Monday, September 15, 2014

Gonvernment Intervention 4 - Price Floors

Price Floors

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Remember (floors are high) - When drawing an effective price floor it must be drawn above the                                                         equilibrium.

Price floors are also known as minimum price, refers to setting a price higher than the market equilibrium by the government and no seller can sell the good at a lower price than the set minimum price.

Government reasons to set a price floor.
  • to protect the sellers and stabilize their incomes - agricultural products
  • to prevent deprivation for disadvantaged sellers - minimum wage
The graph above has a binding price floor that is set higher than the equilibrium price. This causes an excess supply of products. The high price causes the quantity demand to decrease allowing a glut or a surplus to form. The high prices help the producers (red area above) and hurts the consumer (blue area) as their surplus shrinks,,, the yellow triangle area is dead weight loss (DWL) or a loss to society in that these trades were not allowed to happen. 

mjmfoodie video - price floors and ceilings Watch It!!!



Impacts of a Price Floor

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1.    Government measures to dispose of the surplus:

The price floor (high price) causes a surplus or excess supply. What's to be done with this excess. In some instances the government decides to buy the excess supply. The governments buying is described as actions necessary to keep the price high. The expense is financed by the taxpayer and incurs a loss to society.

 Buffer stock schemes are not on the AP, (or I haven't found any examples) but the concept of the governments intervention and especially the effects are relevant.


2.     Producers gain and consumers loose:

Producers now receive a higher revenue than before, and are better off. However, consumers lose as they are forced to pay a higher price and (enjoy less of the products).

Venezuela Toilet Paper Shortage: Government To Import 50 Million Rolls 

3.      Loss of Social Welfare:

Less trade less goods and services being enjoyed. Therefore, the people are worse off.
Go back and look at the yellow triangle above.

4.      Inefficient Resource Allocation:

Since the government has started the program to buy the surplus of goods it stands to reason that producers to overproduce, causing inefficient resource allocation. (more resources, land, labor, will be used for producing the (government purchased good) and less for producing other goods.
AP Price Floor Problems

1995 AP Microeconomics Exam
Answer - (D) The price floor would tend to create a shortage of the good in the market.

2000 AP Microeconomics Exam

Answer - 18. (B) WYZ
                             Competitive equilibrium means the equilibrium before the price floor.

 Answer - 19. (C) decreases from OS to OR

2008 AP Microeconomics Exam


Answer - (A) a surplus and the price will eventually fall.

Readings/Videos/Podcasts/Views/Opinions

Welker on Price Controls




Ghana Buffer Stock Schemes - Almost makes you believe it.
https://www.youtube.com/watch?v=krLqeKm0edc

Milton Friedman on Price Controls - Watch! I think he nails it.

Is Price Gouging Immoral? Should It Be Illegal?


Library of Economics & Liberty
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Government Intervention 2 - Subsidies

Government Intervention 2

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Subsidies

Subsidies - Pajholden



Subsidies  - are grants provided by the government (taxpayers) to firms aiming at lowering production costs and increasing output.

Reasons that governments (taxpayers) give subsidies:
  • to promote exports by lowering the price of goods so they are more competitive in foreign markets.
  • to encourage socially beneficial activities. ex. community centers
  • to encourage consumption of merit goods. ex. libraries, museums

Impact of Subsidies:

Imposition of a subsidy will decrease the market price level and increase the quantity transacted of goods and services. This is graphed by a supply curve shifting to the right.


Effects on Stakeholders:

  • Consumers - are better off because they can pay a lower price to purchase goods and services. The vertical distance between the old supply curve and the subsidized supply curve is the value of the subsidy.
  • Producers - revenue increases and producers are better off.
  • Society - a welfare loss of (section A) is incurred. Resources are misallocated as there is potential gain that is not being captured.
There are no Multiple choice questions or FRQ's from the last 10 years having to do with subsidies. That is a good reason to study them.

Readings/Videos/Podcasts/Views/Opinions/Issues

Ag subsidies: Support system or sham?


GOP Farm Subsidies



Milton Friedman on Agricultural Subsidies:

Should the Government Subsidize…Silly Walks?

http://www.learnliberty.org/videos/should-government-subsidizesilly-walks-0/




Sen. Obama on Agricultural Subsidies  - Proposed


Sen. Obama on Agricultural Subsidies  - Reality


Romney on Subsidies - 

Farm Subsidies -- Stossel in the Classroom


Subsidizing Stupid Risks -- Stossel In The Classroom



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Sunday, September 14, 2014

Government Intervention 1 - Indirect Taxes

Government Intervention

Conversations welcome - Econowaugh on Facebook

Includes all of the following:
  • Indirect Taxes
  • Subsidies
  • Price Floors
  • Price Ceilings
  • What I like to call (world price)
Nixon imposes wage and price controls - 1971


Venezuelan President Nicolas Maduro, furthers Price Controls, 2013


Venezuela used cars. Price Controls


Indirect Taxes

Indirect taxes  - are taxes on the expenditure of goods and services. It increases the cost of production and shifts the supply curve to the left.


The vertical distance between the old and new supply curve is the size (amount) of the tax.
Governments impose indirect taxes for several reasons:
  • to finance government expenditures (raise revenue)
  • discourage socially undesirable activities (raises the taxes on gas to discourage driving)
  • promote economic growth (imposes tariffs to lower consumption of imported goods)
  • reduce inequality
Two types of Indirect taxes:
  • specific
  • ad valorem
Specific Tax - a tax on a good that is set as a fixed amount per UNIT.
                         ex. the government imposes a two dollar a pack cigarette tax.

Ad Valorem Tax - an indirect tax expressed as a percentage of the price of the product.
                                ex. VAT taxes - Value Added Tax - the government enforces a 20% tax on the                                             expenditure.

The best way to learn how to do tax intervention, cause and effect is to do an AP tax problem. Look closely at the graph and what is asked for in the question. The same structure is used for many of the Gov't intervention FRQ's.

1995 AP Microeconomics Exam - FRQ, #2

2) The graph above shows the market for a good that is subject to a per-unit tax. 

      (a) Using the labeling on the graph, identify each of the following:

  • The equilibrium price and quantity before the tax.
This is easy in that we just need to look at the original supply curve and trace the equilibrium price (12) and the equilibrium quantity (100).          
  • The  area representing the consumer surplus before the tax.  
Did you see the before the tax,,, Important, right! The consumer surplus before the tax is the sum of the A+B+C+F, area. 
  • The area representing the producer surplus before the tax.
I know you saw the before the tax this time,,, failure to read the question closely is a big problem with answering these questions correctly. The producer surplus before the tax is D+G+E, area or 100$.

(b) Assume that the tax is now imposed. Based on the graph, does the price paid         by the buyers rise by the full amount of the tax? Explain.

If we look at the old equilibrium price of ($12) and the after the tax, new equilibrium price of ($13) we can say that the price paid by consumers increased by $1 after the tax. But the question asks, does the price paid by the buyer rise by the full amount of the tax, since the tax is $2 per unit and the consumer only paid $1 of the tax,, the consumer in fact, did not pay the full amount of the tax.

Explain, why? - Remember that the vertical distance between the two parallel supply curves is equal, up and down the curves. With that in mind, look at the vertical line running down from the new, taxed, equilibrium to the new quantity of 80 units. Look at the original supply curve and recognize that if the distance between old and new supply curve is the amount of the tax,, then we can see that the tax increased the cost of the good by $2 from $11 to ($13 the new equilibrium amount). Draw a line straight down through the new (taxed) supply equilibrium and where it crosses the old supply curve will show you the amount of the tax.  

That's a lot of words. :0

OK, so we can see that the tax was $2 and the consumer paid only $1 of the tax,,, why??

Answer - The price paid by the buyer does not rise by the full amount,, and since supply and demand have the same elasticities both pay half. The more elastic the demand curve (flat) the more producers will bear the tax burden,,, the more elastic the supply curve the (flat) the more consumers will  bear the tax burden.

Nice graphic example:

SPEND SOME TIME UNDERSTANDING THIS CONCEPT.

(C) Using the labeling on the graph, identify each of the following after the                     imposition of the tax.

  • The net price received by the sellers.
Net price received by seller is $11 (net is what the seller actually puts in his pocket) after he pays his $1 to the government and the consumer pays his $1 to the government.
  • The amount of tax revenue.
 Tax revenue (money collected by the government from the tax)  is the areas B+C+D or $160.
The revenue is the $2 per unit tax times the number of units sold = 80,, so 2*80 = 160.
  • The area representing the consumer surplus.
Consumer surplus is A.
  • The area representing deadweight loss.
Deadweight loss is what has been lost by society due to the higher prices,,, they are looking for either an area or a quantity. The area of DWL (dead weight loss) is F+G. The quantity is 20 units.


Pajholden on Indirect Taxes - 

Welker on Indirect taxes - Elastic

Welker Indirect (excise) tax - Inelastic





1995 AP Microeconomics Exam

Answer - (D) The supply curve will shift to the left.

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Government Intervention 3 - Price Ceilings

Price Controls - Price Ceilings 

Conversations welcome - 


Price Controls - refer to the setting above or below the market equilibrium (binding) by the                                   government. Price controls result in shortages and surpluses.



mjmfoodie video - Price floors and ceilings - 

Price Ceilings

Price Ceiling (max price), refers to the setting of the price lower than the market equilibrium by the government and no seller is allowed to sell the goods at a higher price than the maximum price.

Remember -  (Ceilings are low)


Ceilings are meant to help the consumers,,, with lower prices. Remember, the lower prices mean that quantity demand will increase, but from the producers standpoint lower prices are a incentive to supply less. So with a high quantity demanded and low quantity supplied we naturally have shortages.

Reasons for Price Ceilings:
  • To protect (help Buyers so that lower income households can afford the good or service. Ex. food price controls and rent controls.
  • to lower the price of goods that the government deems unreasonably high.
Impacts of Price Ceilings:

1.     Non-Price rationing emerges - When a price ceiling is imposed, Qd exceeds Qs. Shortages           occur. Therefore, sellers have to ration the goods using non-price rationing mechanisms,             such as lines, first-come, first-served, nepotism (favors,  me and mine first).
  
2.     Underground Parallel Markets (Black Markets) - Those who cannot obtain the goods                   desired on the regular market may seek to buy the goods at higher prices at the black                 market. As the black market is unregulated and unlicensed, the purchasing of goods                   services may pose a health and safety risk.

3.      Falling Quality of Goods - As producers are not allowed to sell goods at a price higher                  than the maximum price. they may try to lower the production costs to increase profit or            cover costs. The quality of goods may be reduced.

4.    Consumers might gain or loose - Consumers who are able to buy at the lower price of                  course are the winners. Since price ceilings notoriously cause shortages, some (those who            show up late) find that the supply has all been bought and so they loose.

 5.     Loss in Social Welfare - The distortion in people being able to purchase or sell goods                    goods reduces producer and consumer surplus by the shaded (DWL = Dead Weight Loss)          amount in the picture below.

Ok let's get to the Problems -

 2005 AP Microeconomics Exam


Answer (C) There will be a shortage. 

Reffonomics - Practice makes perfect -
http://www.reffonomics.com/TRB/INPROGRESS/index12apriceceilingpricefloorunit1.html

Welker - Price floors and ceilings  - always watch Welker!!
Determining the Effects of Price Ceilings and Price Floors

Milton Friedman on Price Controls
https://www.youtube.com/watch?v=UGKl1MzOc8k

Podcast - Mike Munger - Price Gouging
http://www.econtalk.org/archives/2007/01/munger_on_price_1.html

Mike Munger Article - Price Gouging
http://www.econlib.org/library/Columns/y2007/Mungergouging.html

Venezuelans snap up cheap electronic goods after government forces stores to lower prices - Video





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Monday, September 8, 2014

Demand 3 - Determinants of Demand (non-price) also known as Shifters of Demand

Determinants of Demand/ Shifters of Demand

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The shift of the demand curve means the quantity demanded changes at every price level. Factors resulting in a shift of the demand curve are non-price factors of the good.  (or shifting happens with factors other than price.

Shifters of Demand
  1. Numbers of Consumers (size of the market)
  2. Income Normal Goods
  3. Income Inferior Goods
  4. Preferences 
  5. Prices of Related Products:  Substitutes
  6. Prices of Related Products: Complements
  7. Expected Future Prices by Consumers
  8. Expected Future Income by Consumers
Mjmfoodie doing it well:

1. Numbers of Consumers (size of the market)

Changes in the size of a market (the number of consumers) will have an effect. As the size of a market increases, demand for most products will tend to rise. As the size of the markets decreases, demand for most products will tend to rise.


Population Increase - energy and water

2. Income - Normal Goods

When income increases, the demand for normal goods will increase - shifts demand to the right
When income decreases, the demand for normal goods will decrease - shifts demand to the left

1995 AP Microeconomics Exam

Answer - (D) a normal good

2008 AP Microeconomics Exam


Answer - (B) reinforces the income effect

3. Income - Inferior Goods

When  income increases, the demand for inferior goods will decrease.
When income decreases, the demand for inferior goods will increase.

2000 AP Microeconomics Exam


Answer - (D) An increase in consumer income will decrease the demand for bologna.

4. Preferences 

Changes in taste and preferences affect demand. Preferences can be affected by consideration of health, weather, fashion trends, advertising etc. Ex. an increase in awareness of overweight problems will lower the demand for red meat and pastries. (Possibly)




Our preferences are influenced by all types of information. (sometimes it's difficult to know who to believe)


1995 AP Microeconomics Exam


Answer - (A) An increase in the demand for air travel. ( People's preference for flight over cars or bus travel increase the demand for aircraft mechanics.)

1995 AP Microeconomics Exam


Answer - (B)  The demand curve will shift to the left, decreasing the price of beef.

2005 AP Microeconomics Exam


Answer - (B) The price of artichokes will increase. (preference for eating artichokes will increase raising demand)

5. Prices of Related Products:  Substitutes

Substitutes exist for all of our wants and needs. Think of the products you have in your shower and the differing shampoos and soaps that exist in the grocery store. If the price of your favorite shampoo doubles you might decide to substitute a cheaper brand. 



2000 AP Microeconomics Exam


Answer (A) An increase in the price of pizza, a substitute for hamburgers.

6. Prices of Related Products: Compliments

Two goods are considered compliments if they are consumed together. Examples would include, peanut butter and jelly, toast and jam, hamburgers and french fries (chips), toothpaste and toothbrushes, coffee and sugar. 



If the price of peanut butter skyrockets then we could expect the price of jelly to fall as the increase in the price of peanut butter will cause its Qd to fall which in turn will cause the demand for jelly to fall.

2000 AP Microeconomics Exam


Answer - (D) The release of three summer movies. (In essence more movies bring more people                           to the movies and when people come to the movies they like to eat popcorn.)

 1995 AP Microeconomics Exam

Answer - (E) complementary goods

 2005 AP Microeconomics Exams

Answer - (B) An increase in the price of potatoes, if potatoes and beef are complementary                                  goods.

 2005 AP Microeconomics Exam

Answer - (B) X & Y are complementary. (This problem is easier (for me) if I add real products for the variables X &Y. )

7. Expected Future Prices by Consumers

If you expect the price of that dress to go on sale next week you will wait until next week to buy it. If you expect that dress to increase in price next week you will usually go out and buy it now. 

Expectations are powerful incentives,,, think of the milk section before a big storm hits. 










8. Expected Future Income of Consumers

If you expect to get a big raise in the next month, or a big bonus you might choose to spend know knowing that you will be able to pay for your purchases later. 

Know these Concepts


Reffonomics - website with interactive determinants of demand.

Welker and the Determinantes of Demand - Video

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Demand 2 - Why does the Demand Curve Slope Downward

Why does the Demand Curve Slope Downward

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Pajholden doing it well.



There are 3 reasons that the Demand Curve slopes downward.
  1. Substitution Effect
  2. Income Effect
  3. Law of Diminishing Marginal Utility

Substitution Effect:

Definition - If the price of X increases then all other goods automatically become relatively cheaper                       so consumers will tend to substitute other goods in place of X.
                    (If the price of beef rises then I will switch to chicken, or pork or fish)

                    or - as the price of a good X decreases, consumers switch from other higher priced goods                            to the lower priced good X. (As the price of beef decreases I will switch from                                      chicken, pork or fish back to beef) 

Income Effect:

Definition - When the price of good X increases, consumers' real income is lowered so the quantity of                     good X they can afford is lowered. (When things get more expensive its harder to make                       ends meet)

                   or - When the price of a good decreases, the quantity demanded now increases because                               consumers now have more real income to spend. (When the price of a good                                           decreases we can buy more of it)



Law of Diminishing Marginal Utility:

Definition - As we consume additional units of something, the satisfaction (Utility) we derive for each additional unit (marginal unit) grows smaller. (diminishes).

Law of Diminishing Marginal Utility - done well by mjmfoodie




Reffonomics - Why the Demand Curve slopes down. - Interactive







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Demand 1 - Demand & Quantity Demand

Demand

Demand - definition - the willingness and the ability to purchase a quantity of a good or service at a                                       certain price over a period of time

Law of Demand - an increase in price leads to a decrease in Quantity Demand (Qd).

Introduction to Demand - by mjmfoodie.



Watch the video and then see if you can answer this AP exam question,,

2000 AP Exam Microeconomics - 


Answer - (C) In the past several months, as the price of compact disk players has decreased the quantity of compact disk players sold has increased. ( Doesn't this make sense, price goes down more is bought/sold)

* In a demand curve the price and the Quantity Demanded have an inverse relationship... 


What does that mean? 

It means that as the price of a good goes up the quantity demanded goes down. Conversely, if the price goes down the quantity demanded goes up.

Say it again,,, (Price goes up less is bought,, Price goes down more is bought.)  Simple right?

Quantity Demanded is not Demand (Say it over & Over)

Please watch the video below..

Quantity Demand is a movement up or down the curve. 
Quantity Demand is driven by a Price Change.


I'm going write this again,,, Quantity Demanded is driven by price. Look at the curve above. When a cake costs

  • at $9 a cake the quantity demanded is 1 cake,
  • at $8 a cake the quantity demanded is 2 cakes, 
  • at $7 a cake the quantity demanded is 3 cakes,
  • at $6 a cake the quantity demanded is 4 cakes,
  • etc etc, all the way until at a price of $0 the quantity demanded will be 10 cakes.
All students have an issue with the difference between a movement on the curve and a shift of the curve. 



Take a moment and go to this website and play with the interactive graphics.
http://www.reffonomics.com/TRB/chapter4/quantitydemanded.swf

Always good to watch a video by Welker -












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