Transcription
How's the class? So today we're gonna talk about chapter four. Chapter four, uh, extends beyond chapter three, where chapter three brought in supply and demand. Chapter four is the extensions of supply and demand analysis.
So, a reminder about using supply and demand. Remember, we had two different types of market systems: command and control, and then a market-based price system. So, we are generally talking when it comes to supply and demand, we're talking about the price system or the market system. And essentially, we call it the price system because prices provide info to households and firms. Uh, it's a very important signaling mechanism, and the price system indicates what is relatively scarce and what is relatively abundant. If things are relatively cheap, then things are abundant. If things are relatively scarce, then they tend to be more expensive.
So, one thing about markets, it emphasizes the concept of voluntary exchange. We voluntarily enter the marketplace and choose to purchase or sell, depending which side you're working from. And the markets therefore determine the terms of exchange, and the markets also facilitate exchange. So, when we talk about voluntary exchange, this is a concept where, uh, voluntary exchange will make both parties subjectively better off. Now, it's possible that one side gets ripped off from the other side in terms of one gets a better deal than the other, but if both believe that they're better off, well, then they're subjectively better off. So, irrespective of what the actual outcome in terms of who wins and who loses, subjectively is the term there, anyway.
Along with, uh, in the market system, uh, there are transaction costs as well with exchange. So, example would be price shopping. Uh, you know, in you, when you're in the marketplace, you want to find the best deal, and that is an opportunity cost, the effort for price shopping. And of course, the same thing for determining quality, determining reliability, and service availability. And of course, there's the concept of the cost of contracting, which is negotiations and seeking out and background checks and whatnot, if you're talking about, uh, constructions and so forth. But if you think about, uh, the world nowadays with amazon.com and ebay and so forth, uh, price shopping, determining quality, determining reliability, certainly has gotten easier in many ways. But of course, there are problems as well. I know Amazon has a lot of issues with, uh, false or biased, uh, reviews that were kind of paid for or, in a sense, it was, are subtly bribed with the free goods for their review. So, uh, that can be an issue as well, and that increases transaction costs because you're having to sift through all that information and determine what is reliable. Uh, so sometimes middlemen or intermediaries, they're, they're very important to reduce transaction costs. So, some examples we have here: real estate brokers or stock brokers. Their understanding of the marketplace allows you to not have to understand so much. So, it does reduce the transaction costs of buying a home. But of course, there is other costs as well, the cost of, uh, for a real estate agent, for example, their commissions and so forth. But we assume that, uh, that is worth it to us because we undertake that instead of learning how, uh, to negotiate in the marketplace, all the contracting, all the process that goes along with real estate. So, their professional training and so forth will reduce transaction costs, and we do find a value in it.
Now, when we talk about changes in demand and supply, if you recall, uh, we talked a lot about ceteris paribus, so holding other variables constant. The thing about changes in supply and demand in the real world, it doesn't always, I mean, you don't see ceteris paribus, but it's just a method for us to start learning the tools so we can apply our understanding. But change in supply and demand create some sort of disequilibrium, and when there's disequilibrium, then prices and quantities adjust. And actually, I think I will give a quick example. Look at that. So, if you look at a situation where we have price and quantity, supply and demand, and then we have an established price, we'll say P1 and Q1. And then we see a situation of demand increasing from D1 to D2. So, now, with this situation, this would be the new equilibrium, but it takes time. There's a disequilibrium at first because we're stuck here at P1, Q1. And what happens is now, based on the given price, with the increase in demand, now there's this distance here where quantity demanded exceeds quantity supplied. And when quantity demanded exceeds quantity supplied, if you recall, there's going to be upward pressure on the price, the consumers bidding up the price. And then price eventually does adjust to P2. So, that's a situation where disequilibrium occurs, uh, because D2 shifted out, but we're stuck at P1. But eventually, price and quantity adjust.
Okay, so also, we can look at a situation when both supply and demand increase. There's a question of what happens to prices, but we can also say that quantity for sure increases. So, we can take a look at that. So, we have price, quantity, supply, and demand. Okay, we have a given P1, Q1. Now, if both supply and demand increase, we have demand D2, and we also have supply S2. Now, here it shows that price maybe looks like it was the same, but what happens if one of the curves shifted to the right but not as much or more than I indicated? Either way, it's hard to, whatever it is, it's hard to tell what price does. It could be a little higher than P1, or it could be lower than P1. But one thing's for certain is that quantity will have increased. It's this part, price, that's ambiguous. It really depends on the magnitude of the shift of supply and demand and where S2 and D2 falls. So, that's why it's unclear.
Now, the same thing can be said when both supply and demand decreases. Again, depending on the magnitude, the changes in the price is unclear, but for sure, we do know that quantity decreases. And then when supply decreases and demand increases, well, for sure, we know that price increases. But what happens to quantity? Again, it's unclear. It really depends on what, uh, what the magnitudes of the shift were. So, let's look at the situation when supply decreases and demand increases. S1, D1, PQ have P1, Q1. So, we said supply decreases, so it shifts to the left, S2, and demand increases, D2. So, we have a new equilibrium for sure, okay? And so, one thing is for sure, price increased, P2, somewhere, are somewhere above P1. But again, depending on the magnitude, it's unclear whether we're going to be to the left of Q1 or to the right of Q1, depending on how both supply and demand changed. And then the same thing occurs for when supply increases and demand decreases. Again, price for sure will decrease, but quantity result is unclear without more information, for example, of the magnitudes of the shifts.
So, now we can talk about the rationing function of prices. Essentially, that price is the mechanism, is the incentive that assures that rationing occurs appropriately. So, to reach equilibrium, we're looking at the synchronization of decisions of buyers and sellers, and they're all reacting to the price situation. Price is too high, this is what they'll do. Price is too low, this is what they'll do. And depending on which side they are, the supply side or the demand side, again, all that, all that comes into play here. So, the methods of non-price rationing is a situation where we're dealing with scarcity and we need to make sure that we allocate our goods. It could be concert tickets, it could be bottled water, it could be COVID vaccines, for example. But methods of non-price rationing, uh, one is by rationing by queues, essentially saying, you know, get in line, and we're gonna serve the, the order of the line. Or by random assignment. Another way is to say, you know, he, uh, we're, I'm just going to draw names from a hat, or an equivalent method in the marketplace that would be, uh, a random assignment. And coupons. So, for example, you issue this many coupons to say, present this, and you'll get a free this, or you'll get 50% discount, whatever it is. But you're gonna affect behavior and ration goods through these non-price rationing methods. Okay, so it's this issue of scarcity that forces us to ration.
Now, price versus non-price rationing. Price rationing leads to what we consider the most, quote, efficient use of available resources. So, efficient, one way to look at the concept of efficiency is that those who are willing and able to pay the most for a good or service are the ones who actually receive it. That's what we consider efficient. Now, is that fair? I mean, it benefits the rich versus the poor, especially when something is scarce and expensive, right? Is that fair? That's not the issue. In economics, we don't really, I mean, we do talk about fairness in a way, but the main issue is efficiency. Um, so, in a sense, in the last bullet point, all gains from mutually beneficial trade are captured. And we're going to talk about consumer and producer surplus upcoming in in upcoming chapters, and that'll be applied to this concept of efficiency. So, consumer and producer surplus in the bottom point has to do with the concept of efficiency. Okay, so the question then that we can look at is, price actually the best way to ration? Well, best is more of a normative statement versus a positive statement. Normative with a subjective and so forth. Positive statements are purely descriptive statements, or statements of what is. Uh, so price, the best way? Well, best is unclear, but what we can say is that the price method leads to the most efficient use of available resources. Okay.
Now, um, there's the policy of government, uh, imposed price controls. Price controls are government-mandated minimum or maximum prices. So, we'll be talking about in this case, price ceilings, which is a legal maximum price, or price floors, a legal minimum price. So, let's see regarding price ceilings, a legal maximum price. A lot of people get this mixed up at first. So, if we're talking about price ceiling, price, quantity, supply, and demand, here's our equilibrium price. People think the price ceiling would be above their equilibrium price, P star, because they think of a ceiling being above their heads. But think about what controls are, their constraints. They're keeping us from reaching our equilibrium point. Equilibrium is like our center of gravity, and that's what our market forces are trying to return us to. So, a price ceiling is actually set below, I'll put the letter C there for the word ceiling, and it's set below the equilibrium price. So, you can kind of look at it this way. The, the P star center of gravity is everything's trying to get there, but this price ceiling is my individual here is hitting their head on this ceiling, not able to reach equilibrium. So, the constraint of a price ceiling is actually set below equilibrium price. And likewise, a price floor is keeping this individual up here from reaching, I'll put F for floor, from reaching our equilibrium, uh, supply quantity supplied equals quantity demand. This floor is keeping them from reaching it as well. So, it's a constraint. Therefore, it's a little bit opposite of what sometimes people think. A lot of people kind of reverse these and think, well, a price ceiling will be above, and a price floor will be below equilibrium. But no, that's not the case.
Now, price ceilings, uh, cause inefficiencies. Again, a price set too low, inefficiencies cause it would be inefficient allocation to consumers. So, for example, people who want it and are willing to pay high still can't get it. Wouldn't that be frustrating if you had the money, you worked hard, and the item that you really wanted, you really desired, is price is set below equilibrium? Therefore, people who don't want it nearly as much, people who aren't willing to pay as much as you are, will get it because of the lower price. It can't be charged at a higher price. Therefore, this is what we consider inefficient allocation because you might have been one who was willing to pay more and able to pay more than the other people, yet you still weren't able to get it. So, it's inefficient wasted resources. Uh, well, in a situation where there's going to be shortages, for example, you not getting what you want, there's going to be efforts that you spend dealing with the shortages and trying to get what you want. And again, the opportunity cost, that's a wasted resource. And of course, inefficiently low quality. Low price tends to lead to the seller offering low quality goods. Typical, uh, with ceiling type of situation here would be rent controls, keeping rents artificially low. Now, if you were the landlord and you had a, a unit that you wanted to rent for $3,000, and you could rent it because people were willing to pay it, but the law says you can't rent it for more than $1,000. So, you're stuck with that. Well, there might be some now repairs that might be needed, you know, painting that might be need to be done and so forth, maintenance issues, upkeep, or even redecorating. But why would you, if you cannot capture the rent that you were actually, uh, hoping for or able to, in absence of the price ceiling? So, what happens is inefficiently low quality occurs because nobody has the incentive to upkeep on property that they cannot capitalize upon. And of course, there's illegal activity. Whenever these shortages occur and laws are skewing the situation, then people start to go into black market situations and try to get around the laws. Uh, so that's a situation, uh, that where ceilings cause inefficiencies.
And likewise, price floors, artificially high prices also cause inefficiencies. Inefficiencies cause would be the inefficient allocation of sales among sellers. So, in that case, those willing to sell the goods at the lowest price are not always the ones who managed to sell it. Imagine that you were a firm and that you have the ability to produce a good or a service at a lower cost, simply because you're smarter and more efficient than every other seller selling that good or service, but the law says you can't sell it below a certain price, you have to sell it for a higher price. Now, you aren't able to cut your prices to capture more market share and gather more customers because the law is not going to let you. So, your comparative advantage in producing that good or service is not something you can capitalize upon because of the laws. So, again, wasted resources. For the second bullet point, also comes in surpluses are destroyed or spoilage. This is a situation with agricultural products where we have artificially high prices set, and, uh, for like for our farmers and so forth. And what happens is they're unable to sell it, they have surpluses, and for that reason, they gotta destroy it, get rid of it, because otherwise it's just sitting around and spoiling. Um, and inefficiently high quality goods also occurs, because the prices are kept artificially high, sellers are trying to get more market share. And if they can't do it on price, well, then they're going to offer higher quality at a high, at that higher price. But you know what? Buyers might prefer lower quality at lower price. So, that's a situation where inefficiently high quality goods are produced when there's a government imposed price floor. And then of course, again, illegal activity to get around these market forces, are these, uh, the market, uh, distortions, rather.
Okay, so, um, non-price rationing devices are essentially all methods used to ration scarce goods that are price control, and that oftentimes lead to black market activity. Black market is a market in which price controlled goods are sold at a generally an illegally high price. Of course, there's black market goods where things are sold at a low price too, but that's, uh, uh, we're not focusing on that right now. But here's a situation of a black market. This might be a little confusing, so let's kind of spend a little time talking about this. Let's say that we're looking at a price ceiling of $600. Okay? Now, at $600, which is not the higher price equilibrium of $1,000, it's low. So, the supply curve, which is the firm side, they don't like the low prices. So, at $600, they found it only worth their while to produce 5,000 units. So, now the quantity is fixed at 5,000. So, irrespective of what the price does, price goes up, no more will be produced. Uh, I mean, sorry, not price goes up, but because there's no ability for price to adjust, we're stuck at 5,000. So, now there's this implicit supply schedule where we look at this 5,000 units that I, I hope I said it correctly earlier, but 5,000 quantity that we're only producing because the price ceiling at $600. But now it creates this implicit supply schedule because now at 5,000, one way to look at it is if there's only 5,000 goods that can go around, looking at the demand curve, there are people who are willing to pay $1,400. Because quantity is constrained at 5,000, there's a certain amount of people on the demand curve who pay $1,400. And this is the black market price that they would be paying at this implicit supply schedule because quantity is constrained at 5,000 due to this price ceiling of $600. So, that's how this black market situation, where the price ceiling creates an implicit supply schedule.
So, here's some other examples. The policy of controlling rents. The function of market rental prices. Well, when we talk about market rental prices, that means supply and demand is allowed to reign in the marketplace to control the marketplace. Market rental prices, they promote efficient maintenance and construction because people are able to capitalize on and gather the rents that they want. That's fair, and it does allocate the existing housing. It's efficient. It's making sure the people who are willing and able to pay the most receive the good or service, and therefore it rations the use of housing. Price controls on the other hand, discourage, have been shown to discourage construction. So, with some of this old data, but it's, it's still relevant. With a 16% vacancy rate and no price controls, Dallas recently built 11,000 new rental units. Now, with a 1.6% vacancy rate and controls, San Francisco recently built 2,000 new rent rental units. Think about that, 1% vacancy rate versus 16% vacancy rate. Housing is, housing is relatively scarce based on this low vacancy rate. Everyone's living in places. You would think that more units would be built, but only 2,000 new rental units were built. Whereas, 16% vacancy rate, there's a quite a bit more relative percentage of empty units, yet 11,000 new rental units were built. So, the price controls discourage construction.
Effects on the existing supply of housing and current use of housing. Property owners cannot recover costs, the cost of maintenance, repairs, capital improvements. We kind of mentioned that. It also rations the current use of housing. There's reduced mobility. In New York, if you're probably familiar with that, there's housing gridlock because of price control. A lot of people are in units that they don't want to let go because it's really, really low. And therefore, you know, people are needing it, people might want to move out, but there's all kinds of issues such as black market activity. For example, somebody might have a unit that they're paying $1,500 for. The market price might actually be $3,000 for. Now, they want to retire and go to Florida, maybe, but they, they don't want to let go of that $1,500 a month unit. So, what they might do is rent it to somebody for $2,500, $500 cheaper than the market price, and thereby create this black market environment. Uh, so there's attempts to evade rank, rent controls, because rent controls are basically, usually set up for, kind of, if you've, if you've qualified for it, you have the rent control unit until you die or until you pass it on to an offspring. But if you don't have an offspring or something to pass it on to, then it is released from the rent control, and now the landlord can capture the appropriate rents for it. So, landlords might do things, try to force tenants to leave. Of course, I mentioned the tenants subletting apartments as well. And all this created a special housing court in New York to deal with all these issues. I'm not sure if you're familiar, but even it was proposed in, uh, in Hawaii on Oahu, I think, that we're looking at not a housing court, but a homeless court. I think they wanted to put together a special court to deal with homelessness issues, and, and because there was too much to have it go into our regular court system. But anyway, essentially, there's expensive costs regulating rent control. Like we just said, there was an entire judicial system developed in the state of New York to deal with rent control issues.
So, when it comes to rent control, who gains and who loses? The losers tend to be the property owners because they can't, uh, get the rents that they feel they deserve. And of course, actually, not of course, but believe it or not, low-income individuals are the losers. Why are they the losers? Because look at the gainers. The gainers happen to be upper-income professionals. Empirical data shows that upper-income professionals benefit the most, and it, that their benefit ability to benefit is due to the master, the bureaucracy, and large network of friends and connections that they're able to, you know, get their, get their bids in or or get an edge on other competitors for the unit, simply because, well, kind of money talks, and people with money kind of they congregate, they work together because at some point they're going to be capitalizing off each other again anyway.
Another example of a price distortion, and in particular, a price floor, is in the labor market. And in particular, the minimum wage is a price floor. So, it's a wage floor legislated by government. Okay. So, taking a look at the effect of a minimum wage. So, let's, uh, let's kind of talk about this real briefly. This is the labor market. This is a little different because normally when we're thinking of supply, we think about the supply as the firms. But this time, I'm going to use HH for households. Households are the supply of labor. They're the workers, and they respond to the price of labor, wages. So, one way to look at it is the higher the wage, the more a household individual is willing to work. You'd like to work at McDonald's if you're getting, in today's dollars, and on and so forth and so on, $250,000 a year for pressing a button with a picture of fries on it or a hamburger on or a soda on it. I, I'm joking. I don't know what the registers look like. But the point is, is that the supply of labor is upward sloping. Just like if the wages are low, you know, as a household member who could work, you're not so excited about working for $2 an hour. You might decide to do other things with your time, go surfing, go to the movies, go golf, whatever you can afford, if so, of course, or just sit on the sit on the couch and watch reruns of Law & Order. Essentially, the upward sloping supply curve is the households, the workers who supply the labor. And the demand for labor are the firms. So, it's a little reverse from what we talk about supply and demand from chapter three.
So, now, minimum wage is a price floor, as shown here. Now, what it does is it creates point A and point C. But keeping in mind, we're talking about our starting point of equilibrium, WE, at point E. That's our equilibrium point, leading to this quantity down here below it, QE. Now, that means point B up here is the original quantity. But due to this price, or this minimum wage, WM, we have the demand for labor at point A, and the supply of labor at point C. In normal times, our normal market situation, we'd be at point B in terms of quantity. So, going, uh, with this new minimum wage, there's a gap between A and B. This right here, this arrow right here, is the reduction in quantity of labor demanded. And then now, over here, relative QE to QS, that's the increase in the supply of, uh, quantity of labor supply because the workers like the higher wages that they could earn. So, the gap here, A through C, is the total amount of unemployment. But we can break it down in terms of the two arrows, like we said here and here, based on these factors. Okay, so this is the effect of the minimum wage. Essentially, it creates unemployment. There's an oversupply of labor and under demand of, uh, of the labor from the firm's perspective.
And that ends, uh, what I intended to cover for chapter four. So, hopefully, that's good to get you guys, uh, started on the homework sets. And after this, we will continue on. And I hope everyone's doing well. Stay healthy. I hope everything's going well. And I will talk, look forward to talking to you guys soon. Aloha.