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Title: Econ 1000 M2L3


1
Econ 1000 M2L3
  • C.L. Mattoli

2
This week
  • Mod 2, part2 Markets in Action
  • Chapter 4, Layton

3
What you should already know
  • 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.

4
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

5
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.

6
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.

7
What you should already know
  • The quantities supplied and demanded are the
    dependant variables that depend on price.
  • Supply and demand curves, by themselves, dont
    mean that much they are only schedules of
    intentions for buying and selling quantities, if
    prices were at various levels.

8
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.

9
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.

10
What you should already know
  • 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

11
Learning objectivesModule 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

12
What you should be able to do in the end
  • 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.

13
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.

14
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.

15
Changes in Market Equilibrium
16
Equilibrium changes
  • 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.

17
Equilibrium changes
  • 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.

18
Equilibrium changes
  • 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.

19
Equilibrium changes
  • 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.

20
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.

21
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.

22
Changes in demand
  • Example demand rises (contd.)
  • This will mean that there is a shortage in the
    market.
  • 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.

23
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 SUVs.

24
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.

25
Effects of demand shifts on equilibrium
  • Diagrams and causal chains

Increase in Equilibrium price
Increase in Quantity supplied
Decrease in Quantity supplied
Decrease in Equilibrium price
Decrease in demand
Increase in demand
When Haircut demand rises
When SUV demand falls
P










P
S
S
D1
D2
D2
D1
Q
Q
26
Extended causal chains
  • We expand the cause and effect chains as

Increase in Equilibrium price
Increase in Quantity supplied
Demanders will begin to bribe suppliers
Increase in demand
Shortage will obtain
Decrease in Quantity supplied
Suppliers Will begin to Discount
Decrease in equilibrium Price
Decrease in demand
Surplus Will exist
27
Changes in supply
  • 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.

28
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.

29
Changes in supply
  • 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.

30
Changes in supply
  • 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.

31
Changes in supply
  • 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.

32
Changes in supply
  • Example supply recedes
  • Suppose that police crack down on street vendors
    selling illegal copies of DVDs on the streets of
    Guangzhou.
  • As a result, supply will decrease, and there will
    be a shortage of illegal copies of DVDs 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 DVDs especially for them.

33
Changes in supply
  • We will move up the old illegal DVD demand curve
    until we reach a price at which illegal DVDs
    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.

34
Supply Changes
  • 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

Decrease in Equilibrium price
Increase in Quantity demanded
Increase in Equilibrium price
Decrease in quantity demand
Increase in supply
Decrease in supply
P










P
S2
S1
S1
S2
D
D
Q
Q
35
Extended causal chains
  • We expand the cause and effect chains as

Increase in Equilibrium price
Decrease in Quantity demanded
Demanders will begin to bribe suppliers
Decrease in supply
Shortage will obtain
Increase in Quantity demanded
Suppliers Will begin to Discount
Decrease in equilibrium Price
Increase in supply
Surplus Will exist
36
Changes in both
  • Theres 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.

37
Changes in both
  • 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.

38
Changes in both
  • 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










P
S2
S1
S1
S2
D1
D2
D2
D1
Q
Q
39
Laws are laws Trying to Violate the Laws
40
Government Dickering in Markets
  • 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.

41
Ceilings
  • 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.

42
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 counter-productive and, in fact,
    lead to other more subtle costs.

43
Ceilings
  • 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)

44
Ceilings
  • Graphic effect of rental ceiling on market.

Causal Chain
Quantity demanded Exceeds quantity Supplied at
price
Price Ceiling On rents
Shortage of Units obtains
P





1000
D
Rental price per month
S
800
600
Ceiling
400
Housing Shortage
200
Q
600
400
800
200
1000
Millions of units per month
45
Ceilings costs and bad behaviors
  • Of course, rigging a market and not allowing
    market forces to prevail will result in some
    adverse affects.
  • Tenants
  • 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.
  • 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.

46
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

47
Price Ceiling Revenues
Revenue ( PxQ) at Equilibrium Revenue
with ceiling
P
S0
P0
P1
D0
Q0
Q
Q1
48
Ceiling Economical alternatives
  • 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

49
Break time
  • Take 10 minute break
  • Use time to come up and ask questions

50
Floors
  • 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.

51
Floors minimum wage
  • 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.

52
Floors minimum wage
  • 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.

53
Minimum wage economical alternative
  • 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 well-off members of the society.

54
Minimum wage counterarguments
  • 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.

55
Graphical minimum wage
  • Classical graphical minimum wage market.

Causal Chain
Quantity demanded Falls short of
quantity Supplied at price
Unemployment Of unskilled workers
Price Floor On Wages
P
Hourly wages unskilled labor





10
S
D
Unemployment
8
Floor
6
4
2
600
Q
400
300
500
200
100,000s annual unskilled labor hours
56
Market Failures
57
Why fail?
  • 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.

58
Lack of competition
  • 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.

59
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.

60
How can they do that?
  • 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 Unions Competition Bureau, in Europe.

61
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.

62
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.

63
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.

64
Rigging the market for supply
  • 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.

65
Rigging supply higher prices, less available
  • 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
Sfree
SRestricted
Prestricted
Pfree
Qfree
Q
Qresticted
66
Case study Commissions on stock trades in the
U.S.
  • 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 1980s, commissions on buying stock
    were as much as 1 per share.

67
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-1980s, 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.

68
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.

69
Externalities
  • Markets can display failure because of
    side-effects 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.

70
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 neighbors music consumption
    habits.
  • You drive through a community where all the
    houses are beautifully painted and have
    magnificent gardens.

71
Externalities simple examples
  • You derive pleasure from the scenery, even though
    you had to contribute nothings, and you enjoy the
    fruits of other peoples production efforts.
  • It is a positive production-based externality.
  • Another example of a positive production
    externality is spillover of technological
    developments from RD of one firm to others.
    This is actually very important to growth of an
    economy.

72
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.

73
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 earths 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.

74
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.

75
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
SNPC
SPC
PPC
PNPC
QNPC
Q
QPC
76
Pollution externalities costs restrict supply
  • 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.

77
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.

78
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.

79
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.

80
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.

81
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.

82
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
DIB
S
DNIB
PIB
PNIB
QNIB
Q
QIB
83
Immunization redistributing unpaid benefits
  • 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.

84
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.

85
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 Australias
    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.

86
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.

87
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

88
Public Goods
89
Public Goods
  • 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,

90
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.

91
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.

92
Income inequality
93
Inefficiency versus inequality
  • 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, CEOs and
    doctors get huge incomes, while the unskilled and
    disabled get small or no wages.

94
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.

95
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

96
Ask Yourself
  1. How can you find producers total revenue from
    the supply-demand equilibrium graph?
  2. Name several reasons/situations that the
    government might get involved in markets.
  3. What do you expect will happen if a price ceiling
    is lifted in a market? A price floor?

97
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 weeks lecture)

98
Problems due in tutorial
  • Chapter 4
  • Problems 1-10
  • Multiple choice 1-12

99
Next week
  • Next week we discuss the concept of elasticity,
    which will require some mathematical
    understanding.
  • We shall cover chapter 5.

100
END
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