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Summary Microeconomics Major European Economy
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Contains chapters KWG 4,5,6,8,19 and BW 4,6,9,11,12
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Micro economie Week 2Price controls and Quotas: meddling with markets chapter 4
supply and demand.
Demand curve and consumers surplus
Willingness to pay: the maximum price at which the consumer would buy a good.
This defines the demand schedule.
Individual consumer surplus is the net gain a buyer achieves from the purchase of a
good. It is the real price minus the price the consumer was willing to pay.
The total consumer surplus is the net gain of all consumers together. The term
consumer surplus is used by economists to refer to individual and total consumer
surplus.
The demand curve is stepped when it is the surplus of only a few consumers, when
there are many consumers the demand curve is a smooth curve. The total consumer
surplus generated by purchases of a good at any given price is equal to the area below
the demand curve and above the price curve.
Supply curve and producers surplus
The lowest price at which a producer wants to sell is called the sellers cost. This cost
represents opportunity costs of the supplier.
Individual producer surplus is the net gain a producer achieves from the purchase of
a good. Total producer surplus is the total gain to all sellers of the market. Producer
surplus indicates both the individual and the total producer surplus. The total
producer surplus from sales of a good at any given price is the area above the supply
curve and below the price.
The total surplus is the sum of the consumer and the producer surplus.
Governments can control markets if they think the equilibrium price and quantity are
not high enough. When a government intervenes to regulate prices, we say it imposes
price controls. The market can be controlled in two ways: with a price ceiling (the
government sets the highest price that can be asked for a good) and with a price floor
(the government sets the lowest price that can be asked for a good). These price
controls may seem great, but there are also negative side effects. Imagine the price to
rent a house was $1000, and after the price ceiling the price becomes $800. The
consumer surplus will grow, but the supply surplus will decline. This leads to shortage
of houses: more people want to rent a house than offer their house for rent. If a price
ceiling is above the equilibrium price it won’t have any effect, so you won’t see this
disadvantage. Shortage leads to inefficiency: gains from trade go unrealized. The
quantity of apartments reduces, it leads to misallocations of would-be renters, it leads
to wasted time and effort as people look for apartments, it leads landlords to maintain
their apartments in low quality/condition.
The result is the loss in the total surplus associated with the transactions that no longer
occur due to market intervention: deadweight loss.
Inefficient allocation to consumers: inefficiency that occurs due tot price ceilings,
some people who want the good badly and are willing to pay a high price don’t get it,
and some who care relatively little about the good and are only willing to pay a low
price, do get it.
To avoid this, it would be an idea to sublet apartments, but this is illegal.
, Another inefficiency of a price ceiling is that it leads to wasted resources: people
expend money, time and effort to cope with the shortage of housing. This leads to
opportunity costs: the people (who would have accepted a higher rent price) could
have worked instead of looking for apartments.
A third effect of price ceilings is inefficiently low quality: sellers offer low-quality
goods at a low price even though buyers would rather have higher quality and would
be willing to pay a higher price.
The fourth effect is black markets: goods or services are bought and sold illegally,
because it is illegal to sell them or because a price ceiling prohibits the prices. This
illegal activity worsens the position for those who are honest, they might never find
an apartment because others are willing to bribe the landlords.
The results of price ceilings:
- Shortage of the good
- Inefficiency arising from the shortage
- Emergence of a black market
Still, the price ceilings do benefit some people, people don’t realize they would be
better off without the ceilings, and the government doesn’t always understand supply
and demand, that’s why these ceilings still exist.
Price floors
Governments intervene to push up market prices; this is called a price floor. An
example of the price floor is the minimum wage. A price floor leads to higher prices,
and the demand declines at this price. This price floor leads to an unwanted surplus.
When the price floor is set beneath the equilibrium price, the floor is not binding (the
floor has no effect). The unwanted surplus is often bought by the government and
stored somewhere. When the government is not prepared to purchase the surplus, a
price floor means that would-be sellers cannot find buyers.
4 negative effects of price floors:
- Inefficiently low quantity. A price floor raises the price of a good, and reduces
the quantity demanded by consumers. Sellers can’t sell more than the
consumers are willing to buy and this leads to a deadweight loss.
- Inefficient allocation of sales among sellers. Those who would be willing to
sell the good at the lowest price are not always those who actually manage to
sell it. People would be willing to work for less money than the minimum
wage, but law forbids this.
- Wasted resources. A lot of production is useless and the government destroys
this part of the surplus. The price floor leads to wasted time and effort. Would-
be workers search for work for a long time.
- Inefficiently high quality. Suppliers offer goods of a too high quality, while
suppliers and buyers could make a mutually beneficial deal in which buyers
got goods of lower quality for a much lower price.
Price floors also lead to illegal activity, such as black labour. This is very common
in southern Europe.
Controlling quantities
The government regulates the quantity of a good that is bought and sold rather
than the price at which it transacted by quantity control/quota. The total amount
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