ECO 110 Exam 2

How markets naturally eliminate a shortage or surplus

§ An economic situation is at equilibrium when no individual would be better off doing something different. § Markets usually reach equilibrium via changes in prices, which rise or fall until no opportunities for individuals to make themselves better off remain. § Since markets work toward equilibrium, we can depend on them to work in a predictable way.

Price floors

The opposite of a price ceiling is a price floor. Just like price ceilings prevent the market price from going above a certain level, price floors prevent the market price from going below a certain level.

surplus

- When quantity supplied is more than quantity demanded, we call it a surplus. What happens? o Sale time! Sellers have an incentive to lower the price so they can outcompete with other sellers. The price will continue to fall until the quantity demanded is equal to the quantity supplied, and equilibrium is reached.

Consumer surplus in price ceilings

After the price ceiling is imposed, the quantity supplied is the amount supplied. The consumers that are going to get the insulin is only a small amount. · Consumer surplus after the price ceiling is imposed is below the demand curve and above the price ceiling, but it is cut off by the new quantity supplied. · The total area for producer and consumer surplus has decreased.

With price controls in place, the economy became dis-coordinated

All types of businesses and companies, oil plants, etc. had to close because once one closed, a slippery slop occurred. o In a market economy, when it gets cold on the east coast and the demand for heating oil increases, entrepreneurs ship oil from where it has low value, in California, and ship it to where it has high value. § Buy low, sell high. § With price controls in place, high-value consumers of heating oil couldn't bid up the price and so there was no incentive for entrepreneurs to bring oil to where it was in greatest need.

Change of seasons demand

As the leaves on the trees turn beautiful fall colors what happens to the demand for lawn mowers?o Consumers want fewer lawn mowers, not because the price of lawn mowers increased, but because of a change in the desire for lawn mowers.o At every price people want fewer lawn mowers. -> Decrease in demand. Shift to the left on the demand.

Changes in the technology

Changes in the technology used to produce a good or service will cause a change in supply§ Suppose there is an improvement in the technology used to produce cell phones.· Business firms supply more cell phones, not because the price of cell phones increased, but because of a change in the technology used to produce cell phones.o At every price firms will supply more cell phones.§ Increase in supply.

Changes in the prices of related goods

Complements o Go with each other.· Substitutes o In place of each other· Depends on the consumer.· Suppose toaster waffles and maple syrup are complementary goods.o What impact will a decrease in the price of waffles have on the demand of maple syrup?§ Increase in demand for maple syrup.

Consumer surplus

Consumer surplus is the difference between what an individual is willing and able to pay and what they actually pay for a product or service. o We will use consumer surplus as a measure of the well-being of individuals and households.

Consumer surplus equation

Consumer surplus= maximum willingness to pay - price paid

When the price of a product falls, consumer surplus increases.

Consumer surplus= ½ x base X height § = ½ x 200 x ($7.00-2.50) § =$450.00 § The fall in price by $0.50 increases consumer surplus by $150.00

Shortages in price ceilings

Government proposes a controlled price, which is where the ceiling is. o At the controlled price, the quantity demanded exceeds the quantity supplied. Buyers want more of this, so there would be competition and the price would increase to the market price. § It's illegal in this case, we get this shortage that doesn't go away. o Sellers have more customers than goods. o Sellers can cut quality, cut costs and stills ell everything they want to sell at the controlled price.

How does consumer surplus measure or reflect well-being?

If individuals are able to purchase something for less than their maximum willingness to pay, this frees up income to be spent on other things.

Changes in income demand

If your income increases do you buy more goods and services or less?o Typically more.· Normal good: consumers purchase more of a normal good when income increases· Inferior good: consumers purchase less of an inferior good when income increases.o These depend on the individual· Suppose that due to a downturn in the economy household income decrease Assuming fast food is an inferior good, what will happen to the demand for fast food?§ Increase in demand

Producer surplus

Is the amount a producer receives for their product (total revenue) minus the minimum amount they must receive in order to supply the product or service. - Just like the height of the demand curve shows the maximum willingness to pay for a product, the height of the supply curve shows the minimum amount that producers must receive in order to be willing to supply the product. - The minimum price that a producer must receive in order to supply a product is heavy influenced by the cost of producing that product.

Price floor example: Minimum wage

Is the minimum price a seller must receive for their product or service. Price floors protect producers or suppliers. - In 1938 Congress passed the Fair labor Standards Act which created the federal minimum wage. o What impact will this have on the market for unskilled labor? o Businesses can pay workers higher than the minimum wage but not lower than the minimum wage. - On the market for unskilled labor, we now have hourly wage instead of price. Business move from the supply side to the demand side. Workers are on the supply side of the market. - A surplus in the labor market is the same as unemployment. The floor stops the price from going any lower. - Can follow the price floor until the new quantity demanded, and we can draw down. We can keep going until we hit the supply curve, and follow down to the quantity supplied. - The market cannot eliminate the surplus of labor because we cannot lower the price floor. It has created a surplus and a permanent surplus. May substitute capital for labor. So they don't need as much labor.

What impact does the minimum wage have on the market for unskilled labor?

It creates a permanent surplus or unemployment. o Because the wage rate cannot move below the minimum wage the market cannot eliminate the surplus created by the price floor.

Producer surplus is the area below the price line but above the supply curve.

It is the difference between what producers actually receive for their product (price) minus the minimum among that they must receive in order to supply the product.

Changes in the cost of inputs supply

The decking on most lawn mowers is made out of aluminum. What will happen to the supply of lawnmowers if the price of aluminum increases?§ Business firms supply lawn mowers, not because the price of the lawn decreased, but because of a change of the cost of an input used in production.§ At every price firms will supply fewer lawn mowersà decrease in supply.

Deadweight loss

The loss of consumer and producer surplus. It is not transferred to someone else.

What do we mean by demand?

The quantity demanded of a good or service is the amount that consumers are willing and able to purchase in a given period of time at a particular price.

What do we mean by supply?

The quantity supplied of a good or service is the amount that business firms are willing and able to supply in a give period of time at a particular price.

Producer surplus in price ceiling

There is a new price line. It is the area below the price ceiling but above the supply curve. It is smaller than it was before the price ceiling. · Producers are made worse off by the imposition of the price ceiling.

The minimum wage causes unemployment... or does it?

Usually most places have minimum wages above the minimum wage, this is to attract workers. This bid up the starting wage for unskilled labor. o The minimum wage is a non-binding price floor in 2021. o Many people want the minimum wage to increase to $15.00. Will it still be a nonbinding price floor? The minimum wage per hour places it above the equilibrium price. It would lead to unemployment. Some workers will be helped while other workers will be hurt. Will depend on how business owners influence it.

Calculating consumer surplus

We can calculate the amount of consumer surplus by calculating the area of the triangle we identified in our graph o To calculate the area of a triangle we use the formula: § Area= ½ X base X Height § Area=1/2 X 150 X ($7.00-3.00) § Area= $300.00= consumer surplus

Calculating producer surplus

We can calculate the amount of producer surplus by calculating the area of the triangle we identified in our graph. o To calculate the area of a triangle we use the formula: § Area= ½ X base X Height § Area=1/2 x 150 x ($3.00-1.00) § Area= 150 dollars= producer surplus o When the price of a product increases, producer surplus increases. § Producer surplus= ½ x base x height · = ½ x 200 x ($4.00-1.00) · = $300.00 · The increase in price by $1.00 increases producer surplus by $150.00

Changes in the Number of suppliers

When individuals choose to open a business or when they close a business it causes a change in supply.o Suppose that many restaurants in the area are forced to close due to a loss of business because of COVID-19§ A reduction in the number of firms in a market will cause a decrease in supply.

Price Ceiling

With a price ceiling, buyers are unable to signal their increased demand by bidding prices up. Suppliers in turn have no incentive to increase the quantity supplied because they can't raise the price. The result is a shortage. The quantity demanded exceeds quantity supplied.

Governments intervene when markets fail

o Markets do not produce enough of a good or service that is valued by society. o Markets produce too much of a good or service that is harmful or is not valued by society. o Market outcomes are perceived to be unfair or could hurt a particular group of people.

Five important effects of price ceiling

o Shortages o Reduction in product quality o Wasteful lines and other search costs o A loss in gains from trade (deadweight loss) o A misallocation of resources.

shortage

o They compete to buy the product and the seller will increase the price and it will rise until quantity demanded is equal to the quantity supplied.