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Equilibration Jim Cox, University of Alabama at Birmingham Murray Rothbard has an excellent illustration of equilibrium in his Man, Economy, and State: "[Equilibrium] is like the mechanical rabbit being chased by the dog. It is never reached in practice, and it is always changing, but it explains the direction in which the dog is moving." The Law of Demand and
Fixed Charges or Discounts Ben Collier, Northwest Missouri State University Students are frequently less than excited about the Law of Demand. Since it should be perfectly obvious to anyone that the lower the price the more consumers would want making such a statement is rarely cause for excitement. To generate interest in this fundamental theorem I find it useful to introduce some of its less obvious implications. For example, a fixed shipping charge added to both a high quality and a low quality version of the same basic product will cause the high quality product to be consumed in relatively greater proportions. Thus the ratio of high quality to low quality Florida oranges consumed will be higher in New York than in Florida. In New York a high quality orange costs less in terms of a low quality orange than it does in Florida. This same argument can be applied to the use of discounts such as coupons which give a fixed price reduction for two or more sizes of a product. In such cases the law of demand predicts that the smaller size will be consumed in relatively greater proportions. This may be food for thought the next time a student receives a coupon good for a dollar off either a medium or large pizza. Waylon D. Griffin, Hofstra University Often my students think that a shooting war in the Persian Gulf is the cause of increases in the world price of crude oil. War, per se, does not affect oil prices. Shooting and bombing do cause speculators to get excited and buy more oil to increase inventories; as a result, prices rise on the spot and futures markets follow in the near term, several days. But in the longer term, several weeks world oil prices are determined by the marginal changes in the physical barrel of oil, not the speculative, or paper barrel. So, to make the point I say, "The Persian Gulf can literally turn to blood but if the normal movement of oil tankers is not disrupted, the world price of oil will not change. Yet, if not one finger is pricked of blood, but a tanker sinks and slows the movement of other tankers, prices will rise." War must in some way affect the marginal quantity of oil available for sale to affect oil prices; otherwise, war has no affect. Price Floors and Black
Markets for Low Quality Produce Roy B. Levy, Pennsylvania State University-Delaware A number of states, e.g., Delaware and New Jersey, employ an English auction for the sale of farm crops. As a former produce buyer, I often observed that an initial price announcement by the auctioneer (P0 in Figure 4-1) for a low quality lot generated no bids among the buyers. At such an effective price floor, the equilibrium quantity at the auction was zero.
Figure 4-1 A nearby gasoline station or restaurant, sites known to both seasoned buyers and sellers, served as a location for the formation of black markets for low quality crops. Many of the low quality lots of produce that comprised the surplus quantity (Q0 in Figure 4-1) typically sold on the black market at a price below P0. Classroom use of this anecdote has served to introduce the adjustments that some economic agents make in response to price controls. Movements Along vs.
Shifts in the Demand Curves Mark Zupan, University of Rochester To help students distinguish between movements along and shifts of the demand curve, I let my students think of traffic school. In many states, including California, one can get a moving violation erased from one's traffic record each year by paying $35 in tuition and attending an 8-hour traffic school. The presence of traffic schools has two counteracting effects on the demand for speeding. First, it induces a movement along the demand curve by lowering the price of speeding since for many people the $35 in tuition and 8 hours on a Saturday attending the school is less of a burden than a $75 ticket and the increased insurance costs that accompany the violation on one's traffic record. Second, traffic schools attempt to shift the demand for speeding leftward by having instructors lecture students on the need to obey the law and having students watch movies about what can happen to drivers who speed excessively. One the other hand, some people have claimed that traffic schools actually shift the demand for speeding rightward since instructors will often tell students about the various techniques available to them for getting out of future tickets. In the school I attended, for example, the instructor spent nearly 3 of the 8 hours of class telling us how best to deal with a California Highway Patrol officer, how to change the venue on a violation in the hopes that the officer will not show up thereby causing the charge against you to be dropped, how to fight a ticket in the courtroom, etc. A recent statistical study by the California Department of Motor Vehicles indeed reveals that, all other things equal such as prior driving record, attendance at traffic school does not make you a better driver and that the demand shifting effect of traffic schools may thus be nonexistent. Given the two competing effects and the evidence that traffic schools may not be too successful at shifting the demand for speeding, the students come to the conclusion that traffic schools work to increase the equilibrium amount of speeding. Traffic schools may also worsen the efficiency of the insurance market by partially masking drivers' records, thus making it more difficult for insurance companies to distinguish bad drivers from good drivers. Explaining Why Market
Quantities Change Mark Zupan, University of Rochester In reviewing market operations, point out that while comparative statics is typically used to predict what will happen to equilibrium if a determinant of D or S changes, it can also be used in reverse to explain why a particular change in equilibrium has occurred. As an example, give them a graph such as that shown in Figure 4-2 of the market for lawyers, where the equilibrium has shifted northwest of the equilibrium in, say, 1930. Ask them why? This will get them to thinking that the dominant change has been a rightward shift in demand and get them wondering about which determinant of D has been changing (Y?, an increase in tastes for engaging in legal disputes and for defining personal property rights (e.g. in divorce, etc.).
Figure 4-2 The Changing Market For Lawyers Simultaneous Changes in
Supply and Demand Djehane Hosni, University of Central Florida It is important to emphasize that the effects of simultaneous changes in supply and demand are simply the sum of the separate effects of supply and demand, respectively. We can isolate each effect and then treat them as though they were, in a sense, simultaneous equations. Four cases can be distinguished. The most effective classroom presentation occurs if you place tables of the following type on your blackboard, with arrows up or down to indicate determinate directions of change, or a big question mark when the result is ambiguous. A. Supply And Demand Both Increase Supply Demand Net Effect Effect Effect Quantity Up Up Up Price Down Up ? B. Supply And Demand Both Decrease Supply Demand Net Effect Effect Effect Quantity Down Down Down Price Up Down ? C. Supply Grows But Demand Falls Supply Demand Net Effect Effect Effect Quantity Up Down ? Price Down Down Down D. Supply Falls But Demand Grows Supply Demand Net Effect Effect Effect Quantity Down Up ? Price Up Up Up Students should see that quantity unambiguously increased (decreased) when both demand and supply increase (decrease), but that the direction of the change in price is indeterminate because the double shift produces forces working in opposite directions. Similarly, they should see that price rises if demand rises while supply declines, and that price falls if demand falls while supply grows, but that the direction in which quantity changes is ambiguous in both of these cases. This exercise also provides a good place to discuss the differences between qualitative predictions and quantitative predictions. A Martini to Help Us
Understand How Markets Work Charles C. Fischer, Pittsburg State University As teachers we soon discover how useful a good physical analogy can be in helping students understand some abstract concept or idea. Ideally, the analogy should involve a physical concept or phenomenon that students are already familiar with, that closely approximates the economic counterpart in question, and that is of interest to students and, thus, acts as an attention-getter. The following analogy does a pretty good job of meeting this criteria. I tell my students that to understand the concept of equilibrium price and the process by which this price is established in the market, we need one, and only one, good martini. This requires a martini glass, some gin, a little vermouth, and a perfectly round cocktail onion. Of course, substitutions are allowed, such as beer and a round hard-boiled egg, or Coke and a maraschino cherry for non-alcoholic drinkers. (Mentioning the beer and egg combination usually brings out some moans of disgust from students, but it does get their attention). After making a crude drawing of our martini on the blackboard (see Figure 4-3.), we discuss the concept of equilibrium as a resting place, the onion being at rest on the bottom of the glass, and as a balance of opposing forces, in this case, the force of gravity acting upon the sides of the glass. Next, with the aid of Figure 4-4, I demonstrate that an equilibrium price also is a resting place and a balance of opposing forces. Here, the economic counterpart of physical gravity consists of the forces of supply and demand. The notion of a market surplus (AB at P') putting downward pressure on the market price corresponds to the force of gravity operating on the onion. Furthermore, the changes in quantity demanded and quantity supplied that take place as the price is driven down by the surplus is analogous to how the shape of the martini glass influences the resting position of our cocktail onion. Of course, this analogy can easily be extended to include a discussion of stable and unstable equilibria, and the impacts of various changes in the givens. A nice pedagogical attribute of this analogy is that not only does it have strong heuristic appeal, but, as you can see, its graphic representation provides visual confirmation of the linkage between physical gravity and economic gravity. The martini we make in class demonstrates that it is a small step to go from the familiar physical notion of gravity to the idea of economic gravity and the workings of the market. Figure 4-3 Figure 4-4 The Economics of Death
and Dying in America Henry N. McCarl, University of Alabama-Birmingham All economists are familiar with the old saying, "There is nothing more certain than death and taxes." While the latter is especially familiar in April of each year, the former is a subject often avoided in the study of economics. A best-selling book titled The American Way of Death, and the movie The Loved One, both touched on the economic aspects of dying in America, but the real truth is seldom known until a close relative passes away and the family rushes to make the necessary final arrangements. Some students find it an interesting even if a bit off-beat, project in economic analysis to examine the financial aspects of life insurance, funerals, perpetual care cemetery plots, internment in mausoleums, cremation, posthumous donation of body parts and related costs and potential economic benefits. Alternatives to internment may also be examined in terms of cost effectiveness. Analysis of supply and demand concepts can be associated with an examination of alternative uses for urban land that has been used historically for cemeteries or burying grounds. A discussion of social customs and mores can be associated with economic analysis to show the restrictions placed on future land uses by attitudes toward alternative recreational uses of sacred ground such as golf courses. Examine the etiquette of playing through funerals or open graves as alternatives to sand traps, etc. Additional economic aspects can be examined with the limitations and problems created when building streets and highways, as well as dams and reservoirs, when they impact on the final resting place of the dear departed. H. J. O'Neill, Suffolk County Community College Officer prison camps in Germany during World War II contained separate sections for British, French, Flemish, Dutch, and other nationalities. Inputs: a. GOODS: Red Cross - Food and tobacco parcels; food from guards and camp kitchens. b. SERVICES: Skills of prisoners as seamstresses, watch repairs, barbers, cobblers, dental repair, etc. At first barter was used, later cigarettes became a standard of value, and eventually script money appeared, but it was discontinued due to counterfeiting. Red Cross parcels arrived once per month. Some men set up as specialists--a still for liquor, dealing with guards, dealing with prisoners of different nationalities, finding desired goods for a fee, storekeeper or peddler, banker or loan shark, pawnbroker for jewelry, watches, etc. Each nationality had a market area with stalls, posted prices and translators to deal with other nationalities. In time, some individuals or groups became very wealthy in goods or cigarettes or script and were usually disliked. They had paid bodyguards, servants, and lived better than most prisoners. Future deliveries of Red Cross parcels or services or extra clothing were often pledged for loans or desired goods.
Figure 4-5 The Prisoner of War Camp High demand items included tobacco, candy, canned fruit, liquor, underwear, mittens, sweaters, soap, and musical instruments. Speculators checked prices in other nationalities' areas and hired translators. Camp guards raided barracks for illegal hoards, but they could be bribed; a warning could be obtained to move stock or, for a larger fee, guards would divert the raid to a competitor. WELFARE ASPECTS - prisoners never starved - always had shelter, prison rations and one parcel a month from the Red Cross. Suggestion: Recommend the novel King Rat, by James Clavell, to your students. a. What happened to prices 10 days before a delivery was due? b. What happened to prices the day before a Red Cross delivery? c. Why was a skilled or cheating card player in a superior position? d. Why did non-smokers or candy-haters have an advantage? e. Why did specialists continually check prices in other markets? f. How did a confiscation raid by guards in a particular section affect prices in their own and other sections? g. What skills would facilitate success in this economy? h. What happened when a Red Cross delivery did not arrive? i. What happened when a double Red Cross delivery arrived? j. What happened when word arrived that the allied armies were only a few miles from the camp? This example illustrates a real-life economy with all inputs controlled. Ralph Byrns Offer stock markets and commodities markets as examples where supply and demand are in such constant flux that prices and quantities move daily. [You might assign students to do a little library research to trace the prices of volatile stocks (e.g., stocks of companies that are rumored to be targets of takeover bids, or computer or electronics stocks from 1993-2005) or farm commodities (e.g., wheat or hog bellies) for short periods to make this point, and to familiarize your students with the financial pages.] Then offer some examples of markets that seem to be highly stable over long periods (e.g., the demand and supply of nuts and bolts in your local hardware stores, or for ice cream cones -- real prices and quantities change very little over time.) Analogies for
Equilibration Paths Ralph T. Byrns Emphasize that transaction costs prevent instantaneous equilibration. After suggesting that equilibration time is positively related to the transaction costs incurred, you might use some of these analogies to describe the time paths of equilibrating prices and quantities: DIRECT PATHS Like barracuda that attack their prey in a straight line. Like an iron ball attracted by a powerful magnet. Like an ace moving from a card shark's sleeve into his hand. CIRCUITOUS PATHS Like a shark that circles and nudges before closing in to feed. Like a nine ball caroming six rails on a pool table before going into a pocket. Like a marble spinning on a roulette wheel before it settles on a number. Ralph T. Byrns Although the text describes a roughly cyclical pattern of annual adjustments to supply in the wheat market, it does not explicitly deal with cobweb models. Your students may benefit from a more formal discussion of cobweb adjustments. For example, suppose that a bumper corn crop depresses corn prices in year 1, resulting in hog production of quantity Q1 in Figure 4-6 (the supply of hogs is temporarily and unexpectedly high.) Hog prices will fall from P0 to P1. This low price may so discourage hog farmers that the production of porkers drops to Q2 in year 2, raising the price temporarily to P2. The unexpected high prices and profits could stimulate production to Q3 in year 3, driving the price down to P3. And so on.
Figure 4-6 Illustrating Cobweb Models The Reincarnation of
Adam Smith William Hildred, Northern Arizona University, and Frank S Wert, University of Central Oklahoma An unexpected classroom visit by Adam Smith and the resulting dialogue proved a lively and effective team teaching method to illustrate Smith's ideas on mercantilism, specialization, and the proper role of government. Donning a full Smithian costume, one of us shows up, unannounced, shortly after the start of the other's class, claiming to be a reincarnation of Smith himself, and demanding the floor in order to right some misinterpretations about what Smith actually said, or didn't say, in The Wealth of Nations. The ensuing lecture, preferably given in a heavy Scottish brogue, is laced with many of Smith's most famous quotations and examples: i.e., division of labor in the pin factory; the invisible hand; the self-interest of the brewer, the butcher, and the baker; and the philosophy of natural liberty. The host professor frequently interrupts the lecture to ask Smith for further clarification or to challenge him on particular points. The format thus becomes an interactive dialogue. This provides an excellent forum to reinforce the use of the scientific method in the social sciences as Smith talks about the influence that Isaac Newton had on his work and that of his contemporaries. The specific objectives of the lecture, and the principles to be covered, easily can be modified to fit almost any economics class. The technique is fun, and student interest is high. Frank Whitesell, University of Southern Mississippi We teach that the competitive equilibrium price is the right price, in the sense that supply and demand are in balance. But there is still a tendency for students, as consumers, to feel that a lower price must always be a good thing. After all, doesn't everybody like a bargain? And aren't high prices inflationary? To convince your students that lower prices are not always better for consumers, have them imagine what would happen if they woke up tomorrow morning and everything were free. Ask them where they would go first to start picking up their free goods. Then have them think about some of the problems they would be likely to encounter there. Subsequently, consider the longer run. What would store inventories look like on the second day of this consumer utopia? What about the quality or availability of services, like haircuts or automobile repairs. Such a thought experiment gives students a real appreciation of the fact that market prices are necessary supply-side incentives as well as demand-side rationing devices. It is a simple step from here to discuss the problems that arise from ceiling prices, such as rent controls. Price Controls Understanding Price
Floors and Ceilings Dale Sievert, University of Wisconsin-Madison Students often find it hard to remember whether price floors are set above or below the equilibrium price. I encourage them to learn the intent of such laws, instead of trying to memorize how they are established. Understanding is made easier by using comparison with a building. At times governments want to aid the buyer in a market. It does so by guaranteeing low prices. The student is then asked to imagine that price is represented by one's position in a tall building, having no stairs or elevators. A person then can be prevented from going higher in the building by being placed at or near ground level and by having ceilings placed overhead. There could be dozens of such ceilings, of course, each representing one story of the building. Wherever one is positioned in that building, it is the ceiling that prevents rising higher in the building. Similarly, price ceilings prevent rising prices. Conversely, suppose a government wanted to help a seller. Prices would be prevented from falling. Again, with the analogy, the person would be placed near the top of the building (a high price). Now, however, a downward movement is prevented by the floors in each story. Thus, price floors prevent falling prices. Floors and Non-price
Competition Michael Kuehlwein, Pomona College Price floors prevent firms from competing with each other through lower prices, encouraging them to engage in non-price competition. One fun example is the way banks competed under Regulation Q, which prevented them from paying interest on checking accounts and limited the interest they could pay on savings accounts. Some banks tried to attract customers by giving away free gifts for opening up an account: clocks, radios, and the like. When the government forbade this practice as a violation of Regulation Q, banks began offering the free gift to the friend of a person opening up a new account. In a case reported by the Wall Street Journal, a bank offered to send a friend of yours a free color TV if you would do business with them. One can also use this example to highlight the inefficiency of non-price competition. What if you (and perhaps your friend) didn't want a new color TV and would have much preferred higher interest rates on your deposits? Tahany Naggar, Westchester University Upon reviewing the difference between price ceiling and price floor, I realized that several students were confused and even questioned whether I had reversed the discussion. I tell them to imagine that they are standing in a building which has three floors and they are on the middle floor. Thus, the layer of the first floor on which they are standing is the ceiling of the first floor, while the layer of the third floor right above their heads is the floor of the third floor. Ultimately, the price ceiling, equilibrium price and price floor are analogous to the first, second and third floors of an apartment building consecutively. A Generic Example of
Price Ceilings Gary Galles, Pepperdine University The analysis of price ceilings is a very fruitful area for showing students how useful economics can be in understanding the world. However, it seems to me that we can fail fully to communicate the analysis in two different ways: 1) we can stick to a dry textbook style treatment of the general analysis which, while covering the analysis, does nothing to generate student interest or an appreciation of the wide variety of ways these effects work themselves out in different types of markets; or 2) we can tell all sorts of "stories" about various price controls, which students find highly interesting, but which do not always leave them with a coherent understanding of the general analysis. In an attempt to avoid both these errors and to give my students an appreciation for both the general (or generic) effects of price controls and some specifics of how these effects work themselves out in different markets, I have used the following method with success. The method is very simple. I introduce a particular example of price controls (which I call a generic example, to drive home the point that the purpose of this is to understand the general analysis): a maximum price of a nickel a loaf is imposed on bread. Then, by directed questioning of the class, I lead them to see what sorts of specific effects a price ceiling on bread could be expected to have. Next, for each specific effect (or set of specific effects), I ask the class to identify the general nature of the effect involved (e.g., a smaller loaf is one way to reduce quality). Finally, I tell them that such a general effect is to be expected from any effective price ceiling or price floor (whichever is then being discussed), and I reinforce this by telling them how those general effects have shown up in several different markets. An abbreviated version of this lecture on controls is as follows, using price ceilings as the example: QUESTION 1: What would happen to the size of a loaf of bread? ANSWER: If producers were allowed to, they would reduce the size of a loaf. If you can't raise the price per loaf, you can raise the price per ounce by reducing the size of a loaf (I tell them I'm sure they could get a Hostess Twinkie sized loaf of bread, sandwich sliced, for a nickel). QUESTION 2: What would happen to the quality of the bread's ingredients? ANSWER: If producers were allowed to, they would lower the quality of the ingredients. Not only would types of bread like Honey Wheat Berry disappear in favor of the cheaper plain white or wheat, but even those ingredients would be allowed to fall in quality (I suggest sawdust, since you don't really want to sell the bread for a nickel anyway). GENERALIZATION: One effect of a price ceiling below the equilibrium price is that the quality of the good will be lowered in whatever dimensions are possible. EXAMPLES: The disappearance of full serve and the appearance of cash only policies and reduced hours at service stations during gas price controls; the reduction in maintenance and service expenditures (e.g., painting, fixing problems) under rent control. QUESTION 3: Would those who enacted the controls want to allow quality to fall, since that evades the intent of the controls? ANSWER: No, so that a bread control board of some sort would be set up to regulate, investigate and enforce standards for sizes and ingredients, and to adjudicate any alleged violations. GENERALIZATION: Price ceilings tend to lead to the establishment of regulatory bodies to prevent quality from deteriorating in whatever manner can be legislated (although there are always ways that can't be either detected or enforced), and these bodies consume scarce resources that wouldn't be necessary in the absence of price controls (repeat business and reputation give firms sufficient incentives, absent the controls). EXAMPLES: Santa Monica or New York rent control boards; regulation of fees, etc. in states with usury laws setting maximum allowable interest rates. QUESTION 4: If you could give bread a new name or form to escape the controls, would you? ANSWER: Of course. You might expect the emergence of jumbo bagels or sandwich style muffins, as well as a resurgence of frozen bread dough, all as ways to sell bread and avoid price controls. GENERALIZATION: If there is any way to rename a good or alter it so as to avoid price controls, it will be tried. EXAMPLES: Under steel price controls during the Korean war the price of seconds (with "imperfections") rose dramatically, far above the controlled price of standard steel, and the percentage of seconds produced also rose dramatically; condo conversions, since ownership or mortgage payments were uncontrolled, while rents were controlled under rent control laws. QUESTION 5: Might I try to capture some of the true value of the bread by tying its purchase at the controlled price to purchase of other goods not controlled? ANSWER: Certainly. A supermarket may offer (real) bread at 5 cents, provided you buy $20 or more in groceries or provided you buy a particular type and size of jelly (at an appropriate price), or a bakery may require the purchase of doughnuts as well. GENERALIZATION: Attempts will be made to tie purchases of price controlled goods to purchases of some non-price controlled good so that the owner to capture the value of the price controlled good. QUESTION 6: If you could change a price controlled market transaction to one that avoided direct money payment (and hence the controls) might you try it? ANSWER: Yes. There would be an increase in barter, e.g., butchers and bakers may trade beef for bread. There would also be an incentive for intensive bread users (who have trouble buying under price controls) to either buy a bakery (avoiding markets for bread) or become self-sufficient in bread production (the same is true for households, even though this would otherwise be less efficient). GENERALIZATION: People will try to avoid market transactions: barter, vertical integration, and self-sufficiency will expand. EXAMPLE: Johnny Rogers bought a San Diego service station under gas price controls to assure gas for himself and his friends. QUESTION 7: What would happen to the amount of bread available for purchase under a price ceiling? ANSWER: Unable to capture the value of the bread to consumers, the quantity of bread available will fall, as some bakeries and bakers go out of business and others shift into alternative baked goods. GENERALIZATION: A price ceiling reduces both the price received by the seller and the quantities of a good provided by suppliers. EXAMPLES: Deterioration of the South Bronx and the explosion of condo and office conversions under rent controls; gas stations closing or cutting their hours of operation under gas price controls; the capping of "old" natural gas wells under natural gas regulation. QUESTION 8: What would happen to the costs of finding bread under price controls? ANSWER: Because there is less bread available at the lower price (i.e., there is a shortage) and because the "market" price no longer provides accurate information about cost and availability of bread, the costs of search and acquiring information about bread availability will rise. GENERALIZATION: Since price controls mean that price no longer allocates the scarce goods in question, some other allocative device must be chosen. This eliminates the market's ability to transmit very low cost information about availability and prices, raising the costs of search and acquiring information. EXAMPLES: The difficulties of finding a rent-controlled apartment; AAA announcements of the % of stations open each weekend, and added search for an open station under gas price controls.
QUESTION 9: Will there be more or less discrimination against Pygmy Eskimos (a seemingly safe discriminated against group) under price controls? ANSWER: More. Without controls, if I refuse to sell to someone, it lowers my profits and so costs me something--discrimination is costly. Under controls, the cost of such discrimination is zero, as lots of more desirable (to the discriminator) groups are more than willing to buy as well at the controlled price. GENERALIZATION: Since price controls prevent prices from rationing scarce resources, some other way of discriminating among demanders must take its place. By lowering the cost of discriminating, price controls increase discrimination. EXAMPLES: Discrimination against families with kids or pets, lower income families (higher risk of payment), more people per unit (usually poorer, or disliked racial groups) under rent control; discrimination against smaller and riskier borrowers under usury laws; discrimination in favor of bigger customers and owned subsidiaries under steel price controls; The Apartment, starring Jack Lemmon; discrimination in favor of your own family members under rent control. QUESTION 10: As a price control was left on over time, what would happen to the severity of the shortages? ANSWER: Since over time, more and more bakeries will be due for replacement or renovation, but the profit incentive for production is weak, the quantity of bakeries and the availability of bread will both tend to decline progressively and the shortage will worsen. GENERALIZATION: Price controls reduce the financial incentives to supply a good reducing maintenance of existing supply sources and reducing incentives for new sources to enter, which leads to a progressive reduction over time in the quantity of a good available. EXAMPLES: Deterioration of the housing stock over time under rent controls; deterioration in the available supply of "old" natural gas under price controls; reduced farm output in Third World countries when price controls hold down crop prices. QUESTION 11: Who gains from price ceilings? ANSWER: Those who get to allocate those resources (in their own interests) when the market is prevented from doing so (usually some governmental body) and those who actually acquire the goods more cheaply than otherwise. GENERALIZATION: Price controls transfer power from market forces (individual preferences) into political forces, benefiting the political establishment and those best able to manipulate it. EXAMPLES: Schools in the Northeast which get preferential natural gas rates; rent control bodies; subsidized western consumption of electricity (from Hoover Dam) and water. (NOTE: This same approach can be repeated for a generic price floor as well, but space precludes doing so here.) Shortages and Public
Utilities John P. Cochran, Metropolitan State College of Denver A perceptive student may offer public utilities as examples where prices are controlled but shortages do not occur. Here is a counterexample: In growing cities, booming housing construction frequently confronts price controls on natural gas, water, and other utilities. Local utilities commonly try to adjust to the resulting shortages by restricting the number of "taps" (connections) for these services. Builders have at times countered by putting multiple single-family dwellings on common water or gas taps. Then local public officials have countered by restricting building permits. And so on. These adjustments have, on balance, restricted the growth of housing and caused the prices of existing housing to soar. Price Ceilings and
Opportunity Costs Carole E. Scott, West Georgia College Suppose the demand for bread increases, that is, at every price people want more bread. This means that more can be charged for every possible level of output. To help the poor and prevent bakers from enjoying so-called windfall profits, the government prohibits sellers from increasing the price of bread. Without the incentive of a higher price, bakers will not increase their output of bread. Thus, at the existing price people will wish to buy more bread than is available. As a result, people will show up at stores before they open in order to try and be one of those who gets some bread. Thus, long lines will form. There will be an added cost to buying bread: waiting in line. For some people the opportunity cost of standing in line will be higher than the price increase which would have occurred if the government had not prevented price hikes. Some people will incur the cost of standing in line but not get any bread. Clearly, the government has not prevented a rise in the cost of obtaining bread, but it has prevented more bread from being available to buyers. Ralph T. Byrns Elaborate on the adjustments that some people make in response to price controls. Examples of the ingenuity of people who want to finesse controls help students see the variety of adjustments people develop in response to diverse incentive structures. a. The gasoline shortage of 1974-75 caused many people to get up earlier in the morning in attempts to be at the front of the queue that formed at many service stations. A standard signal that a station was not pumping gas was for attendants to lay their hoses over the pumps. Many consumers persistently "topped-off" their tanks whenever possible, when otherwise they would have let their gas tanks drop close to "Empty" before filling up. (This is an example of how consumers build private inventories of products anticipated to be unavailable.) Some station owners tried to beat price controls by such subterfuge as giving a "free" tank of gasoline to customers who purchased a lucky rabbit's foot key chain---for $25-35. b. "Old" oil became "new" oil and "domestic" oil became imported oil when price controls varied for crude oil beginning in 1975. The price was severely restricted (to roughly $4.00 per barrel) for domestic oil pumped from wells discovered before the Arab oil embargo, but was permitted to be much higher (roughly $10 per barrel) for imported oil or domestic discovered during the energy crisis. Oil companies adjusted by drilling new wells next to old wells they shut down; miraculously, they discovered "new" oil. Along the Texas border, oil was exported to Mexico, and then "imported" at the higher price (a road was widened in Nuevo Laredo, Mexico, to allow oil tanker trucks to turn around and truck oil back into Laredo, Texas.) And on and on. The Justice Department was still filing charges as recently as 1982 against companies that tried to finesse these two-tiered controls. c. Point out that price supports in agriculture have not prevented farmers from experiencing severe financial problems, as indicated by widespread farm foreclosures during 1984-86. Suggest that price floors encourage some people to begin farming, borrowing funds or investing all their financial capital in the process. Many of these people err on the side of optimism, and so are "marginal" farmers who tend to be wiped out if things change slightly for the worse. The long term answer for farmers threatened by bankruptcy is not higher price supports, because higher price supports will merely encourage a new wave of marginal farmers to enter this market on a shoestring. You can make this point strongly by asking students if they think that the U.S. federal government could create a domestic banana industry by guaranteeing a price floor of $10 per pound of bananas. After suggesting that the industry would emerge in Florida or south Texas, appeal to their intuition to suggest that many of these banana growers would be "marginal", and threatened by bankruptcy from mildly bad weather or some other unforeseen problem. Micro Responses To Policies Mark Zupan, University of Rochester As a simple comparative statics example of how economists look at crime, tell students that Massachusetts has the highest auto theft rate in the country. Somerville, Cambridge, and Allston always rank in the top 10, as far as cities with high auto theft rates go. Ask students why this is so. Is it because people in Massachusetts are more evil? Why are the equilibrium points shown in Figure 4-7 for Massachusetts far to the right of other states?
Figure 4-7 ANSWER: In Massachusetts auto theft is only a misdemeanor and not a felony. Rumor has it that it was changed from a felony to a misdemeanor when the son of a prominent state legislator was caught joyriding several decades ago. Gary Galles, Pepperdine University When a social problem attracts public attention, whether it is littering, jaywalking or illegal drug dealing, the result is often a political program designed to solve the problem by cracking down on offenders. Unfortunately, however, hasty political solutions often fail to anticipate the results from the new incentive structures created, and may make the problem worse instead of better. Some simple examples to illustrate this might include the following:
1. A few years ago, jaywalking in downtown Los Angeles became a public issue and a crackdown using overtime police officers to monitor and fine jaywalkers was proposed. The safety considerations which prompted the crackdown would not be solved by this action, however. While jaywalking might be reduced somewhat, jaywalkers would now spend increased time looking for police and relatively less looking for cars, and any pursuit would involve police officers in risky jaywalking as well, thereby increasing the accident risk. Further, those officers could have provided other types of safety that the public might well have valued more highly.
2. Putting in crosswalk markings has long been considered a safety enhancement, yet some places are now sandblasting off those markings as a safety measure. It seems that pedestrians, by far the lowest cost accident avoiders, were being lulled by the markings into a false sense of security, not taking sufficient avoidance precautions, and accident rates were going up rather than down. 3. It was recently proposed in San Diego that litter penalties and enforcement be increased and a new litter court be established to lower the costs of litter in the area. It wasn't considered that there are two types of responses possible to such a crackdown: littering less or littering smarter. If people chose to litter smarter, they would litter when and where the odds of being caught were lower. This would be in more isolated, scenic areas, where there are fewer police as well as fewer residents. Increased litter in such areas may actually be more costly than decreased litter elsewhere, both because the aesthetics spoiled would be greater and the cost of cleanup would also be greater in such isolated areas. In addition, the alternative use of the enforcement resources would be foregone.
4. Cradle to grave toxic waste tracking laws, to begin at some known future date, actually increase toxic waste dumping in the interim.
5. Drug crackdowns, which raise the price and profitability of drugs that do change hands, may induce increasing numbers of entrants and attempts to distribute drugs. Those entrants may remain after the crackdown, and more drugs may be sold afterwards than if there had been no crackdown. You can extend this idea to consider differences between policies that shift supply, crackdown on sellers and those that shift demand, crackdown on users. Ben Collier, Northwest Missouri State University After covering the introductory topics of supply and demand and exchange I find it extremely useful to see if my students are able to apply these concepts to a nontraditional application. Namely, the possibility of selling babies. Not only is there certain shock effect value but it beautifully illustrates some basic points which we try to teach. Concepts such as 1) buying something doesn't mean that you can do anything you want to with it, 2) goods flow to those who value them the most, not the richest, 3) the gains from specialization. This can also lead into an interesting discussion regarding the "protection" offered to orphans through adoption agencies (making sure they receive "proper" parents) versus the lack of "protection" for children of natural parents. Although I generally win very few converts, the students and I find the discussion fun and long after they have forgotten definitions and facts they will remember this example. Ralph Byrns Many people are outraged by discussions in which human desires and actions are viewed unemotionally as the interplay of such forces as desires to have or desires to exchange. The right to be a parent – to raise a child, and to watch that child grow and develop – is a desire deeply imbedded in most of us. The analysis at this Economics of Adoption link examines adoption of children as an economic good. My intent is to show that the cold light of economic reasoning may lead to more humane policies than those based on psychological “gut instincts” or moralistic preachings. You may use this material as a hand-out for your class if you think it worthy. |
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