20 30 40 50 60 70 80

Q
63

Quantity of Cereal

Change in Demand
Demand Schedule
Price
Quantity Demanded

Price of Cereal
$5

Decrease in Demand Prices didnt change but people want LESS cereal

$5 $4

10 0 20 5

$3
$2 $1

30 20
50 30 80 60
1

D2
10 20 30 40 50 60

Demand
70 80

Q
64

Quantity of Cereal

What Causes a Shift in Demand?

5 Determinates (SHIFTERS) of Demand:

1. Tastes and Preferences 2. Number of Consumers 3. Price of Related Goods 4. Income 5. Future Expectations
Changes in PRICE dont shift the curve. It only causes movement along the curve.
65

Prices of Related Goods

The demand curve for one good can be affected by a change in the price of ANOTHER related good.

1. Substitutes are goods used in place of one another.

If the price of one increases, the demand for the other will increase (or vice versa) Ex: If price of Pepsi falls, demand for coke will

2. Complements are two goods that are bought and used together.
If the price of one increase, the demand for the other will fall. (or vice versa) Ex: If price of skis falls, demand for ski boots will...
66

Income
The incomes of consumer change the demand, but how depends on the type of good. 1. Normal Goods As income increases, demand increases As income falls, demand falls Ex: Luxury cars, Sea Food, jewelry, homes 2. Inferior Goods As income increases, demand falls As income falls, demand increases Ex: Top Romen, used cars, used cloths,

67

Change in Qd vs. Change in Demand

Price of Cereal

There are two ways to increase quantity from 10 to 20

1. A to B is a change in quantity demand (due to a change in price) 2. A to C is a change in demand (shift in the curve) D2
D1

$3

$2

10

20

Q Cereal

Quantity of Cereal

Practice
First, identify the determinant (shifter) then decide if demand will increase or decrease
Shifter
1 2

Increase or Decrease

Left or Right

3 4 5 6 7 8
69

Practice
First identify the determinant (Shifter). Then decide if demand will increase or decrease Hamburgers (a normal good) 1. Population boom 2. Incomes fall due to recession 3. Price for Carne Asada burritos falls to $1 4. Price increases to $5 for hamburgers 5. New health craze- No ground beef 6. Hamburger restaurants announce that they will significantly increase prices NEXT month 7. Government heavily taxes shake and fries causes their prices to quadruple. 8. Restaurants lower price of burgers to $.50 70

Supply
71

Supply Defined
What is supply? Supply is the different quantities of a good that sellers are willing and able to sell (produce) at different prices.

What is the Law of Supply? There is a DIRECT (or positive) relationship between price and quantity supplied. As price increases, the quantity producers make increases As price falls, the quantity producers make falls.

Why? Because, at higher prices profit seeking firms have an incentive to produce more.

EXAMPLE: Mowing Lawns

72

GRAPHING SUPPLY
Supply Schedule
Price
Quantity Supplied

Price of Cereal
$5

Supply

$5 $4

50 40

$3
$2 $1

30
20 10
1

10

20

30

40

50

60

70

80

Q
73

Quantity of Cereal

GRAPHING SUPPLY
Supply Schedule
Price
Quantity Supplied

Price of Cereal
$5

Supply

4
What if new companies start making cereal?

$5 $4

50 40

$3
$2 $1

30
20 10
1

10

20

30

40

50

60

70

80

Q
74

Quantity of Cereal

Change in Supply
Supply Schedule
Price
Quantity Supplied

Price of Cereal
$5

Supply

S2

$5 $4

50 70 40 60

$3
$2 $1

30 50
20 40 10 30
1

Increase in Supply Prices didnt change but there is MORE cereal produced
10 20 30 40 50 60 70 80

Q
75

Quantity of Cereal

Change in Supply
Supply Schedule
Price
Quantity Supplied

Price of Cereal
$5

Supply
What if a drought destroys corn and wheat crops?

$5 $4

50 40

$3
$2 $1

30
20 10
1

10

20

30

40

50

60

70

80

Q
76

Quantity of Cereal

Change in Supply
Supply Schedule
Price
Quantity Supplied

Price of Cereal
$5

Supply

S2

$5 $4

50 30 40 20

$3
$2 $1

30 10
20 1 10 0
1

Decrease in Supply Prices didnt change but there is LESS cereal produced

10

20

30

40

50

60

70

80

Q
77

Quantity of Cereal

6 Determinants (SHIFTERS) of Supply

1. 2. 3. 4. Prices/Availability of inputs (resources) Number of Sellers Technology Government Action: Taxes & Subsidies
Subsidies
A subsidy is a government payment that supports a business or market. Subsidies cause the supply of a good to increase.

Taxes Regulation 5. The Opportunity Cost of Alternative government can reduce the Regulation occurs when the supply of some goods by placing an government steps into a market to Production excise tax on them. An excise tax affect the price, quantity, or quality of is a tax on the production or sale of a good. Regulation usually raises 6. Expectations of Future Profit

Changes in PRICE dont shift the curve. It only causes movement along the curve. 78

a good.

costs.

Supply Practice
First, identify the determinant (shifter) then decide if supply will increase or decrease
Shifter Increase or Decrease Left or Right

1 2 3 4 5 6
79

Supply Practice
1. Which determinant (SHIFTER)? 2. Increase or decrease? 3. Which direction will curve shift?

Hamburgers 1. Mad cow kills 20% of cows 2. Price of burgers increase 30% 3. Government taxes burger producers 4. Restaurants can produce burgers and/or tacos. A demand increase causes the price for tacos to increase 500% 5. New bun baking technology cuts production time in half 6. Minimum wage increases to $10
80

Supply and Demand are put together to determine equilibrium price and equilibrium quantity
Demand P Schedule $5

Supply Schedule

P Qd $5 10

P Qs $5 50 Equilibrium Price = $3 (Qd=Qs) $4 40 $3 30 D

10 20 30 40 50 60 70 80

$4 20 $3 30 $2 50
$1 80
2

$2 20
$1 10
81

Equilibrium Quantity is 30

Supply and Demand are put together to determine equilibrium price and equilibrium quantity
Demand P Schedule $5

S
What if the price increases to $4?

Supply Schedule

P Qd $5 10

P Qs $5 50 $4 40

$4 20 $3 30 $2 50
$1 80
2

$3 30 D
10 20 30 40 50 60 70 80

$2 20
$1 10
82

At $4, there is disequilibrium. The quantity demanded is less than quantity supplied.
Demand P Schedule $5

P Qd $5 10

Surplus (Qd<Qs)

Supply Schedule

P Qs How much is the surplus at $4? Answer: 20 $5 50 $4 40 $3 30 D $2 20

$1 10
83

$4 20 $3 30 $2 50
$1 80
2

10

20

30

40

50

60

70

80

How much is the surplus if the price is $5?

Demand P Schedule $5

What if the price decreases to $2?

Supply Schedule

P Qd $5 10

P Qs

Answer: 40

$5 50 $4 40

$4 20 $3 30 $2 50
$1 80
2

$3 30 D
10 20 30 40 50 60 70 80

$2 20
$1 10
84

At $2, there is disequilibrium. The quantity demanded is greater than quantity supplied.
Demand P Schedule $5

Supply Schedule

P Qd $5 10

P Qs How much is the shortage at $2? Answer: 30

Shortage (Qd>Qs)
10 20 30 40 50 60 70

$5 50 $4 40 $3 30

$4 20 $3 30 $2 50
$1 80
2

D
80

$2 20
$1 10
85

How much is the shortage if the price is $1?

Demand P Schedule $5

Supply Schedule

P Qd $5 10

P Qs

Answer: 70

$5 50 $4 40

$4 20 $3 30 $2 50
$1 80
2

$3 30 D
10 20 30 40 50 60 70 80

$2 20
$1 10
86

The FREE MARKET system automatically pushes the price toward equilibrium.
Demand P Schedule $5

P Qd $5 10

$4 20 $3 30 $2 50
$1 80
2

S When there is a surplus, producers P Qs lower prices $5 50 When there is a shortage, producers $4 40 raise prices $3 30 D
10 20 30 40 50 60 70 80

Supply Schedule

$2 20
$1 10
87

Shifting Supply and Demand

88

Supply and Demand Analysis

Easy as 1, 2, 3
1. Before the change:
Draw supply and demand Label original equilibrium price and quantity

2. The change:
Did it affect supply or demand first? Which determinant caused the shift? Draw increase or decrease

3. After change:
Label new equilibrium? What happens to Price? (increase or decrease) What happens to Quantity? (increase or decrease)

Lets Practice!

89

S&D Analysis Practice

1. Before Change (Draw equilibrium) 2. The Change (S or D, Identify Shifter) 3. After Change (Price and Quantity After)

Analyze Hamburgers
1. Price of sushi (a substitute) increases 2. New grilling technology cuts production time in half 3. Price of burgers falls from $3 to $1. 4. Price for ground beef triples 5. Human fingers found in multiple burger restaurants.
90

Double Shifts
Suppose the demand for sports cars fell at the same time as production technology improved. Use S&D Analysis to show what will happen to PRICE and QUANTITY.

If TWO curves shift at the same time, EITHER price or quantity will be indeterminate.
91

Voluntary Exchange Terms

Consumer Surplus is the difference between what you are willing to pay and what you actually pay. CS = Buyers Maximum Price Producers Surplus is the difference between the price the seller received and how much they were willing to sell it for.

PS = Price Sellers Minimum

92

Consumer and Producers Surplus

P $10 8 6 $5 4
2 1 2 4 6 8 10
CS

Calculate the area of: 1. Consumer Surplus 2. Producer Surplus 3. Total Surplus

PS

1. CS= $25 2. PS= $20 3. Total= $45

D Q
93

Government Involvement
#1-Price Controls: Floors and Ceilings #2-Import Quotas #3-Subsidies #4-Excise Taxes
94

#1-PRICE CONTROLS
Who likes the idea of having a price ceiling on gas so prices will never go over $1 per gallon?

95

Price Ceiling
Maximum legal price a seller can charge for a product. Goal: Make affordable by keeping price from reaching Eq. P Gasoline Does this S $5 policy help consumers? 4 Result: BLACK 3 MARKETS
2
To have an effect, a price ceiling must be below equilibrium

Price Ceiling

Shortage (Qd>Qs)
10 20 30 40 50 60 70

D
80

96

Price Floor
Minimum legal price a seller can sell a product. Goal: Keep price high by keeping price from falling to Eq. P Corn S $ Surplus To have an effect, a price floor must be (Qd<Qs) above equilibrium
4

Price Floor

Does this policy help corn producers?

D
10 20 30 40 50 60 70 80

97

Practice Questions
1. Which of the following will occur if a legal price floor is placed on a good below its free market equilibrium? A. Surpluses will develop B. Shortages will develop C. Underground markets will develop D. The equilibrium price will ration the good E. 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 98 D. Price floors above equilibrium cause a shortage

Are Price Controls Good or Bad?

To be efficient a market must maximize consumers and producers surplus
P S CS Pc
PS

D Qe
99

To be efficient a market must maximize consumers and producers surplus P S

Price FLOOR

Are Price Controls Good or Bad?

CS
DEADWEIGHT LOSS The Lost CS and PS.

Pc

PS

INEFFICIENT!
D Qfloor Qe
100

To be efficient a market must maximize consumers and producers surplus P S CS Pc

PS

Are Price Controls Good or Bad?

D Qe
101

To be efficient a market must maximize consumers and producers surplus P S

Are Price Controls Good or Bad?

Pc
Price CEILING

CS
PS

DEADWEIGHT LOSS The Lost CS and PS.

INEFFICIENT!
D Qceiling Qe
102

#2 Import Quotas
A quota is a limit on number of exports. The government sets the maximum amount that can come in the country.
Purpose: To protect domestic producers from a cheaper world price. To prevent domestic unemployment
103

International Trade and Quotas

Identify the following: 1. CS with no trade 2. PS with no trade 3. CS if we trade at world price (PW) 4. PS if we trade at world price (PW) 5. Amount we import at world price (PW) 6. If the government sets This graphs show the domestic a quota on imports of supply and demand for grain. Q4 - Q2, what happens The letters represent area. to CS and PS?

#3 Subsidies
The government just gives producers money. The goal is for them to make more of the goods that the government thinks are important.
Ex: Agriculture (to prevent famine) Pharmaceutical Companies Environmentally Safe Vehicles FAFSA
105

Result of Subsidies to Corn Producers

Price of Corn S

SSubsidy
Price Down Quantity Up Everyone Wins, Right?

Pe P1

D
o Qe Q1 Q
Quantity of Corn
106

Excise Tax = A per unit tax on producers For every unit made, the producer must pay $ NOT a Lump Sum (one time only)Tax The goal is for them to make less of the goods that the government deems dangerous or unwanted.
Ex: Cigarettes sin tax Alcohol sin tax Tariffs on imported goods Environmentally Unsafe Products Etc.
107

#4 Excise Taxes

Excise Taxes
Supply Schedule P $5
$4

Government sets a $2 per unit tax on Cigarettes P

$5

Qs 140
120

$3 $2
$1

100 80
60
2

D
40 60 80 100 120 140

108

Excise Taxes
Supply Schedule P $5 $7
$4 $6

Government sets a $2 per unit tax on Cigarettes P

$5

Qs 140
120

$3 $5 $2 $4
$1 $3

100 80
60
2

D
40 60 80 100 120 140

Q 109

Excise Taxes
Supply Schedule P $5 $7
$4 $6 P
$5

STax

Qs 140
120

$3 $5 $2 $4
$1 $3

100 80
60
2

Tax is the vertical distance between supply curves

D
40 60 80 100 120 140

Q 110