PRICE DETERMINATION IN A MARKET ECONOMY:

Transcription

1 DETERMINATION IN A MARKET ECONOMY: Quantity THE INTERACTION OF SUPPLY AND DEMAND AND MARKET INTERFERENCES 1

2 CETARIS PARIBUS "ONE STEP AT A TIME" One of the most useful terms in all of economics is indeed "Cetaris Paribus". The translation of this Latin phrase literally means "all else remaining equal". This concept is very useful in all sciences, not just economics, and the reason is very simple. Consider the bio-medical researcher who is conducting clinical experiments to study the effects of a new drug to treat a health problem. They do experiments in small steps, changing only ONE variable at a time to test the results. For example, they may give the patients a specific dose of the drug, and chart the results. Later, they may raise or lower the dose, then check the results. Some patients are only given a placebo, or fake pill, and the results are charted. The point of all of this is to see how changing only one variable affects the patient. If they would give the same patient different doses of the drug and a placebo all at the same time it would be almost impossible to see what is actually happening, and the effectiveness of the drug could never be charted. In your chemistry class you must consider several different variables when doing labs and mixing chemicals. The amount of each chemical being used, the temperature, and the volume of the container are all important to the experiment. By changing only ONE variable at a time you are able to see the results of the change. In economics the concept of Cetaris Paribus is very important because we need to see how one change in the economy affects prices in a particular market as well as other elements of the economy. Consider the following example to make it a little clearer: Suppose that you are studying the world market for gasoline, and you noticed that there was a large increase in the price of gasoline during the summer of If you wanted to get to the bottom of this you would have to isolate some different events in the economy individually, then look at their cumulative effects. There are four main variables that you have to look at to explain this increase in the price of gasoline, by applying them to the market ONE AT A TIME you should be able to see why gasoline prices rose so much in such a short period of time. 1. Due to tension in the Middle East, people were worried that oil shipments would be interrupted, and the price of oil was being bid up due to feared future scarcity. (Supply) 2. America has not built a new oil refinery in over 10 years, and our ability to refine oil into gasoline was stretched to the limit. (Supply) 3. People begin to drive much more in the summer months, beginning with the Memorial Day holiday, and many more people are driving poor fuel economy SUV's. (Demand) 4. The world economy, particularly China, was getting stronger and world demand for oil was driving up the price of oil on the world market. (Demand) When we apply each of these variables one at a time we can see that it was inevitable that the price of gasoline would rise dramatically. Each variable, be they supply or demand forces, was pushing price in the same direction. This example is simple, but it would be more difficult if some forces were pushing in different directions. Let us assume that the world economy, instead of growing was in a recession. This would have the opposite effect on oil and gasoline prices, but would it be enough to outweigh the other forces pushing prices upward? The only way to tell would be to apply it to the market and see what happened. So you see, applying variables one at a time is indeed very important, especially when forces are working in the opposite directions on a given market. In the next few readings on supply and demand you will see that it is critical to use the concept of Cetaris Paribus to understand the interaction of supply and demand. You must isolate one change in the economy at a time, trace its effects, then apply other variables and trace their effects. Keep this concept in mind throughout the year, but especially during this unit, it will pay rich dividends to those who truly understand it. 2

3 DEMAND, S, AND MARKETS It s all supply and demand said the cashier to the young lady, and with that the young girl was off to explain why he spent $52 of her fathers hard earned money on a pair of green pants from Abercrombie & Fitch. Supply and demand she thought; at least if I have a real reason, especially one that an economist thought of, my dad shouldn t get too mad at my relentless pursuit of finding ways to waste his money. I m sure that many students have echoed these very words in defense of squandering their parents money, but in the case above, it is a justifiable reason to explain a high price paid for a good. While most people have heard the term before, supply and demand is actually a much more complex system than the vast majority of society realizes. As we have already studied, scarcity is the most fundamental problem in economics. Supply and demand is nothing more than a tool that we use to study this basic problem. It allows us to see three things: A. How will we produce to meet our wants and needs? B. What will we produce to meet our wants and needs? C. Who will get what is produced? In our market system we use prices to answer all of these questions. Prices allow us to produce goods for the least amount of money, to decide what people want, and to give different people the different things that they want or need. Prices allow us to measure the opportunity cost of economic decisions, and in this sense they help us to use societies scarce resources where they are needed the most. Prices, what exactly are they, and how are they set in a market oriented economy like ours? Most people think that prices are set almost entirely by the manufacturer or retailer of the goods that we buy. In some cases this is true, but there is certainly a lot more to it than this. Before a company can set a price for something the usually do a considerable amount of research into the market that they are about to enter. Most of this research is centered on the consumer and their willingness to spend money on a product. What you have just read should help you to realize that as the old saying goes It takes two to tango. In other words it is not only the supplier that sets prices, the consumer has a considerable input into this process too, even though they might not think so. It is this idea that forms the basis for supply and demand. In our economy the consumer forms the demand side of the market. The producers, be they large or small, form the supply side of the market. As you should have noticed in the wheat market game, there is a very important difference between the supplier and the demander in the economy. The demander wants the goods for the LEAST amount of money; this is because they want to MAXIMIZE utility for the least cost. The supplier, on the other hand, wants to sell for the highest price. This is true because they MAXIMIZE their utility by making as much profit as possible. It is this interaction between the buyer and seller that sets prices in the economy. If something is too expensive and does not sell, the supplier is forced to lower the price until the goods are sold. If something is too cheap people will flock to buy it and raise the price, as the good becomes scarcer. This is what keeps the market continually moving, and why prices are always changing. Now let us look more closely at each of the players in the economy. DEMAND AND QUANTITY DEMANDED: Demand is nothing more than a SET OF CONDITIONS that explain why we do or do not want to buy a product or service. At times things are in high demand, at other times they are very low in demand. But, even if something has high demand, one thing is always true. The more of something we buy, the less we are willing to pay for each additional unit of the same good. Consider this example: If you go to the mall and buy a red shirt for $20 dollars, would you be willing to buy another of the exact same shirt for the same amount of money? Probably not, but why? The reason is that the second shirt will not give you the same amount of utility as the first because it is exactly the same product. This is the first economic LAW of the reading. THE LAW OF DIMINISHING MARGINAL UTILITY: This law simply states that as we buy more of the same good, we get less utility from each extra unit. How many times do you want to wear the same shirt, and would you even buy more than one of them anyway? This law is very important because it explains why we buy less of something as the price of the good or service rises. You must ALWAYS REMEMBER that the relationship between and the QUANTITY of a good on the demand side of the economy is INVERSE! This means that as price drops we buy more, and as it rises we buy less. It is this fact that forces companies to think very hard before they price a good on the market, and also why we often see 2 for 1 sales in your favorite stores. THE LAW OF DEMAND: Derived from the Law of Diminishing Utility, the Law of Demand states that we will only demand a greater quantity of a good if the price that we pay for the good is lower. This makes perfect sense, for less utility gained means that we will spend correspondingly less to get the utility. Think of a donut lover who is eating the first donut versus the 10 th. He or she would certainly not pay as much of the 10 th as the first because they will be sicker and sicker after each donut! 3

4 As you should have implied from what you have just read, price is very important in determining how much of something we do or do not buy. But, you must understand that price only affects the QUANTITY DEMANDED of a good, and price DOES NOT change any of the UNDERLYING REASONS that we buy goods or services. Think back to cost benefit analysis, when the price of a good is changes, it only affects the cost, not the benefits. If the price of CD s increases, you might buy a lesser quantity, but you still enjoy music the same. Your love of music is the UNDERLYING REASON for buying music! Remember this rule: RULE: Changes in price ONLY affect the quantity of a good demanded, not actual demand for a good. Now let us learn a little about DEMAND for a product, and the reasons that we buy or do not buy products. Demand for a good, as previously mentioned, is nothing more than a set of conditions that relates to a product that we wish to buy. It is very important that you realize that the factors that affect demand are ALWAYS CHANGING. Specific conditions only exist for a short while, and are replaced by different conditions. A simple example of this is right after you have just eaten a big lunch. Before lunch you had a set of ideas in your head of what you wanted to eat, and these conditions told you how much to spend and what to eat. After lunch, you have an entirely different set of conditions now that your appetite has been satisfied. Of the millions of things that affect DEMAND for a good, most can be classified into one of the following categories: 1. CHANGE IN INCOME: As consumers incomes rise, they are willing to buy more of a good at ANY given price level. The opposite is also true, as incomes fall, people are willing to buy less of all goods at any given price. 2. CHANGE IN POPULATION: As the population rises, people will buy more of a good at ANY given price. This is true because there are simply more people to buy things. 3. EXPECTATIONS: Depending on what people EXPECT to happen, they may pay either MORE or LESS for a good. If you expect gasoline to go up in price next week, you may fill up the tank today to avoid higher prices later. The opposite is also true. 4. PREFERENCES: As consumers preferences for a good increase, they will buy more of the good at any given price level. This is true because the good now provides more UTILITY than before, and thus a higher price will be paid. This is the goal of advertising. Did you ever see a product such as Pepsi, when they give the can a new look, the product has not changed, but the consumer now likes the look more, and should buy more of the good. 5. SUBSTITUTES: There are many goods that we can substitute for one another, and the relationship between these goods has a very important effect on demand. Coca-Cola and Pepsi are a good example here. If the price of Coke rises, people should buy more Pepsi at a given price. This is true because the substitute (Coke) is now more expensive, and we want more Pepsi at its original price. 6. COMPLIMENTARY GOODS: There are many goods that we commonly use together with another good, and this relationship is very important. Coffee and sugar are good examples of this. If the price of SUGAR rises, we will DEMAND less coffee at any price. This is true because it is now more expensive to drink coffee the way that we want it. Remember that nothing happened directly to the coffee market, but the change took place because of something that happened in the sugar market! Each of the examples that you have just seen are called the DETERMINANTS OF DEMAND. This means that they have the power to actually change the entire conditions under which we demand goods and services. On a supply and demand graph this means that we must change the ENTIRE DEMAND CURVE to show the effects of changes in one or more of these determinants. Numbers 1,2,3and 4 are straight foreword, a change in any of these will change demand for a good DIRECTLY! Numbers 5 and 6, substitutes and compliments, are more INDIRECT. This means that we must look at a change in one market and see how it affects a RELATED MARKET. A related market is simply a market for one good that is in some way related to another market. EXIT QUESTIONS: 1. Why are prices set by both producer and consumer in a market economy? 2. What is the difference between DEMAND and QUANTITY DEMANDED? 3. What is the Law of Diminishing Marginal Utility, and what relationship does it illustrate between price and quantity demanded? Do you think that this relationship is always true? 4. Why is the demand for a good continuously changing? 5. Give a SPECIFIC example of how changing expectations could change the demand for a good. 6. What determinant of demand does advertising target, provide a SPECIFIC example for this one. 7. Provide THREE SPECIFIC examples of substitute goods in the economy. What is the relationship between a change in the price of a substitute and demand for the original good? 8. Provide THREE SPECIFIC examples of complimentary goods in the economy. What is the relationship between a change in the price of a complimentary good and demand for the original good? 4

5 THE GRAPHICS OF DEMAND Now that you have read and understood the theory behind the demand side of the market, let us not turn to the graphical models to show the relationships on the demand side of the market. Pay particular attention to the following items when studying the following graphs: 1. The axes on the graphs and what is measured on them. INTERNALIZE this information, never forget it, and your confusion will certainly be limited! 2. The general slope of the demand curve and the reason for it. 3. The difference between MOVEMENT along a given demand curve and a SHIFT in the entire demand curve. YOUR BASIC DEMAND SCHEDULE AND DERIVING THE DEMAND CURVE: The demand schedule is nothing more than a Price and Quantity combination that tells how much people in a market will pay for different quantities of a good. Plotting these Price and Quantity combinations on a graph and connecting the points creates a basic demand curve. QUANTITY DEMANDED (COOKIES) $ DEMAND SCHEDULE DEMAND CURVE QTY. COOKIES THINGS OF NOTE ON THE DEMAND CURVE DIAGRAM: 1. The relationship between and QUANTITY. People will only buy more of a good in a given market if the price of the good decreases. (Law of Demand) 2. The DOWNWARD SLOPE of the demand curve. It will always look this way due to the laws of diminishing marginal utility and demand. 3. That this is a general relationship for the entire market, not just for one person. What you are seeing here is a basic representation of the behavior of all people who are in a market, individuals within the market may have a personal demand curve that looks very different than the one shown above. 5

6 FROM CHANGES IN AND QUANTITY TO CHANGES IN DEMAND: As you have seen in the demand reading, if there is a change in only the of a good, there will be movement ALONG the given demand curve. Refer to the diagram above, what will happen if market price goes from.60 to $1.00? There will be a lesser quantity demanded, thus movement along the same demand curve. This occurs when there is NO CHANGE in the UNDERLYING CONDITIONS within the market. If there is a change in the overall market for cookies for some reason, we would have to change the position of the entire demand curve. In the following diagram you will see what happens if there is a change in DEMAND. We will use the same market for cookies to start with. THINGS TO LOOK FOR: 1. Notice the TWO different demand schedules, one for the old set of conditions and one for the new. 2. Note the change in the entire demand curve, it has SHIFTED, thus representing a new set of conditions. 3. Note the reason that is has shifted, a new demand schedule. ***ASSUME, FOR THE FOLLOWING EXAMPLE, THAT A STUDENT FOUND TWO DEAD FLIES IN A COOKIE PURCHASED IN THE CAFETERIA AND THAT THIS INFORMATION SPREAD TO OTHERS THROUGHOUT THE DAY. QTY. DEMANDED (OLD) QTY DEMANDED (NEW) DEMAND CURVE DEMAND CURVE QTY. DEMANDED WHAT DID WE FIND?: Once the students found out that the cookies may contain things that they do not want to eat, DEMAND for cookies in the cafeteria fell. This is indicated by the new demand schedule from above. Students will buy less cookies at any given price, for example if they were $1.00 each, they would buy none. Compare this to the original demand schedule, they would have bought 1 cookie at this price, but since conditions have changes, they will buy none. ON THE GRAPH: 1. Notice how the entire demand curve SHIFTED inward to represent the changing conditions, this is from the new demand schedule. 2. Notice how the fact that the students will buy fewer cookies at any given price is shown here with a visual line. 3. Note that this was ONE change CETARIS PARIBUS, and does not factor in any other changes. ***Note that this would mean that the price of the cookies would have to be LOWERED to sell them, this is due to a decrease in demand. 6

7 THE BASICS OF SUPPLY: MAIN DETERMINANTS Just as demand changes the prices of goods and services in the economy, the supply of a good has very powerful effects on prices and availability of all of the things that we use to meet our wants and needs. You are much more familiar with the demand side of the economy, so now it is time to give many of you your first taste of supply analysis. There are some basics that we need to consider before we can see the effects of supply changes on prices and quantities of goods in the marketplace. First, you must be aware of the fundamental difference between SUPPLY and QUANTITY SUPPLIED in a given market. QUANTITY SUPPLIED is simply the amount of a good that will be supplied to the market at various price levels under a given set of conditions. In the oil market, producers will supply different amounts of oil at different prices. In this way the market allow just the right amount of its scarce resources to be used on oil production. If it were not for price, markets would never know how much of a good to produce and we would end with either too much or too little of a good. There is another law that we must introduce at this time. It is similar to the Law of Diminishing Marginal Utility, but it affects the supply side of the market, not demand. THE LAW OF INCREASING COSTS: This economic law states that extra output of a good can only occur at higher prices because inputs needed are becoming more scarce or that output is occurring at lower levels of efficiency, Cetaris Paribus. Thus, the relationship here is direct. If the price of the good rises, suppliers will supply a greater quantity of a good. The logic behind this law is relatively simple because it is directly related to scarcity. As more of societies scarce resources (L,L,C) are devoted to increased production, the price of these inputs rises. The only way that a producer can increase the Qty. Supplied is to pass the increase in input prices on to the consumer. Consider a small company with a fixed size factory that has a maximum level of output. If the company wants to produce more it must pay workers overtime and buy more inputs. In a limited size factory, more workers or more tired workers mean crowding or more inefficiency. Thus, as you can see, the price of the good being created must also rise. THE LAW OF SUPPLY: Easily traceable to the law of increasing costs, the Law of Supply states that as the overall supply of a good increases, the price of the good must rise to compensate for the increased cost of producing the good. Now that we know a little more about the quantity supplied under a given set of conditions, let us look more closely at supply itself. SUPPLY itself is nothing more than the set of conditions that form the foundation for production of a good. Economists are interested in studying these conditions to see what happens if they change. Just like demand, Cetaris Paribus rules apply to supply. What we want to do is simply change one or two of the conditions in the market and see what happens to QUANTITY and in the given market. REMEMBER, changing a DETERMINANT of SUPPLY changes the ENTIRE market and producers will supply more or less of a good AT ANY GIVEN! The following is a list of the DETERMINANTS OF SUPPLY, and a brief description of each. A. THE NUMBER OF FIRMS IN THE MARKET: As the number of firms increases so too does supply in the entire market, the reverse is also true. If SUPPLY increases, the market price of the good or service will DECREASE, the reverse is also true. Consider the market for personal computers. Apple and IBM used to control the entire market; now that there are many companies that make these computers the price has fallen dramatically. B. THE OF INPUT GOODS: Inputs are used to make all goods and services. If the price of one or more of these inputs rise, the SUPPLY of the good will decrease, the inverse is also true. As supply decreases so too does price, the reverse is also true. The logic here is simple. If the price of oil rises, gasoline companies will supply less gasoline at ANY GIVEN, this is because the price of oil has increased and it is more expensive to produce each gallon of gasoline, so companies cut back production to compensate for the higher input price. 7

8 C. TECHNOLOGY: As technology advances production becomes more efficient and scarce inputs create more output than before. Thus, as technology increases, companies increase SUPPLY at any given price. By doing so they decrease prices and compete with other companies better thus increasing sales. A simple example is using robotics in car production. This decreases labor costs, and increases supply in the market. When this happens we see more cars in the market and lower prices for these cars. D. BUSINESS ENVIRONMENT: This is a broad category that includes many government regulations and taxes that businesses are charged or have to comply with. If cleaning up the environment is a main goal of the government, companies must clean up their act. This increases the cost of each good produced. Thus, companies cut back supply because the current market price is not high enough to cover all of the costs to the company. E. S OF RELATED OUTPUTS: Related outputs are nothing more than two or more goods that use the same inputs in production. Take milk for example. You can make cheese, milk to drink, yogurt, or any other number of items. If the price of one of these goods rises, more of the input will be used to create the item whose price has risen. This means that the supply of the other goods MUST DECREASE. If demand for yogurt drives up it s price, dairy companies will use more milk for yogurt and less for cheese. Thus, the SUPPLY of cheese will decrease and its price will rise to. You will notice in this example that it is something in a related market that caused the change, not something in the cheese market, but rather, something in the yogurt market. Now that we have seen the determinants of supply, let us review the concepts that we have seen so far. only changes the Quantity Supplied not the conditions under which SUPPLY is based. Secondly, a change in any of the DETERMINANTS of supply will cause the entire supply of a good to change. This will cause the and QUANTITY in the market to change due to something related to supply, and not in demand. Remember this: A. An INCREASE in supply will cause the quantity in the market to increase, and the price of the good to DECREASE. B. A DECREASE in supply will cause the quantity in the market to decrease, and the price of the good to INCREASE. Just like demanders in the economy, suppliers are always faced with continuous changes in the conditions in the market. They react in a predictable way to these changes in conditions, and always follow the rules that we have outlined above. When suppliers react to these changes, they change the prices in the market that is being studied, and these price changes send important signals to tell the market what we should and should not produce. Remember that ugly shirt that has been on the sale rack for the last two months? Chances are that the shirt will no longer be produced unless there is a considerable change in the tastes of the consumer. You can also be sure that when the price of computer chips decreases, the number of PC s on the market will increase. This is due to the fact that suppliers must always react in a way that is most favorable to the profits and sales of the business. Just like you they want to maximize the amount of output that they can produce with each input. EXIT QUESTIONS: 1. What is the Law of Increasing Costs, and what effect does it have on supply in a given market. 2. Re-read each of the determinants of supply. Create a specific example for each for EACH of these determinants and explain the effect of the change that you have created on and QUANTITY in the given market. 8

9 THE GRAPHICS OF SUPPLY Now that you have studied the theory behind the supply side of the market and the elements of supply, let us turn to the graphical side of supply. The general ideas behind the supply curve are the same as on the demand side, the difference comes in the slope of the supply curve and the reasons for the change in slope. Below you will find a supply schedule for cookies in the cafeteria and a graph that depicts this relationship. QUANTITY SUPPLIED SUPPLY CURVE SUPPLY SCHEDULE QTY. SUPPLIED THINGS TO NOTE WITH THE SUPPLY CURVE: 1. The relationship between Quantity Supplied and Price. This is due to the Laws of Increasing Costs and Supply. Firms will ONLY supply a greater quantity of a good if the price being offered for the good increases. This is just the opposite of Demand. 2. The slope of the Supply Curve. It is always going to be upward sloping to some degree or another due to the Price/Qty. Supplied relationship indicated in number one. This is very important because when we put supply and demand together, you can see why prices rise when demand for a good rises. 3. Note that this is the overall supply for a given market and not just for one single firm in the market. This graph represents the sum of all firms, an individual firms supply curve may look very different than that of the market overall. 9

10 FROM CHANGES IN QUANTITY SUPPLIED TO CHANGES IN SUPPLY: As you have seen in the supply reading and the schedule/graph above, changes in the market price of a good will cause firms to supply either a greater of lesser QUANTITY of a good. Now we will look at the implications of a change in the underlying conditions of supply which will cause the entire supply curve to SHIFT either outward or inward. As with demand you must keep the idea of Cetaris Paribus in mind and make only one change at a time to see the results of the change. Things to look for on this graph: 1. Note the two different supply schedules, one for the old conditions and one for the new. 2. Note that the entire curve has SHIFTED to represent the new conditions. 3. Note the reason that it has shifted. ***KEEPING WITH OUR COOKIE THEME, ASSUME THAT THE CAFETERIA HAS PURCHASED A NEW COOKIE OVEN THAT CAN MAKE COOKIES TWICE AS FAST AS THE OLD ONE. YOU WILL SEE THE RESULTS ON THE SUPPLY SCHEDULE BELOW. QTY. SUPPLIED (OLD) QTY. SUPPLIED (NEW) SUPPLY CURVE 2 SUPPLY CURVE QTY. SUPPLIED THINGS TO NOTE: 1. The entire supply curve shifted OUTWARD due to the change in technology in the cafeteria. 2. That the firm will now supply more output at ANY given price due to the fact that it is cheaper to create each additional unit of output. 3. In the end this will lower overall prices in the market because the supply of the good has increased. This is what is meant when people say that increasing supply lowers prices. 10

11 EQUILIBRIUM: WHEN SUPPLY AND DEMAND MEET AND FALL IN LOVE (FOR NOW!) If someone says that their equilibrium is off due to an inner ear infection the signs are readily visible, trouble keeping balance and seeing straight. After the problem corrects itself, everything is back to normal. EQUILIBRIUM is a condition where there are no changes in outside forces to push something in one direction or another, simply put, it is a state of natural balance. With supply and demand, equilibrium is a state where there are no other outside forces acting to push either supply or demand in another direction, thus prices will settle at a certain level UNTIL some force acts to change it. These forces have already been outlined in the S/D readings as their determinants so you should be intimately familiar with them. (No need to review RIGHT!) Below you will see our original supply and demand schedules in the cafeteria cookie market as well as a graph that illustrates where equilibrium will occur in the market. Pay attention to the following items to better understand this concept: 1. At what price on the supply and demand schedules are quantity EQUAL to one another? 2. Where to the two curves intersect? QTY. DEMANDED QTY SUPPLIED EQUILIBRIUM SUPPLY CURVE DEMAND CURVE QUANTITY THINGS TO NOTE: 1. Equilibrium occurs under this set of conditions at.60 and at 3 cookies both supplied and demanded. This is where the market price would settle until some outside force pushes it to a different level. 2. If the cafeteria would try to set a price higher than this level there would be cookies that were not sold (surplus) 3. If the cafeteria would try to set a price lower than this there would not be enough cookies (shortage) 4. If we apply either of the changes in the market that we used for the supply and demand examples we would see one curve or the other shift either inward or outward. This would set a new price and a new level of equilibrium. Try this with either example that we used earlier and see what happens. Just plot out the other combinations, one at a time, on this graph and find the new point of intersection. 11

12 CEILINGS AND FLOORS: INTERFERENCES IN THE MARKETPLACE As we have seen so far, the market economy does a very good job of associating our level of utility with the costs of producers, and is continually setting and re-setting prices in the economy. All of this activity takes place because of the millions of combined decisions of consumers and producers in the economy, and serves as a stark reminder that our economy is always in motion, and is always striving to allocate resources to the areas that place the highest value on them. While the market system does a good job at this task, there are times when some goods are perceived to be too expensive, or when producers of certain goods need help just to stay in business. It is times like these that we look to the government for help, and ask for some intervention on the part of the government to solve the problem. The minimum wage is a good example. It guarantees a certain wage to workers for each hour of labor that they provide. Another example occurs in some of America s largest cities, when citizens complain of rent being too high, and the government puts a ceiling on rent so that people can afford to live in a particular area. While both of these ideas, particularly the minimum wage, may seem like good ones; they are indeed interfering with very powerful forces. They act as limits that control some of the most basic aspects of human nature, and in doing so, they can cause unintended consequences and impose unintended costs on the very people that they seek to help. Let us now look at the two major tools that the government uses to try to cure some of the market systems ails. A. CEILINGS: These are nothing more than maximum prices that the government sets for certain products that society perceives as being too high. The government sets the maximum prices that people are allowed to charge for something, and makes it illegal to charge more for these goods and services. EXAMPLE: In New York City the local government has set a ceiling on the amount of money that a landlord can charge for square feet of apartment space in certain areas of the city. The intent is to give the people affordable housing, but it ignores some of the basic laws of supply and demand in doing so. Thus, it can create some unintended consequences. B. FLOORS: These are just the opposite of price ceilings, and this is when the government sets prices on something that must be accepted as an absolute minimum. The intent is usually to help out a particular group of people who are having trouble in a particular industry or area of the economy. EXAMPLE: The minimum wage is the example that you are most familiar with. The intent is to guarantee people a minimum level of income for hours worked so that they will be able to survive. High school students love the minimum wage, yet it does have important consequences in job markets that the writers of such laws often do not consider, or at least feel that the benefits of such laws will outweigh the costs. OUTCOMES OF CEILINGS AND FLOORS: As mentioned above, government interference in markets often cause unintended consequences due to their interference with the basic principles of supply and demand. Let us look at these outcomes with a little supply and demand analysis. EFFECTS OF A CEILING: P A. Increases the quantity demanded B. Decreases the quantity supplied C. Black markets and waiting lists often develop in the market Q EFFECTS OF A FLOOR: P A. Decreases the quantity demanded B. Increases the quantity supplied C. Leads to overproduction and oversupply of a good in a market 12 Q