Transcript document

ECONOMICS:
EXPLORE & APPLY
by Ayers and Collinge
CHAPTER 4
“The Power of Prices”
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©2004 Prentice Hall Publishing
Ayers/Collinge, 1/e
Learning Objectives
1. Interpret how demand represents marginal
benefit and supply marginal cost.
2. Explain the concept of social surplus and how
it is divided between consumers and
producers.
3. Demonstrate how both exports and imports
increase efficiency while simultaneously
harming either consumers or producers.
4. Identify inefficiencies associated with price
ceilings.
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©2004 Prentice Hall Publishing
Ayers/Collinge, 1/e
Learning Objectives
4. Show why price supports are unnecessary
and politically counterproductive.
5. (E&A) Pinpoint the economic flaw in
California's deregulation of electricity.
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©2004 Prentice Hall Publishing
Ayers/Collinge, 1/e
4.1
PRICE SIGNALS FOR EFFICIENT
CHOICE
The marketplace depends upon price signals.
The market price sends a message to consumers
and producers.
For consumers market price signals how much of a
good they wish to buy.
For producers it signals how much of a good they
wish to sell.
When market price falls consumers respond by
buying more, and producers respond by selling
less.
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Ayers/Collinge, 1/e
Consumer Surplus
 Consumer surplus is how much the good is
worth to the consumer, in the abstract, minus
what the consumer actually paid for it.
Consumer Surplus = Demand - Market Price
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Marginal Benefit and
Consumer Surplus
$
Demand
The
Thedemand
maximum
curve
price
shows
is
the
theconsumer’s
maximum price
marginal
the
benefit
consumer
– the would
incremental
pay
value
for each
of each
quantity
additional
that
might
itembe
consumed.
purchased.
1
2
3
Quantity
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Ayers/Collinge, 1/e
Consumer Surplus
Dwight’s demand
for blue jeans.
Dwight’s benefits from buying
blue jeans.
Price
Quantity
Quantity
Marginal
Benefit
Total
Benefit
$20
1
1
$20
$20
$15
2
2
$15
$35
$10
3
3
$10
$45
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Ayers/Collinge, 1/e
Consumer Surplus
Dwight’s demand
for blue jeans.
Dwight’s benefits from buying
blue jeans.
Price
Quantity
Total
Benefit
Total Paid
Consumer
Surplus
$20
1
$20
$20
$0
$15
2
$35
$30
$5
$10
3
$45
$30
$15
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Ayers/Collinge, 1/e
Consumer Surplus
$
Consumer surplus
in general.
Price
=$10
Demand
1
2
3
Quantity
The consumer
surplus is the
area under the
demand curve and
above the market
price. It is what
consumers gain
from their purchases
after deducting the
cost.
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Consumer Surplus
$10
$
$5
$0
Price
=$10
Demand
1
2
3
Quantity
At a price of $10 per
pair of jeans, Dwight
buys three pair, and
receives $15 worth of
consumer surplus.
His consumer
surplus equals the
sum of the consumer
surplus from the 1st,
2nd, and 3rd pair of
jeans.
$10 +$5 + $0 =$15.
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Marginal Cost and
Producer Surplus
The supply curve depicts the minimum price
that the producers of a good would be willing to
accept for each quantity offered.
That minimum price is the producer’s marginal
cost, which is the incremental cost of producing
each additional item offered for sale.
The producer surplus is equal to the amount by
which total revenue exceeds the total cost.
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Marginal Cost
$
Supply
Marginal cost increases
as quantity produced
rises.
1
2
3
Quantity
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Producer Surplus
Buddy’s supply
of blue jeans.
Buddy’s cost of producing
blue jeans.
Price
Quantity
Quantity
Marginal
Cost
Total Cost
$5
1
1
$5
$5
$7.50
2
2
$7.50
$12.50
$10
3
3
$10
$22.50
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Producer Surplus
Buddy’s supply
of blue jeans.
Buddy’s cost of producing
blue jeans.
Price
Quantity
Sold
Total Cost
Total
Revenue
Producer
Surplus
$5
1
$5
$5
$0
$7.50
2
$12.50
$15
$2.50
$10
3
$22.50
$30
$7.50
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Producer Surplus
Producer Surplus
$
Supply
Price
$10
1
2
3
Quantity
The producer surplus
is the area above the
supply curve and
under the market
price. It is what
the producers gain
from their sale
after deducting
their cost.
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Producer Surplus
$
$5
Price
$10
$2.50
Supply
$0
1
2
3
Quantity
At a price of $10 per
pair of jeans, Buddy sells 3
pair and receives
$7.50 worth of producer surplus.
His producer surplus equals the
sum of his producer surplus
from the 1st, 2nd and 3rd pairs,
which is $5 + $2.50 +$0
equals $7.50
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Marginal Benefit and Marginal Cost
 Marginal Benefit (to consumers): The
value of each additional unit of the good.
 Marginal Cost (to producers): The cost of
resources used to produce each additional
unit.
The efficient output occurs when society’s
marginal benefit equals marginal cost.
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Market Efficiency
$
Social Surplus =
consumer surplus
+ producer surplus
Supply = Marginal Cost
Consumer
Equilibrium Surplus
Price
Producer
Surplus
Demand = Marginal Benefit
Efficient
Quantity
Quantity
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The Market Equilibrium Price
The market equilibrium price leads to the
efficient quantity.
No other quantity would generate a larger total
of consumer and producer surplus.
If the price is less than the equilibrium price,
quantity falls because producers aren’t willing
to sell as much.
If the price is greater than the equilibrium price
quantity falls because consumers aren’t willing
to buy as much.
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The Market Equilibrium Price
The triangular
area of
forgone social
surplus caused by
inefficient pricing
is called the
deadweight loss.
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Dollars
Dollars
The Paradox of Diamonds and Water
S
Consumer
Surplus
Much
smaller
Consumer
Surplus
High
price
Low
Price
S
D
Quantity of Water
Water Market
D
Quantity of Diamonds
Diamond Market
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The Efficiency of
Imports and Exports
Market prices of goods and services only reflect the
domestic prices of supply and demand within the
country, when a country does not engage in
international trade.
When a country opens its markets to international
trade, market prices change as a world of new
consumers and producers are involved.
Imports are goods and services bought from other
countries.
Exports are goods and services sold to other
countries.
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The Efficiency of
Imports and Exports
The result of trade is that the price in the domestic
market will come to equal the world market price.
If the domestic price rises to meet a higher world
price, then the country exports the good.
If the lower world price causes the domestic price
to drop, then the country imports the good.
In either case, there are some people within the
country who gain, and others who lose.
The gains however, can be expected to exceed the
losses.
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4.2
PRICE CEILINGS AND RENT CONTROLS
 Price Ceiling: a law that restricts a
price from rising above a certain level
 Price Freezes: prohibiting a wide
array of prices from rising
 Rent Controls: laws that limit rent
increases to below what the market
would bear
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Rent Controls
Supply
P*
Ceiling
Price
0
Shortage
QS Q*
QD
Housing
Demand
Quantity
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Rent Controls over Time
Later
Supply
P**
Initial
Supply
P*
Ceiling
Price
Initial
Demand
0
Initial Shortage
Later
Demand
Quantity
Later Shortage
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Price Gouging and Ticket Scalping
 Price Gouging: The practice of hiking up
prices to exploit temporary surges in demand
 Ticket Scalping: The practice of buying
tickets at the price set by concert promoters
and then reselling at whatever the market
will bear
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4.3
PRICE FLOORS/PRICE SUPPORT
 Price floors and price supports are used
by government to artificially prop up prices.
They establish a minimum price that
producers are guaranteed to receive.
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Price Supports and Surpluses
Supply
Surplus
Floor
Price
P*
Demand
0
QD
Q*
QS
Agricultural
Commodity
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The Minimum Wage
 Increases the price of relatively
unskilled labor.
 Higher wage means more people
willing to work.
 Higher wage also means fewer jobs
offered.
Result = Surplus of Labor
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Minimum Wage Laws
$
Supply
Minimum
wage
Surplus of labor
Tony’s
required
wage
Equilibrium
wage
Dave’s
required
wage
Demand
QD
Fewer Jobs
©2004 Prentice Hall Publishing
Q*
QS
Low-Skill Labor
More Applicants
Ayers/Collinge, 1/e
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4.4
AROUND THE WORLD
– Black Markets a Safety Net
o Price controls are in effect around the world.
o The “Black Market” exist when people buy and
sell goods goods illegally.
o This can be seen as the market forces trying to
assert themselves.
o Black Markets can temper destructive policies.
o Black Markets act as a safety net and provide
people in countries where they exist with
necessities they would otherwise have to do
without.
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©2004 Prentice Hall Publishing
Ayers/Collinge, 1/e
4.5 EXPLORE & APPLY
The Price of Power
In 2001 California lawmakers deregulated the
wholesale electricity market.
By increasing supply, the lawmakers felt that
customers would eventually realize savings.
Unfortunately, crude oil prices doubled, and
and caused supply to shift to the left, more than
the rightward shift caused by deregulation.
The decrease in the supply of wholesale
electricity caused the wholesale price of
electricity to rise sharply.
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The Price of Power
Since lawmakers had promised to keep
rates at less than the new equilibrium
price, the result was shortages in the
retail electricity market.
Price ceilings cause shortages!!!
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©2004 Prentice Hall Publishing
Ayers/Collinge, 1/e
Terms along the Way
price signals
marginal benefit
consumer surplus
producer surplus
social surplus
deadweight loss
price ceiling
rent controls
transfer payments
search cost
housing vouchers
price gouging
price floor (price
support)
minimum wage
black market
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©2004 Prentice Hall Publishing
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Test Yourself
1. If Yvette would be willing to pay up to $10 for
one gizmo, up to $8 for a second, and up to $6
for a third, and the price of gizmos is $6
apiece, then Yvette’s consumer surplus totals
a. $24.
b. $18.
c. $6.
d. $4.
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Test Yourself
2. If the government places a price ceiling of
$1.20 on a good which has an equilibrium
price of $1.00 then
a. there will be a surplus of the good.
b. there will be a shortage of the good.
c. neither a surplus nor a shortage will occur.
d. if demand for the good decreases, government
will not let the price go below $1.00.
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Test Yourself
3.
a.
b.
c.
Efficiency requires that
total consumer surplus equal zero.
market prices be fair.
marginal social benefit equal marginal
social cost.
d. people buy low and sell high.
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©2004 Prentice Hall Publishing
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Test Yourself
4. Over time, rent controls that remain in
place lead to
a. increased renovation of old apartments.
b. a greater ability for tenants to move to
the best apartment for their needs.
c. increasingly severe housing shortages.
d. people buy low and sell high.
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©2004 Prentice Hall Publishing
Ayers/Collinge, 1/e
Test Yourself
5. Compared to a free-market equilibrium,
agricultural price supports have the effect of
a. increasing both the quantities supplied and
demanded.
b. decreasing both the quantities supplied and
demanded.
c. increasing the quantity supplied and
decreasing the quantity demanded.
d. people buy low and sell high.
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©2004 Prentice Hall Publishing
Ayers/Collinge, 1/e
The End!
Next Chapter 5
“Measuring National
Output"
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©2004 Prentice Hall Publishing
Ayers/Collinge, 1/e