Assignment for Next Lecture. Do Homework 4 on ‘Homework Assignment’ by next Monday Noon Read Chapter 5 Topics Next Time Concept of Elasticity (degree of price responsiveness). Market Strikes Back. Lecture 6. In This Lecture. Market Interventions Price Floors Price Ceilings
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Market Strikes Back
Even in a society where individuals are free to make voluntary exchanges, a society may decide to intervene in the market through its government. We will discuss the reasons in a later lecture, but for the time being let us assume that the government wants to favor one side of the trades over the other.
Consider two examples that highlight how governments may intervene.
In a later lectures we will argue that a perfectly competitive market will create the greatest amount of combined surplus for consumers and firms. However, we will also suggest that markets can under certain situations fail and consequently the market outcomes can be improved through government intervention (recall Lecture 2). Also the government could justify intervention to pursue non efficiency related goals -- equity or fairness -- often at the expense of efficiency.
Sometimes the sacrifice of efficiency is not justified by the gains in another goal. Justifying this loss in efficiency is not the focus of today’s lecture, however; rather our focus is the potential impacts of government intervention on prices and quantities -- positive analysis.
Do you favor raising the federal minimum wage from its current level of $5.15 to $7.15 per hour?
In the absence of any intervention, low skill workers earn Wo and L0 are employed.
Government institutes a Minimum Wage equal to MW (to be effective it must be above the equilibrium wage)
Workers earn MW but only L1 are employed and LS want to work at this wage
Unemployment is U = LS - L1
Individuals who do find work are better off but Lo-L1 loss their jobs and can’t find work and LS-L0 are enticed into labor market and can’t find jobs
Assume the worker is paid a per hourly subsidy of WS. Workers should be willing to supply the same amount of labor if employers paid them Wo- WS (they would take home the same amount of money per hour).
The Labor Supply Curve relevant to the employers shifts downward by WS. (The analysis is the reverse of that for taxes. Note that the supply price for labor at Lo falls.
Market wage paid by employers falls to WE
Employers hire more workers -- total employment rises to L1
Workers take home per hour MW=WS+WE
Total amount of subsidy paid by taxpayers
New York Times, April 27, 1993
President Clinton has vowed to eliminate poverty among families with a full-time worker. To back that pledge, he proposed a $27 billion increase over five years in the earned income tax credit -- which lowers taxes for low-paid workers or pays them cash if they are too poor to pay taxes. The credit insulates the poor from Social Security payroll taxes and, looking ahead, higher energy taxes. It thus acts to untax the poor who work.
Value of Minimum Wage, 1954-2004
[in 2001 dollars]
Initially there are Ho housing units that rent for Ro
Government sets a price ceiling--the highest price that supplies can require of demanders--MR < Ro
The number of housing units offered for rent falls to H1
The amount of housing demanded rises to to HD
Leaving a shortage in the rental market of HS = HD - H1
Would a subsidy paid to renters be preferable to rent control?
For Landlords to be willing to supply HD rental properties, the rent (supply price) would have to rise to RS.
Renters are only will to pay MR for HD housing, but if they are given a subsidy equal to A dollars per unit of housing, their demand for housing would increase.
A new equilibrium would be established with the equilibrium quantity at HD and the equilibrium price of RS. The cost to renters is RS - A = MR.
Unfortunately the cost to taxpayers is A dollars times the number of units HD.
What problems created by rent controls are solved by subsidies?
Real Gasoline Prices
As the price of gas rose, demand for Japanese cars rose and demand for American cars fell
American Car makers lost market share and approach Reagan Administration for relief -- they wanted the government to increase the price of Japanese cars to make their cars more attractive to American car buyers.
Price Floor on Japanese Cars
Tariffs (tax) on Japanese Cars
Quota on Japanese Imports
Tariff -- a tax on an import that the importer (Japanese Car marker) has to pay. Levied on each car. Tariffs increase the cost of doing business.
A tariff of amount T per car would raise the cost of a Japanese car by $T -- the supply curve would shift upward by $T.
The tariff of amount T would rise the price to the consumer to P*. At this price, consumers would demand the number of Japanese cars they did before the rise in the gas prices.
A quota limits the quantity of a good that can be sold. In our situation, the government would limit the number of Japanese cars to Qo.
The Supply of Japanese cars would now be equal to S’.
The price of Japanese cars would rise to P*.
Question 6 (Problem 9):
The U.S. government would like to help the American auto industry compete against foreign automakers that sell trucks in the United States. It can do this either by imposing a quota on the number of foreign trucks imported or by imposing an excise tax on each foreign truck sold in the United States. The hypothetical demand and supply schedules for imported trucks are given in the following table:
Pretax $50 $50
Postax $55 $30
CHANGE $5 $20
TAX = $5 + $20 = $25
$20 > $5 incidence on producers