1、Markets in ActionAfter studying this chapter you will be able toExplain how housing markets work and how price ceilings create housing shortages and inefficiencyExplain how labor markets work and how minimum wage laws create unemployment and inefficiencyExplain the effects of a taxExplain why farm p
2、rices and revenues fluctuate and how production subsidies and quotas influence farm production,costs,and pricesExplain how markets for illegal goods workTurbulent TimesAs more people compete for scarce land,house prices and rents rise.As new technologies replace low-skilled labor,the demand for low-
3、skilled workers falls.Can governments control prices and wages?How do taxes affect prices and quantities,and who pays the tax:the buyer or the seller?How are farm prices and incomes affected by fluctuations in harvests?What happens in a market when trading a good is illegal?Housing Markets and Rent
4、CeilingsThe 1906 earthquake in San Francisco left 200,000 peoplemore than half the cityhomeless.By the time the San Francisco Chronicle started publishing again,a month after the earthquake,there was not a single mention of a housing shortage.The classified advertisements listed many more houses and
5、 flats for rent than the advertisements for houses and flats wanted.How did the market achieve this outcome?Housing Markets and Rent CeilingsThe Market Response to a Decrease in SupplyFigure 1 shows the San Francisco housing market before the earthquake.The quantity of housing was 100,000 units and
6、the rent was$16 a month at the intersection of the curves D and SS.Housing Markets and Rent CeilingsThe earthquake decreased the supply of housing and the supply curve shifted leftward to SSA.The rent increased to$20 a month and the quantity decreased to 72,000 units.Housing Markets and Rent Ceiling
7、sThe long-run supply of housing is perfectly elastic at$16 a month.With the rent above$16 a month,new houses and apartments are built.Long-Run AdjustmentHousing Markets and Rent CeilingsThe building program increases supply and the supply curve shifts rightward.The quantity of housing increases and
8、the rent falls to the pre-earthquake levels(other things remaining the same).Housing Markets and Rent CeilingsA price ceilingis a regulation that makes it illegal to charge a price higher than a specified level.When a price ceiling is applied to a housing market it is called a rent ceiling.If the re
9、nt ceiling is set above the equilibrium rent,it has no effect.The market works as if there were no ceiling.But if the rent ceiling is set below the equilibrium rent,it has powerful effects.A Regulated Housing MarketHousing Markets and Rent CeilingsFigure 2 shows the effects of a rent ceiling that is
10、 set below the equilibrium rent.The equilibrium rent is$20 a month.A rent ceiling is set at$16 a month.So the equilibrium rent is in the illegal region.Housing Markets and Rent CeilingsAt the rent ceiling,the quantity of housing demanded exceeds the quantity supplied and there is a housing shortage.
11、Housing Markets and Rent CeilingsWith a housing shortage,people are willing to pay$24 a month.Because the legal price cannot eliminate the shortage,other mechanisms operate:?Search activity?Black marketsHousing Markets and Rent CeilingsSearch ActivityThe time spent looking for someone with whom to d
12、o business is called search activity.When a price is regulated and there is a shortage,search activity increases.Search activity is costly and the opportunity cost of housing equals its rent(regulated)plus the opportunity cost of the search activity(unregulated).Because the quantity of housing is le
13、ss than the quantity in an unregulated market,the opportunity cost of housing exceeds the unregulated rent.Housing Markets and Rent CeilingsBlack MarketsA black market is an illegal market that operates alongside a legal market in which a price ceiling or other restriction has been imposed.A shortag
14、e of housing creates a black market in housing.Illegal arrangements are made between renters and landlords at rents above the rent ceilingand generally above what the rent would have been in an unregulated market.Housing Markets and Rent CeilingsInefficiency of Rent CeilingsA rent ceiling leads to a
15、n inefficient use of resources.The quantity of rental housing is less than the efficient quantity,so a deadweight loss arises.Figure 3 illustrates.Housing Markets and Rent CeilingsA rent ceiling decreases the quantity of rental housing.People use resources in search activity,which decreases producer
16、 surplus and consumer surplus.And a deadweight loss arises.Housing Markets and Rent CeilingsAre Rent Ceilings Fair?According to the fair rules view,a rent ceiling is unfair because it blocks voluntary exchange.According to the fair results view,a rent ceiling is unfair because it does not generally
17、benefit the poor.A rent ceiling decreases the quantity of housing and allocates the scarce housing using:?Lotteries?Queues?DiscriminationHousing Markets and Rent CeilingsA lottery gives scarce housing to the lucky.A queue gives scarce housing to those who have the greatest foresight and get their na
18、mes on the list first.Discrimination gives scarce housing to friends,family members,or those of the selected race or sex.None of these methods leads to a fair outcome.Housing Markets and Rent CeilingsRent Ceilings in PracticeNew York,San Francisco,London,Paris,and Boston have or have had rent ceilin
19、gs.Atlanta,Baltimore,Chicago,Dallas,Philadelphia,Phoenix,and Seattle have never had them.Comparing cities with and without rent ceilings,we learn:1.Rent ceilings definitely create a housing shortage.2.Rent ceilings lower rents for the lucky few and raise them for everyone else.Winners are long-stand
20、ing residents.Losers are mobile newcomers.The Labor Market and Minimum WageNew labor-saving technologies become available every year,which mainly replace low-skilled labor.Does the persistent decrease in the demand for low-skilled labor depress the wage rates of these workers?The immediate effect of
21、 these technological advances is a decrease in the demand for low-skilled labor,a fall in the wage rate,and a decrease in the quantity of labor supplied.Figure4 on the next slide illustrates this immediate effect.The Labor Market and Minimum WageA decrease in the demand for low-skilled labor is show
22、n by a leftward shift of the demand curve.A new labor market equilibrium arises at a lower wage rate and a smaller quantity of labor employed.The Labor Market and Minimum WageIn the long run,people get trained to do higher-skilled jobs.The supply of low-skilled labor decreases and the short-run supp
23、ly curve shifts leftward.If long-run supply is perfectly elastic,the equilibrium wage rate returns to its initial level(other things remaining the same).The Labor Market and Minimum WageA Minimum WageA price floor is a regulation that makes it illegal to trade at a price lower than a specified level
24、.When a price floor is applied to labor markets,it is called a minimum wage.If the minimum wage is set below the equilibrium wage rate,it has no effect.The market works as if there were no minimum wage.If the minimum wage is set above the equilibrium wage rate,it has powerful effects.The Labor Marke
25、t and Minimum WageIf the minimum wage is set above the equilibrium wage rate,the quantity of labor supplied by workers exceeds the quantity demanded by employers.There is a surplus of labor.Because employers cannot be forced to hire a greater quantity than they wish,the quantity of labor hired at th
26、e minimum wage is less than the quantity that would be hired in an unregulated labor market.Because the legal wage rate cannot eliminate the surplus,the minimum wage creates unemployment.Figure 5 on the next slide illustrates these effects.The Labor Market and Minimum WageThe equilibrium wage rate i
27、s$4 an hour.The minimum wage rate is set at$5 an hour.So the equilibrium wage rate is in the illegal region.The quantity of labor employed is the quantity demanded.The Labor Market and Minimum WageThe quantity of labor supplied exceeds the quantity demanded.With only 20 million hours demanded,some w
28、orkers are willing to supply the last hour demanded for$3.Unemployment is the gap between the quantity demanded and the quantity supplied.The Labor Market and Minimum WageInefficiency of a Minimum WageA minimum wage leads to an inefficient use of resources.The quantity of labor employed is less than
29、 the efficient quantity and there is a deadweight loss.Figure 6 illustrates this loss.The Labor Market and Minimum WageA minimum wage decreases the quantity of labor employed.If resources are used in job search activity,workers surplus and firms surplus decrease.And a deadweight loss arises.The Labo
30、r Market and Minimum WageFederal Minimum Wage and Its EffectsA minimum wage rate in the United States is set by the federal governments Fair Labor Standards Act.In 2007,the federal minimum wage rate was$5.15 an hour.Some state governments have set minimum wages above the federal minimum wage rate.Mo
31、st economists believe that minimum wage laws increase the unemployment rate of low-skilled younger workers.The Labor Market and Minimum WageA Living WageA living wage has been defined as an hourly wage rate that enables a person who works a 40 hour week to rent adequate housing for not more than 30
32、percent of the amount earned.Living wage laws already operate in many cities such as St.Louis,Boston,Chicago,and New York City.The effects of a living wage are similar to those of a minimum wage.TaxesEverything you earn and most things you buy are taxed.Who really pays these taxes?Income tax and the
33、 Employment Insurance tax are deducted from your pay,and provincial sales tax and GST is added to the price of the things you buy,so isnt it obvious that you pay these taxes?Isnt it equally obvious that your employer pays the employers contribution to the Employment Insurance tax?Youre going to disc
34、over that it isnt obvious who pays a tax and that lawmakers dont decide who will pay!TaxesTax IncidenceTax incidence is the division of the burden of a tax between the buyer and the seller.When an item is taxed,its price might rise by the full amount of the tax,by a lesser amount,or not at all.If th
35、e price rises by the full amount of the tax,the buyer pays the tax.If the price rise by a lesser amount than the tax,the buyer and seller share the burden of the tax.If the price doesnt rise at all,the seller pays the tax.TaxesTax incidence doesnt depend on tax law!The law might impose a tax on the
36、buyer or the seller,but the outcome will be the same.To see why,we look at the tax on cigarettes in New York City.On July 1,2002,New York City raised the tax on the sales of cigarettes from almost nothing to$1.50 a pack.What are the effects of this tax?TaxesA Tax on SellersFigure7 shows the effects
37、of this tax.With no tax,the equilibrium price is$3.00 a pack.A tax on sellers of$1.50 a pack is introduced.Supply decreases and the curve S+tax on sellers shows the new supply curve.TaxesThe market price paid by buyers rises to$4.00 a pack and the quantity bought decreases.The price received by the
38、sellers falls to$2.50 a pack.So with the tax of$1.50 a pack,buyers pay$1.00 a pack more and sellers receive 50 a pack less.TaxesA Tax on BuyersAgain,with no tax,the equilibrium price is$3.00 a pack.A tax on buyers of$1.50 a pack is introduced.Demand decreases and the curve D?tax on buyersshows the n
39、ew demand curve.TaxesThe price received by sellers falls to$2.50 a pack and the quantity decreases.So with the tax of$1.50 a pack,buyers pay$1.00 a pack more and sellers receive 50 a pack less.The price paid by buyers rises to$4.00 a pack.TaxesSo,exactly as before when the seller was taxed:The buyer
40、 pays$1.00 of the tax.The seller pays the other 50 of the tax.Tax incidence is the same regardless of whether the law says the seller pays or the buyer pays.TaxesTax Division and Elasticity of DemandThe division of the tax between the buyer and the seller depends on the elasticities of demand and su
41、pply.To see how,we look at two extreme cases.?Perfectly inelastic demand:the buyer pays the entire tax.?Perfectly elastic demand:the seller pays the entire tax.The more inelastic the demand,the larger is the buyers share of the tax.TaxesDemand for this good is perfectly inelasticthe demand curve is
42、vertical.When a tax is imposed on this good,the buyer pays the entire tax.TaxesThe demand for this good is perfectly elasticthe demand curve is horizontal.When a tax is imposed on this good,the seller pays the entire tax.TaxesTax Division and Elasticity of SupplyTo see the effect of the elasticity o
43、f supply on the division of the tax payment,we again look at two extreme cases.?Perfectly inelastic supply:the seller pays the entire tax.?Perfectly elastic supply:the buyer pays the entire tax.The more elastic the supply,the larger is the buyers share of the tax.TaxesThe supply of this good is perf
44、ectly inelasticthe supply curve is vertical.When a tax is imposed on this good,sellers pay the entire tax.TaxesThe supply of this good is perfectly elasticthe supply curve is horizontal.When a tax is imposed on this good,buyers pay the entire tax.TaxesTaxes in PracticeTaxes usually are levied on goo
45、ds and services with an inelastic demand or an inelastic supply.Alcohol,tobacco,and gasoline have inelastic demand,so the buyers of these items pay most the tax on them.Labor has a low elasticity of supply,so the sellerthe workerpays most of the income tax and most of the Social Security tax.TaxesTa
46、xes and EfficiencyExcept in the extreme cases of perfectly inelastic demand or perfectly inelastic supply when the quantity remains the same,imposing a tax creates inefficiency.Figure 11 shows the inefficiency created by a$10 tax on CD players.TaxesWith no tax,the market is efficient and total surpl
47、us(the sum of consumer surplus and producer surplus)is maximized.A tax shifts the supply curve,decreases the equilibrium quantity,raises the price to the buyer,and lowers the price to the seller.TaxesThe tax revenue takes part of the consumer surplus and producer surplus.The decreased quantity creat
48、es a deadweight loss.Subsidies and QuotasFluctuations in the weather bring big fluctuations in farm output.How do changes in farm output affect the prices of farm products and farm revenues?How might farmers be helped by intervention in markets for farm products?Subsidies and QuotasHarvest Fluctuati
49、onsFigure 12(a)shows the market for wheat in normal times.Once the crop is planted,supply is perfectly inelastic along the momentary supply curve MS0.The price is$4 a bushel and farm total revenue is$80 billion.Subsidies and QuotasPoor HarvestSupply decreases.Farmers lose$20 billion of total revenue
50、 on the decreased quantity sold.But they gain$30 billion from the higher price.Because demand for wheat is inelastic,total revenue increasesto$90 billion.Subsidies and QuotasBumper HarvestSupply increases.Farmers lose$40 billion of total revenue on the original quantity because the price falls.They
