Transcript Lecture 3

Econ 1000 M2L3
C.L. Mattoli
(C) Red Hill Capital Corp., Delaware, USA
2008
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This week
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Mod 2, part2: Markets in Action
Chapter 4, Layton
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What you should already know
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You should understand how to think about
lost opportunity and opportunity cost.
You should understand that, in a world of
limited time, people, natural resources,
and productive capital equipment, that
there is a limit on the amount of goods and
services that can be produced at any one
time.
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What you should already know
You should be able to imagine that the
maximum capacity production of a mix
of goods and services is described by the
production possibilities frontier (PPF)
 That any point to the left of the frontier
is inefficient, and

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What you should already know
Points to the right of the PPF are
unattainable by the economy, on its
own, but a point to the right might be
attained through trade with another
economy.
 You should understand how opportunity
costs relate to moving from one point to
another along the PPF.

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What you should already know
You should understand the behavioral
underpinnings of the laws of supply
and demand, which relate quantities
supplied and demanded to price.
 The laws state that the quantities
supplied and demanded will vary with
price.

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What you should already know
The quantities supplied and demanded
are the dependant variables that depend
on price.
 Supply and demand curves, by
themselves, don’t mean that much: they
are only schedules of intentions for
buying and selling quantities, if prices
were at various levels.

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What you should already know
It is only interesting when we put
supply and demand together and let
them interact to result in an equilibrium
price at which all quantities will be
cleared in the market.
 Graphically, in economics, the quantity
is normally displayed on the horizontal
axis and price is on the vertical axis.

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What you should already know
That is contrary to the normal
convention in math.
 You may say “who cares?”, but there is a
reason that I bring this up: slope is
always calculated as the change in the
dependent variable per change in
independent variable.
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What you should already know
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Also, laws are laws and cannot be broken or we
need a new laws.
You should understand how non-price factors
can transform supply and demand curves into
new curves.
You should be able to imagine how surplus and
shortages will lead to behavior of the players in
the market place that will eventually result in a
unique ideal equilibrium market price and
quantity that will exactly be cleared in the market.
Then, you will be ready to proceed through this
next part of our analysis
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Learning objectives
Module 2 – Market analysis 2.2
On successful completion of this part of the
module, you should be able to:
 Use the concepts of demand, supply, and
market equilibrium
 Use the market model to predict the
direction of change in prices and
quantities caused by changes in the
market-place, and by policy changes
 Explain the concept of market failure and
discuss causes of such failure
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What you should be able to do in the end
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Explain and illustrate the effects of a
change in demand on equilibrium price
and quantity
Explain and illustrate the effects of a
change in supply on equilibrium price and
quantity
Explain and illustrate the effect of the
policy of setting a price floor in a market
Explain and illustrate the effect of the
policy of setting a price ceiling in a market.
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Overview
We studied concepts of opportunity cost
and marginal analysis.
 We looked at basic behaviorally based
laws of supply, demand and market
equilibrium.
 In this part of the module, we apply
these ways of thinking to the further
studies of general markets.

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Overview
 We
examine how and why market
equilibriums might change.
 We also examine some failures of
markets and look at various ways that
governments intervene in markets
and what happens when they do.
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Changes in Market
Equilibrium
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Equilibrium changes
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Market Equilibriums can be constantly
changing.
Equilibrium comes about because
behaviors cause an eventual exact
balance of supply and demand at a
certain price that will exactly clear a
market.
Things in the market might change.
If peoples’ perception changes or they get
more information, they can change their
minds.
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Equilibrium changes
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Non-price factors can make changes of
whole supply and demand lines.
Of course, if one of the lines changes,
supply or demand, there will be a new
intersection point with the old other line,
demand or supply.
If supply changes and demand remains
the same, there will be a shift of
equilibrium along the demand line.
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Equilibrium changes
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If demand changes and supply remains
the same, a new point will be reached on
the supply line.
Changes in supply will cause a new
equilibrium point on the old demand line.
Changes in demand will lead to a new
intersection point on the old supply line.
An example of a dynamic market in which
prices change all day long are the stock
markets and the commodities markets.
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Equilibrium changes
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There, as new buyers and sellers and new
information come into the markets
throughout a day equilibrium prices
constantly change.
We shall discuss reasons for such
changes and can show the situations,
graphically, for changes in one curve or
the other, in order to further understand
the processes at work.
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Changes in demand
Only non-price determinants will shift
a demand curve.
 Simple changes can come from more
buyers entering a market.
 Advertising, word-of-mouth, or
information can change demand.

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Changes in demand
Example: demand rises
 Consider demand at a hair cutting salon. If
everyone tells their friends that one of the boys
there gives the most beautiful haircuts of anyone
in town, the demand curve will shift to the
right, and more haircuts will be demanded at
each possible haircut price.
 In the mean time, supply remains the same. The
boy only works so many hours a day, and he can
only cut so many heads of hair.
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Changes in demand
Example: demand rises (contd.)
 This will mean that there is a shortage in the
market.
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As a result, the price of his haircuts will be
bid up and he will eventually work more
hours because he is willing to work more and
give more haircuts at a higher price on his new
supply schedule.
We illustrate the situation in a slide, below.
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Changes in demand
Example: demand falls
 Next, consider what might happen to
the demand for large SUV automobiles,
if the price of gasoline triples and it is
expected to remain there or higher.
 Automobiles and gasoline are
complementary goods, and the result of
such a rise in petrol prices would likely
be a decrease in the whole demand
schedule for SUV’s.
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Changes in demand
That will leave a surplus in the market.
 As a result, the price and quantity
supplied will eventually be arrived at a
lower price and quantity point along
the automobile makers’ supply curve.
 We show the 2 situations in the next
slide.

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Effects of demand shifts on equilibrium

Diagrams and causal chains
Increase in
demand
Increase in
Equilibrium
price
Increase in
Quantity
supplied
Decrease in
demand
When Haircut demand rises
P
D1
D2
S
Decrease in
Equilibrium
price
Decrease in
Quantity
supplied
When SUV demand falls
P
D2
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D1
S
Q
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Extended causal chains

We expand the cause and effect chains as
Increase in
demand
Shortage
will obtain
Demanders
will begin to
bribe suppliers
Increase in
Equilibrium
price
Increase in
Quantity
supplied
Decrease in
demand
Surplus
Will exist
Suppliers
Will begin to
Discount
Decrease in
equilibrium
Price
Decrease in
Quantity
supplied
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Changes in supply
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Now, lets look at what happened, if we keep a
constant demand curve and change supply.
The supply curve can be transformed into a new
curve by various non-price factors of the supply
equation.
The market will adjust, and a final new
equilibrium will be reached at the new
intersection point of the new supply and demand
curves.
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Changes in supply
Example: technology expands supply
 Suppose that a new process was developed that
allows palm oil producers to squeeze 10%
more oil of palm leaves.
 Then, with only that technological change, the
whole supply curve would shift to the right, and
more palm oil will be offered at every price in a
new supply curve.
 In turn, since the industry is now able to supply
larger quantities at every price there will be a
temporary glut of palm oil on the market at the
current equilibrium price.
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Changes in supply
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A surplus will exist because at the balancing
point of old demand with old supply, the
market was just clearing the former amount
of palm oil offered at an equilibrium price,
and, now, suddenly there is more available
than can be cleared at that price.
The signals to suppliers, seeing the glut, will
lead them to begin to drop the price.
They will also be willing to offer less in the
marketplace as they charge less: they will
move down their new supply curve.
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Changes in supply
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The stopping point on the way down will be
the intersection point of the new supply and
the old demand curves.
At that point, supply will be ahead of old
supply but behind the glut supply level, and
the price will be that which clears the
market.
A new equilibrium will obtain.
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Changes in supply
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Supply can also decrease, as we have seen with
oil production over the last thirty years. Markets
for food stocks can also display decreases in
supply, as, for example, when there is a frost in
early be spring, and the orange crop suffers.
Again, we can analyze the affect on market
equilibrium, and examine the processes at work in
the marketplace that will take us there.
Although we assume that the demand curve
remains unchanged, there could be situations in
which both supply and demand change.
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Changes in supply
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Example: supply recedes:
Suppose that police crack down on street vendors
selling illegal copies of DVD’s on the streets of
Guangzhou.
As a result, supply will decrease, and there will
be a shortage of illegal copies of DVD’s on the
streets of Guangzhou.
Some people will begin to bid up DVD prices to
make sure that their neighborhood black market
DVD dealers save DVD’s especially for them.
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Changes in supply
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We will move up the old illegal DVD
demand curve until we reach a price at which
illegal DVD’s are exactly cleared in the
marketplace.
A new equilibrium price and quantity will
eventually obtain at the intersection of the
old demand curve and the new supply curve.
The price will be above the old price and the
quantity cleared will be down.
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Supply Changes
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Causal chain and graphs.
Note there is a mistake in the arrow for price in the graph in the book on
page 92 for decrease in supply
Increase in
supply
P
Decrease in
Equilibrium
price
D
Increase in
Quantity
demanded
S1
S2
Decrease in
supply
P
D
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Increase in
Equilibrium
price
S2
Decrease in
quantity
demand
S1
Q
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Extended causal chains

We expand the cause and effect chains as
Decrease in
supply
Shortage
will obtain
Demanders
will begin to
bribe suppliers
Increase in
Equilibrium
price
Decrease in
Quantity
demanded
Increase in
supply
Surplus
Will exist
Suppliers
Will begin to
Discount
Decrease in
equilibrium
Price
Increase in
Quantity
demanded
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Changes in both
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There’s no reason that supply and demand cannot
both change.
To truly analyze an exact new equilibrium point
for that situation, we would need more precise
supply and demand schedules than the general
graphical representations that we have relied on
when only one, supply or demand, was changed.
There are 4 possible scenarios with both
changing. Both could increase, both could
decrease, or one could go one way and the other,
the other.
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Changes in both
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If both curves change, the outcome for price and
clearing quaintly after the changes may be more
or less than before the changes, depending on the
size and direction of each change.
Using the logic that we have developed for the
cases of one changing, we could follow the forces
that will come to bear on reaching a new
equilibrium price and a new quantity that will
clear in the market.
We show a few possibilities in the next slide.
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Changes in both
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We show some of the possible combinations of
dual changes in supply and demand, although
there are additional possibilities.
Even the outcomes shown could be different for
the types of changes displayed
P
D1
D2
S1
S2
P
D2 D1
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S1
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Laws are laws:
Trying to Violate the Laws
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Government Dickering in Markets
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Governments all around the world try to affect
some of the markets in their economies.
Their objectives are either to set minimum or
maximum prices in certain markets.
Thus, they seek to either prevent some prices from
rising to equilibrium or to keep others above
equilibrium
For example, a favorite market in which governments
like to set price floors (minimums) is wages.
A market in which they like to set price ceilings
(maximums) is the market for rental housing.
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Ceilings
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A price ceiling is a legally established
maximum price that a seller can charge for a
good or service
Rent controls are common in many U.S.
cities. In other countries, government housing
is subsidized to make rental prices lower.
The rationale for rent controls or subsidies is
to provide a necessity to people that would be
unaffordable many people at the true
equilibrium price.
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Ceilings
So, will the market for rental units simply
conform to the situation that the
government dictated, or will market
forces still be at work?
 We shall see why many economists
believe such controls are counterproductive and, in fact, lead to other more
subtle costs.
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Ceilings
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Assume that market supply and demand curves
are as shown in the figure, below, and
equilibrium would be at a point with rental price
of $600 per month and a cleared quantity 6
million units per month.
Supply and demand theory will predict that, if a
ceiling of $400 per month is artificially placed on
market price, there will be 4 million units
supplied, while demand is for 8 million units per
month.
The result is that a shortage of 4 million units per
month will persist in the market (see next slide)
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Ceilings
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Graphic effect of rental ceiling on market.
Causal Chain
Quantity demanded
Exceeds quantity
Supplied at price
Price Ceiling
On rents
Rental price per month
P
$1000
D
Shortage of
Units obtains
S
$800
$600
Ceiling
$400
$200
Housing
Shortage
200 400 600 800 1000 Q
Millions
units
per month
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Ceilings: costs and bad behaviors
Of course, rigging a market and not allowing market
forces to prevail will result in some adverse affects.
Tenants:
1.
Tenants will spend more time looking for housing
or spend more time on waiting lists to get housing.
This is opportunity cost to the tenant.
2.
The artificially low rent might evolve a black
market, an illegal hidden market, by tenants. They
might sublet their units at a higher price to
someone else and make an illegal profit for
themselves.
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Ceilings: costs and bad behaviors
Landlords
 Because of substandard rents landlords might
skimp on maintenance and leave units in
bad or even dangerous repair.
 Landlords might also resort to discrimination
and preferential treatment of renters in the
market by giving preference to family and
friends, even though they come onto lists
behind others.
 In the end, ceilings lead to inefficient and
undesirable behavior
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Price Ceiling & Revenues
Revenue (= PxQ) at Equilibrium
P
Revenue with ceiling
S0
P0
P1
D0
Q1
Q0
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Ceiling: Economical alternatives
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Economists might suggest an alternative of subsidizing
rental payments, directly, for low income people.
Then, low income people will be able to afford rentals at
the market price.
More importantly, market forces will be allowed to
determine rental prices and availability, and the market
will clear with no shortage, surplus, inefficiency, or
misbehavior.
Although price ceilings were common throughout the
world in the 20th century, they are steadily disappearing
as governments allow markets to work on their own,
while they seek better alternatives to increase their
citizens’ general welfare
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Break time
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Take 10 minute break
Use time to come up and ask questions
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Floors
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A floor is a legally established minimum that a
seller may charge for a good or service.
A common price that governments put floors on
is wages: minimum wages.
Assume that we have the usual downward sloping
demand schedule for unskilled labor. At a higher
wage, business will hire less unskilled workers; at
a lower rate, they will hire more workers.
Concerning supply, workers will be willing to
give up more free-time and work more hours in a
year for higher wages and will want to work
fewer hours for less wages.
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Floors: minimum wage
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If left to their own bargaining, the market would
establish an equilibrium price and a
corresponding quantity of labor employed.
The intention is to help unskilled labor have a
higher standard of living, but will a minimum
wage really help?
First of all, the supply of willing workers will
expand to the point on the supply curve
corresponding to the minimum wage price.
On the other hand, demand will be up the demand
curve to the point represented by the minimum
wage.
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Floors: minimum wage
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Unfortunately, there will be less of a demand for
unskilled labor than there is supply, and
unemployment will obtain.
Rather than pay such a high price for unskilled
workers, companies will add skilled workers or
replace labor with equipment.
Thus, as a result of enacting a minimum wage,
the government unwittingly encourages business
to use less unskilled labor, and there will be a
higher rate of unemployment in the unskilled
labor market.
Thus, the whole exercise is counterproductive.
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Minimum wage: economical alternative
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Many economists would suggest that rather than
fixing a minimum wage, the government, just as
in the case with rent ceilings, would do better by
subsidizing workers ’ wages by giving them
welfare payments, directly.
Again, it appears that it is more efficient to allow
the markets to work on their own and to find an
alternative means of trying to help the less welloff members of the society.
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Minimum wage: counterarguments
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However, other economists argue that by
installing a minimum wage, employers will
ultimately be forced to upgrade the skills and
productivity of workers.
Still others argue that at least some of the less
better off would be raised up in their standards of
living and that the resulting unemployment of
others is a fair price to pay for to pay for the
majority.
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Graphical minimum wage

Classical graphical minimum wage market.
Causal Chain
Quantity demanded
Falls short of quantity
Supplied at price
Price Floor
On Wages
Hourly wages unskilled labor
P
$10
$8
D
Unemployment
Unemployment
Of unskilled
workers
S
Floor
$6
$4
$2
200 300 400 500 600
Q
100,000’s
labor
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Market Failures
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Why fail?
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We have learned how markets are supposed to
operate/
Normally, the price system is expected to
efficiently coordinate society's economic
transactions, but there can be instances of failure
of the market system.
Market failures mean that the price system fails to
operate efficiently, and society loses benefits.
We shall look at 4 causes: lack of competition,
externalities, public goods, and income inequality.
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Lack of competition
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The market theory assumes that there is intense
competition among both consumers and
producers.
If producers collude to restrict output,
artificially raising the price above its natural
equilibrium, they will be able to reap extra
profits.
Especially new markets or markets that are little
understood may have a lack of competition.
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Lack of competition
That will mean that prices and quantities
are not what they could be.
 By subverting consumer sovereignty,
business might reduce the well-being of
society by wasting resources or by
retarding technology and innovation.

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How can they do that?
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Anticompetitive behavior is illegal in many
countries, but it still exists in the world. Many
countries even have government organizations
to keep a watchful eye and protect society
against such behavior.
There is the ACCC ( Australian Competition
and Consumer Commission) in Australia, the
Federal Trade Commission (FTC), in the U.S.,
and the European Union’s Competition
Bureau, in Europe.
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How can they do that?
Cartels, groups of producers, band
together to restrict output, and rig prices.
 Two of the most common examples of
cartels are the petroleum producer cartel,
OPEC, and the diamond producers’
cartel. Both restrict output to keep prices
at artificial levels.

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Rigging the market for supply
We understand that the way markets
work is that supply curve intersects with
the demand curve, and that intersection
point will be the price at which the
market will exactly clear the quantity
offered for sale.
 That process assumes consumer
sovereignty.

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Rigging the market for supply
Then, suppliers will offer what they are
comfortable with, considering their
profits versus opportunities, and their
offerings will be displayed in a supply
schedule.
 Consumers will compete for supplies by
bidding up prices to the point at which
their demand exactly clears the market of
all supply.

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Rigging the market for supply
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However, if suppliers conspire to restrict their
output, they can offer supplies along a supply
curve that does not represent their efficient
decision-making or use of resources.
By moving their supply curve upward, they will
be able to move the intersection point with the
demand curve to a higher price per unit at less
output than they could efficiently produce and
they can make excess profits.
We show the potential situation in the next slide.
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Rigging supply: higher prices, less available

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In the figure we show the natural supply and demand
curves, along with a restricted collusive supply line.
The result is a new intersection point on the demand
line with a higher price than the true free-market price
and less available quantities
Restricted supply market
P
D
SRestricted Sfree
Prestricted
Pfree
Qresticted Qfree
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Case study: Commissions on stock trades
in the U.S.
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Corporate Stocks are traded on stock exchanges and also
OTC.
There are barriers to entry in both. For example, a
membership on the New York stock exchange (NYSE)
will cost over $1 million, and to trade on the NASDAQ
market means membership in the NASD. The cost to go
through the process of filing and registering as a BD was
around $50,000.
In the early 1980’s, commissions on buying stock were as
much as $1 per share.
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Case study: Commissions on stock trades
in the U.S.

There was basically a lack of competition in
commission business because of the limited
number of seats on the NYSE and the high
cost of a seat. In the mid-1980’s, an apparent
loop-hole in the rules of the SEC and the
NYSE was exploited: If you were a registered
broker-dealer (BD), you could gain access to
the commissions charged for brokerage and
clearing, about 1.5 cents.
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Case study: Commissions on stock trades
in the U.S.


In addition, you would also have advantageous
capital, margin, and short requirements, similar
to NYSE members.
People began to take advantage of this
template. With the growth of day trading
salons and internet trading, some of those
people built businesses around trading prices
of 5 cents per share, and commissions have
come down substantially over the past 20 years
for all broker accounts.
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Externalities




Markets can display failure because of sideeffects called externalities imposed on people
other than the actual consumers and producers in
a market.
Externalities, also called spillover effects or
neighborhood effects, are costs or benefits to
people, third parties, other than the actual
market participants.
Thus, externalities can be either positive or
negative.
Externalities can be consumption-derived or
production-derived.
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Externalities: simple examples



If the person next door to you in the dorm,
plays loud music late at night, it might
interfere with either your sleep or your
studying.
It is a negative consumption-based
externality, based on your neighbor’s music
consumption habits.
You drive through a community where all the
houses are beautifully painted and have
magnificent gardens.
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Externalities: simple examples



You derive pleasure from the scenery, even
though you had to contribute nothings, and you
enjoy the fruits of other people’s production
efforts.
It is a positive production-based externality.
Another example of a positive production
externality is spillover of technological
developments from R&D of one firm to
others. This is actually very important to
growth of an economy.
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Externalities: some are of great concern



Externalities are not a minor aspect of market
failure. They can have enormous impact on the
quality of life.
Remember that people are self-interested.
Sometimes self-interest can have a damaging
affect on society, and sometimes it can have a
positive affect.
We shall look at major examples of both:
pollution as a negative and immunization against
disease as a positive.
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Pollution: negative production externality
Consider a steel industry that uses coal to
produce steel without pollution-control
equipment to limit the amount of
poisonous smoke and ash poured into the
earth’s atmosphere.
 The effect of the foul air is to reduce
property values, increase the cost of
health care, contribute to global warming,
and generally erode the quality of life for
third parties.

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Pollution: negative production externality
Because of these detrimental external
affects, the equilibrium price in the
market does not reflect the true cost of
steel production to the society.
 The equilibrium price of steel is too low
because steel supply curves do not reflect
those costs, and the output is too high.
The output is above what should be
socially desirable.

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Pollution: true costs

If producers supply curves were, somehow, to include
all of the external costs, the supply curve would shift
upward, and the equilibrium price would be higher
than the existing market and suppliers would produce
less output as shown, below.
Pollution costs and supply
P
D
SPC
SNPC
PPC
PNPC
QPC
QNPC
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Pollution externalities: costs restrict supply
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You might notice that the result is the same result that
we found for an industry of collusive producers.
In a collusive market, supply is restricted by
producers to increase price.
In pollution, society forces costs onto the producer to
pay for the cost of the external losses to society that
he causes.
By understanding the true costs of production that is
produced by industries or companies that pollute the
environment, society can begin to find remedies to
assure that the final equilibrium prices and quantities
reflect those costs.
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Pollution costs: remedies



There are 2 basic approaches to adding the costs of
externalities to producers costs and changing the supply
curve: taxes and regulation.
The government can charge a tax to producers. The tax
is an added cost of production, which will be passed on
to consumers of their product, and a new supply curve
will intersect demand at a higher price and lower quantity.
The taxes can be used to compensate the third parties
affected by the damaging behavior of the company.
Pollution taxes might also encourage producers to install
pollution control devices, on their own, in order to pay
less tax.
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Pollution costs: remedies


The other alternative is to make regulation
requiring companies to reduce pollution. In
this remedy, producers are forced to
purchase, install and maintain pollution
control equipment. Then, pollution will be
reduced, and the costs to society will be
reduced or eliminated.
The extra cost of equipment will cause the
cost of production to increase, and
equilibrium will obtain at a higher price and
lower output.
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Pollution costs: remedies



However, the cost of complete elimination of
pollutants is prohibitive, so not all pollution
will be eliminated through equipment.
Moreover, producers can cheat on their
polluting.
The tax method can eliminate all of the cost,
but is still left with the uncertainty of the real
long term costs of pollution.
Most countries prefer the tax approach
because it can cover costs and it is easy to
adjust.
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Immunization: case study



In pollution, we found that the supply curve can
understate the costs to society of production. In
immunization, the demand curve can understate
benefits to society.
Modern medicine provides vaccines against many
debilitating illnesses. People usually have their
children immunized when they are very young.
People other than those paying for immunization,
free-riders, because since many people pay for
inoculation the disease becomes less common.
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Immunization: case study




Thus, the demand curve does not truly reflect all
of the external benefits, and adjustment must be
made to account for them.
Because demand does not reflect all benefits,
producers will produce less at lower prices, and
there is inefficient allocation of resources to the
diseases immunization effort.
Now the government can use two methods to
change the demand curve: subsidies or
regulation.
We show the situation graphically, in the next
slide.
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Immunization: unpaid benefits


Demand does not reflect reality because free-riders do not
pay for but receive the benefits of immunization.
Thus, equilibrium price and quantity are too low.
Immunization benefits and demand
P
DNIB
DIB
S
PIB
PNIB
QNIB QIB
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Immunization: redistributing unpaid
benefits

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
Refunding subsidies are one means of
paying for benefits.
This approach involves a payment by the
government to people who have their
children immunized.
In this manner, dollar benefits are gained
only by those who pay for immunization.
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Immunization: redistributing unpaid
benefits




Others still benefit but the cost of the
benefit is also shifted to those who do not
pay for it directly.
The monetary payment might induce
parents to have children immunized.
Only when they are immunized can a
parent be truly confident of no disease and
extra costs for medical care.
Demand may shift.
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Immunization: redistributing unpaid
benefits



What would happen, if immunization was
completely subsidized? Would everyone simply
choose to inoculate their children, and the
problem completely solved?
The answer to that has been seen in Australia’s
decline in immunization even though it is
completely subsidized by the government.
That leads us to consider an alternative for
capturing, quantifying, and costing out the benefit
of immunization: regulation.
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Immunization: redistributing unpaid
benefits


Another means of ensuring that all pay for the
benefit of immunization is to regulate and
require that all children, by a certain age, must
be immunized against certain major diseases.
In the U.S., for example, children are, on the
one hand not allowed to enroll in school, if
they have not been immunized against certain
diseases, like polio or measles. On the other
hand, children of school age are legally
required to go to school.
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Immunization: redistributing unpaid
benefits

In any event, although it may not be
completely enforceable, laws requiring
immunization will shift the demand curve
right, and a proper efficient equilibrium
will occur at a higher price and output,
thus encouraging the health industry to
continue to pursue immunization research
and delivery
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Public Goods
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Public Goods



1.
2.
There are certain goods and services that are
valuable to the welfare of the society but that
would not be made available and purchased in
sufficient quantities without government
intervention.
Public goods are things like national defense,
interstate roadways, and police protection,
Public goods are goods and services that, once
produced, have 2 special characteristics:
The benefit is collectively consumed.
There is no way to prevent free-riders from
taking advantage of the benefit,
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Immigration control: an example



Suppose that, instead of the national coast guard
patrolling the coast of Australia, a private firm
offered to guard against the entry of illegal aliens,
and that the service was offered to individuals.
Then, all individuals, in the society, could decide
whether or not they want to pay for the coast
guarding service.
The result will be that some, if not all, members
of the society will attempt to free-ride, while
reaping the benefits that others pay for, and the
market will either under-produce or not produce.
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Providing public goods



Because these markets are likely to fail,
otherwise, governments tax their citizens
and provide public goods and services for
them.
The government does not have to
undertake production, itself. It can
contract out the production to the private
sector.
It can force payment and eliminate the
free-rider problem.
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Income inequality
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Inefficiency versus inequality

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
In the previous market failure situations that we
described, the markets are inefficient because
they allocate too many or too few productive
resources to producing particular goods or
services.
Even when markets are operating efficiently, they
may result in a very uneven distribution of
income among the members of a society.
Professional basketball players, CEO’s and
doctors get huge incomes, while the unskilled and
disabled get small or no wages.
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So what?
Some politicians and economists argue
that something should be done about this
inequality.
 Others point out that income inequality
provides incentive to gain skills and get a
higher income.
 Many governments, nonetheless, do feel
a need to do something to cure some of
the inequality.

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So what?
They provide welfare payments to the
poor or disabled. They have progressive
income tax systems in which higher
amounts of income are taxed at higher
percentage rates, like those in Australia.
 Others argue that high earners should be
taxed less to provide incentive for them
to work hard and continue accumulate
wealth

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Ask Yourself
1.
2.
3.
How can you find producer’s total revenue
from the supply-demand equilibrium graph?
Name several reasons/situations that the
government might get involved in markets.
What do you expect will happen if a price
ceiling is lifted in a market? A price floor?
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Exam Prep Problems
A shift in either the demand or supply curve for a
particular good will cause a change in the
equilibrium price and quantity of that good. If the
price of the good increased:
 (a) describe the changes in those factors that
would be likely to cause an increase in price;
 (b) illustrate the effect of these changes on the
price and quantity equilibrium; and
 (c) explain and show how the price elasticity of
demand will affect the sellers’ revenue should
there be an increase in the price of this
good.(Next week’s lecture)
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Problems due in tutorial
 Chapter
4
 Problems 1-10
 Multiple choice 1-12
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Next week
Next week we discuss the concept of
elasticity, which will require some
mathematical understanding.
 We shall cover chapter 5.

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END
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