Transcript Markets 101: The Case for Markets

Markets 101:
The Case for Markets
Sabina Shaikh
University of Chicago
CIS Summer Teacher Institute
Understanding the Global Economy:
Bringing the World Market into
your Classroom
June 22, 2009
Why Markets and Globalization?
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The Benefits of Competition and
Trade
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More Choices
Lower Prices and Rising Incomes
Productivity, Efficiency
Innovation
But, Competition Necessarily
Creates Winners and Losers
Does Economics Ignore the
Losers?
$20
$480
$100
$100
The Study of Economics
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Resources are Scarce
“There is no such thing as a free lunch”
Opportunity Cost: What did you give up to be here today?
Individuals see to Maximize Utility
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Preferences and Choice
Comparison of Benefits and Costs
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Abstract Measure of Satisfaction
Is it Happiness? Not exactly
Maximize Benefits
Minimize Costs
Incentives Affect Behavior
Economics tries to be positive not normative
Economics has no morals?
Specialization, Advantage and Trade
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Specialization
Parents send kids to school instead of home schooling
 You visit a doctor when you’re sick
 Pay a plumber to fix a leak
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Absolute Advantage and Comparative Advantage
in Production
Specialization by Comparative Advantage can lead
to mutually-beneficial trades
Gains from Trade Example
Competitive Markets
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Demand for Goods and Services
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Supply of Goods and Services
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Price and Value (Marginal Benefit)
Marginal Benefit is Diminishing
Price and Marginal Cost
Marginal Cost is Increasing
Invisible Hand and Market Equilibrium
Assumptions of a Competitive Market
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Price Takers
No Market Power
No Government Intervention
“Perfect” Information
No Externalities or Public Goods
Homogenous Goods
The Graphical Market
Supplynew
P
Supply = Marginal Cost
Pnew
P*
Demandnew
Demand = Marginal Benefit
Qnew
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Q* Qnew
Q
Equilibrium will change with shifts in Supply or Demand
Supply Shifts: Input prices, technology, weather
Demand Shifts: Income, tastes, prices of other goods
Market Impacts: Global Food Prices
CORN
SOY
P
P
S
MILK
Snew
P
S
Snew
S
Dnew
D
Qcorn
Subsidy to Ethanol
Blenders Increases the
Demand for Corn:
Price of Corn goes up
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D
Qsoy
Higher Price of Corn increases
the demand for land for corn.
Land diverted from other
crops. Supply of Soy decreases.
Price of Soy goes up.
(Same happened to CRP land)
D
Qmilk
Higher Price of Corn
increases the costs of feeding
dairy cows raising the price
of milk.
(Think about the substitution
effects here)
Could we have predicted these impacts?
Could we have predicted the magnitude of these impacts?
Measuring Market Impacts:
Elasticity and Welfare Measurement
P
Consumer Surplus measures the extra
value to the consumer: Value –
Expenditure
S
Producer Surplus measures the extra
value to the producer: Price – Cost
P*
Together the two comprise the total
market value or the net benefit.
D
Q*
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Q
Efficiency requires that this net
benefit be maximized.
The slope of the curves represent the elasticity of demand or supply to price.
Elasticity measures how much demand or supply change for a 1% change in price?
Elasticity can also be used for income or prices of substitutes or complements
Sources of Market Failure
In an otherwise efficient competitive market, the following
can induce market failure:
 Government Intervention
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Price or Quantity Controls
Price Ceilings, Price Floors, Quotas
 International Trade: Tariffs, Quotas, Protectionist Measures
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Subsidies and Taxes
Market Power: Loss of Competition
“Imperfect” Information
Externalities and Public Goods
Government Intervention as Market
Failure: Minimum Wage
Plabor=Wage
S
Pmin=6
P*=5
D
35
80 100 115
Qlabor
At the minimum wage, there is a surplus of labor: the Quantity of labor
supplied exceeds the Quantity demanded. This is an inefficient market
condition or market failure.
Government Intervention as Market
Failure: Minimum Wage
Snew
S
So, the theory says that
minimum wages can
lead to unemployment
and less affordable
consumer goods.
Pnew
P*
D
Qnew Q*
Qgoods
The increased cost of labor shifts the supply curve (which is also the
cost of production curve). Consumer prices go up. This is the market
impact.
Another Example: Rent Controls
Krugman and Wells, 2006
Externalities as Market Failure: Why
Regulate Greenhouse Gases?
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Consider the market for coal-based electric power
What are the costs and benefits of generating electricity
to the power company?
What are the costs and benefits of purchasing electricity
to the consumer?
Who bears the costs of pollution?
How to “internalize” this externality?
An important note: the externality arises from the market
for electric power. The power company would not be
able to sell electricity at current prices without the
consumers.
Market-Based Solutions to Market Failure
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The Role of Incentives
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Government Intervention
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People respond to changes in price
Can we appeal to conscience?
Wait! Wasn’t this a source of market failure?
Yes. Remember how we predicted the market impacts from
minimum wage, price supports, etc.
We can use this to restore market efficiency as well.
Incentives: Price and Quantity Instruments
Property Rights and the Coase Theorem
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Ronald Coase (1960): The Problem of Social Cost
As long as property rights are established, mutually-beneficial
transactions exist even in the presence of externalities.
Simple Coase Theorem Example
One bedrooms = $800/month, two bedrooms = $1400.
Sally smokes causing Jim costs of $150/month.
Can they still live together?
Options
Cost ($)
Net Gain ($)
Sally
Jim
Sally
Jim
Live Alone
800
800
0
0
Live Together
700
700+150
100
-50
Sally is willing to pay X<100 since she will still have a positive gain from sharing.
Jim is willing to accept X>50 since then he will have a positive gain from sharing.
Take $75 as an example.
Options
Cost ($)
Net Gain ($)
Sally
Jim
Sally
Jim
Live Alone
800
800
0
0
Live Together
700+75 700+75
25
25
Internalizing the Externality from
CO2: A Market for Carbon?
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Recall the coal-based electric power example.
Now, given the market failure from the externality, suppose that
we implement a market-based solution
Carbon Tax Vs Cap and Trade
Substitution Effects
 Supply Response: Wind, Solar, Carbon Capture
 Demand Response: Energy Efficiency
We should be able to predict these. A market could work but
there’s a good chance an inefficient market will be established.
Economics does not always make good politics.
Does the Coase Theorem work for pollution?
Examples from Global Markets
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U.S. Auto Companies (Naked Economics)
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Increased competition from Japanese automakers in 1980’s
US auto company response
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Ethanol
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Market Solution: Make more fuel-efficient cars to compete OR
Political Solution: Lobby the government for tariffs and quotas and
avoid fuel economy laws
This could have been a success story for globalization
The Impact of Corn for Fuel
Sugarcane and Tariffs: Positive? Negative?
The Kyoto Protocol
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China and India exempt from Emissions Reductions. Why?
Marginal Costs of Environmental Protection: Specialization and
Trade
Income Elasticity of Environmental Protection
Recommended References
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Naked Economics by Charlie Wheelan
The Economist
The New York Times: Freakonomics, Economix
Textbook: Krugman and Wells, Economics
www.theclimatecommunity.com